What is a Goodwill Contract Service?
Goodwill contract services (GCS) are an innovative way to finance a business acquisition by using the business’s future income. They are frequently used when the buyer and seller have a pre-existing personal relationship and are interested in structuring the sale of a business without cash up front. A GCS can facilitate acquisitions where neither party wants to go through a traditional lending process or where traditional financing is unavailable.
In a GCS, the Purchaser agrees to make payments to the Seller or a business entity controlled by the Seller according to contract provisions that mirror the income of the business being purchased. Payments are typically made on a quarterly or monthly basis, and usually for a period of between three and ten years. The payments reflect income from the business, so variations in the payments occur as the business’s income increases or decreases. The parties negotiate the amount of the installments and the method for determining the payment amounts. Typically , the business’s net profits or gross revenues for the prior period are multiplied by a factor of the parties’ choosing to determine the quarterly payment. The parties also negotiate whether the payments will be interest-free. Financing that draws payments from future income helps Purchaser bridge the gap between the purchase price and the amount of available capital.
Purchasers benefit from GCS because they are able to invest less money in the business up front, thereby minimizing their risk. Also, Purchaser is able to defer tax payments for the business by spreading out the debt satisfaction period over several years.
Sellers benefit from GCS because they are able to maintain their normal income levels while investing in a niche business. Also, Sellers have some measure of control over the business’s financial future, because if the business does not produce as much revenue during the payment period, Seller receives corresponding payment amounts.
The Anatomy of a Goodwill Contract
Every contract is a unique agreement between parties. That said, there are certain elements that make up a typical goodwill contract. The first of those is identifying the specific considerations included in the transaction’s terms and conditions; this may be a lump sum and/or a contingent consideration. The specific performance and payment dates should also be included within the terms of agreement.
Another component of goodwill contracts is an explanation of the method for allocating the purchase price among the tangible assets. This is typically done by assessing which asset contributed most to the creation of goodwill for the buyer. In most cases, the buyer will identify the items or assets it is acquiring and then the seller will pay apportioned values to each item. This requires the development of a valuation (or appraisal) report.
Often, an agreement may include an option to sell and repurchase. A right of first refusal is also a common component.
Finally, some contracts will explicitly state the value of intangible assets that are part of the goodwill agreement. This may include items such as non-compete agreements, consulting contracts, and employment agreements.
Perks of Goodwill Contract Services
Christensen and Jensen outline several benefits to businesses through goodwill contract services. Goodwill contracts promote clarity in goals. When parties enter into an agreement, everyone matters their performance to their relationship with the other party. Parties to a contract have incentives to ensure that the activities and outcomes are in accord. Having clarity in goals allows parties to measure their success against mutually held expectations.
Goodwill contracts foster better performance and outcomes. Parties strive to deliver goods and services exceeding the level required under a contract. Parties that view their relationship as goodwill tend to operate under higher standards because value is added by better service.
Goodwill incentivizes parties to display loyalty. Sometimes parties feel free to violate an agreement because there are no enforceable requirements. A party that feels secure in the relationship may be more likely to take action that further cement the relationship. This may include sharing information or extending financial assistance.
Goodwill contracts enhance business value. Investors prefer to do business with companies that have well established relationships with its service providers and contractors. Parties that are willing to extend credit tend to prefer companies that have been in business for an extended period of time and which have developed relationships with other businesses.
