The Effect of Sales Terms on Goodwill, Risk and Return in Transfers of Closely Held Accounting Practices

Abstract

Most sale proceeds from accounting practice transfers are allocable to goodwill despite the fact that neither sellers nor buyers generate significant profit from ordinary operations. Widely held valuation models hold that goodwill value is driven exclusively by profit and that accounting practice investors ought to demand returns higher than those realized by publicly traded equity investors. The existence of transferable goodwill without operating profit thus seems anomalous. This paper demonstrates that risk reducing sales terms explain these anomalies. As these sales terms are not necessarily unique to accounting practice transfers, the implications for valuation theory are quite significant.