Question

Hernandez’s Auto Repair Service has been in business for five years. He has developed a great reputation of doing a good job at reasonable prices. His reputation has given him a large, loyal clientele. During those years, Mr. Hernandez has purchased net assets of $160,000 on which he owes $50,000. Hernandez has decided to sell his business and open another one 10 miles away. Rudy Rodriguez has agreed to purchase the business for $210,000. Is it ethical for Mr. Hernandez to accept a larger amount for this business than its value? If so, how would Mr. Rodriguez record this transaction? Is it ethical for Mr. Hernandez to open a new business so close to the old business?

Answer 1

1. Yes, why not ? If Mr. Hernandez thinks that his business has brand equity and superior earning power compared to competitors, it is perfectly ethical for him to ask for a price exceeding the net asset value of the business. After all, over the last five years, he has been instrumental in building the business into a profitable one.

2. Mr. Rodriguez would record the excess in his books as goodwill. He would debit the excess of assets purchased over the liabilities as goodwill. He would Debit Assets by $ 160,000, Debit Goodwill by $ 100,000, Credit Liabilities by $ 50,000, Credit Cash $ 210,000.

3. No. It is not. From an ethical point of view, Mr. Hernandez should not compete with the very business that he has sold at a profit. He can start and carry on any other type of business, and that would be perfectly fine. But not the same line of business which he sold to Mr. Rodriguez.

From a legal point of view, agreements in restraint of trade are void, i.e, not enforceable in a court of law. However, if there is sale of goodwill involved, an agreement not to compete is enforceable. It is common these days for the purchaser of the business to pay a non-compete fee to the seller to ensure that he does not compete.