Common Issues Faced with Goodwill Contracts
One of the pervasive problems with goodwill contracts between partners and spouses is described by the oft-quoted but seldom understood principle that "what’s mine is mine and what’s yours is negotiable." Somewhere in the middle of the last century, fairness overtook traditional norms as the basis for negotiation, to the point where arguments became highly predictable. Stripped down, the basic premises are that the controlling party gets what it wants, and the other party gets a pittance for his or her contribution. When several states adopted community property laws sometime after the turn of the 20th Century, it moved the argument away from strictly partitioning marital assets between husband and wife to what is often called current value plus or minus. Simply stated, the presumption or the argument is that the interests that are due to the community at dissolution include the fair market value of all assets plus or minus liabilities. If one spouse or former partner owns a commercial building worth a million dollars which has a mortgage of $900,000, the partner who once owned the property is required to pay the other $100,000 as part of an equitable distribution or settlement of their interests. In other words, the former partner owes to the other half of the equity, or $50,000, and then pays another half of the mortgage debt, or $50,000. But where this really becomes problematic is in family businesses or professional practices. In almost all states, including California, there are provisions for "goodwill contracts . " In abject abuse, many asset owners simply ask their law firm or accountant to find a way to value their interest at something ridiculous, like a multiplier of 48 times 5% of earnings, or some other ill-conceived formula which fails to take into account the fact that "goodwill" is mostly ephemeral, not truly contractual or quantifiable. Which is why the good people at the IRS have seen fit to assign each spouse a percentage of ownership for partnership or sole proprietorship tax purposes equal to his or her share of the total value of the business from the date they begin working in the business until the date the business ends or is sold, whichever comes first. Goodwill contracts between spouses or between business partners who are participating in the business are usually a division of revenues minus expenses, divided on a pro rata basis. The more the business grows, the more the shareholders benefit, but the shareholder who is not active can derive a lesser benefit, with the difference being the shareholder-employee’s compensation. So when our tax and legal staffs are asked how goodwill contracts should be handled, we say they have to be clear and unambiguous in every way. This means that they must contain language that attempts to address every possible eventuality, in writing that is not designed to muddy the purity of the contract’s purpose. They should not be a three page form that incorporates IRS definitions without clear reference to the particular issues faced by the spouses, the partners, or the business in question. The business or the property is worth much more if the contract succeeds in its purpose. If the contract fails, the business loses some of its value, as does the relationship of the parties who are involved in the joint endeavor.
Legalities Involved in Goodwill Contracts
The legal considerations in a goodwill contract are at least as important as the commercial ones. If the contract is not legally valid or enforceable, the commercial context is of limited assistance in enforcing it. You do have to consider both the commercial and the legal context.
Essentially, you want to include:
· The parties.
· Details of the services; the scope of the services can be calculated later, so long as the calculation process is part of the contract.
· How many hours a week the contract requires, and for how long the contract will continue.
· Practicalities (i.e. location) and how the contract will be ticked off each week.
· How you will invoice.
· The schedule within which payment must be made.
· Any trigger events which cause the contract to end; these can include:
· You also need to set out the tax arrangements, i.e. whether the contract will give rise to a tax liability for either party.
· Some goodwill contracts specify that you must be self-employed and not an employee.
· If there are IP (intellectual property) issues, you have to include obligations in relation to them.
· Any other terms and conditions which are standard that everyone needs to agree to.
· Most contracts have a duty of good faith. A non-compete clause is also not uncommon.
· How the contract will be terminated.
Goodwill Contract Management Best Practices
When it comes to managing goodwill contract services, employers should not take a wait-and-see approach. Whether you are a corporate client or a staffing firm or temporary placement service, you need to know how this seeming "miscellaneous" portion of any given employee’s duties is being performed. Absent understanding and knowledge about the performance of those duties, you could be setting yourself up for an OFCCP audit liability.
The best practices for all employers when it comes to the management of goodwill contract services are to proactively evaluate and monitor and regularly review workplace conditions at all locations, including those considered "non-AAP" sites because they do not house the corporate headquarters or because they have fewer than 50 employees.
Vigilant monitoring also requires staying in close touch with facilities and maintaining an open line of communication with local managers regarding their contract suppliers (temps and goods and services vendors). For example, if there are concerns about the employment practices of a contract supplier or some other adverse condition at one or more of the contract facilities, you should be sure to communicate those concerns both up and down your organization. If you receive regular reports on AAP/EEO compliance from the contract suppliers, be sure to be sure to look for warning signs as well.
While your contract suppliers are often expected to self-monitor, that does not mean you are off the hook . While at a minimum you must review and approve their self-audits, you should also conduct your own on-site visits of your contract suppliers at least once annually to ensure that you are receiving the same information from all your suppliers and that your contract suppliers continue to provide equal opportunity workplaces.
In addition to the monitoring efforts outlined above, the best practice is to conduct a thorough review of all of your contractors who provide goodwill contract services at least annually. This should include a complete review of the places where your employees work, visit, and conduct business.
The review should include all of your contract suppliers and third-party administrators of benefit plans as well as onsite reviews of employers and contractor facilities. It is critical to review the information provided by contractors and suppliers who have attempted to evade the rules, e.g., by "running new contracts" to avoid AAP coverage, as well as conduct periodic audits to ensure that no misstatements or errors have been made.
Finally, employers should take a broad view of the contracts and contract amendments with respect to goodwill contract services. Best practice recommends making the best effort possible to ascertain whether your contracts even refer to AAP obligations for your contract suppliers. If they do not include those express AAP provisions, best practice is to amend the contract to do so. And, obviously, employers should ensure that their contracts for those services and goods are keeping pace both with what the law requires and any changes in technological or other developments abroad.