Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

One of the assets specifically identified in the sales instrument was the purchase of goodwill,
namely "all of seller’s goodwill, all of seller’s existing telephone numbers, all costs and sales
records and data, customer lists, mailing lists, files, invoices, advertising material and methods,
warranty records, licenses to conduct the business and any files required to be retained after the
closing by law or regulation for a purchase price of $250,000."
Subsequent to the agreement to purchase and concurrent with the closing of this transaction,
Buyer and Seller enter into a Covenant Not to Compete and Consulting Agreement. The
agreement was for 5 years and covered a 50 mile radius from the site of dealership. Seller was to
receive $300,000 each year for 5 years on the anniversary date of the closing of this sale.
As a consultant, Seller agreed to provide the Buyer with "technical assistance, advice, and
consulting with respect to the management and operation of the dealership, business principles
employed, introduction to key executives of the dealership and outside the dealership, analysis of
market employee relations, and other matters pertaining to the profitable operation of the business
for 5 years from the date of the closing of this sale."
The agreement further stated that if seller died or was to become incapable of performing these
consulting duties during the term of the agreement for any reason he shall be deemed to have
earned the full amount of compensation payable to him under the terms of this agreement.
Facts brought out during the examination:
Seller did provide management of the dealership with advice on how to market in this
particular area. He provided advice on competitors in this market. He provided through his
presence and advice for a smooth transition at the time of purchase.
There was no appraisal of the covenant not to compete. Its valuation was based on
assumptions that seller would take 5 percent of the dealer’s business if he competed and this
would be more than $1,500,000 for the 5 years after the sale. Buyer had no objective criteria
on which to base such an opinion.
The covenant was separately negotiated by the buyer and seller.
Seller was 69 years old and in poor health. The Buyer approached the Seller who had no
intention to stay in business and compete. Buyer was aware of Sellers intentions.
The net worth of the dealership per financial statements just prior to the sales closure was
$6,000,000. The sales price was stated in the closing memorandum to be $7,750,000.
Applying the principles found in Forward Communications Corporation:
1. Whether the compensation paid for the covenant is separable from the price paid for the
goodwill?
The presence of separate goodwill existed in this transaction as shown by the inclusion of
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