Goodwill and Why It Exists Would You Like a Write-Up with Your - - PowerPoint PPT Presentation

How to C Calculate Goodwill – and Why It Exists

Would You Like a Write-Up with Your Plug?

This Video: We Haven’t Covered This Before?!!

I was looking at this channel the other day and realized that we had videos on Negative Goodwill and Purchase Price Allocation for Noncontrolling Interests… But nothing on a far more basic topic: how to calculate Goodwill in the first place!

This Video: We Haven’t Covered This Before?!!

Also, we get a surprising number of questions about this topic, even though there’s detailed coverage of it in our guides and courses… and lots of articles

• nline!

So, here goes, starting with why Goodwill exists and a simple example:

Why Goodwill Exists

• SHORT ANSWER: Goodwill is an accounting construct that exists

because in M&A deals, Buyers almost always pay more than what Sellers’ Balance Sheets are worth (i.e., Assets – Liabilities)

• The Buyer “gets” all the Seller’s Assets and Liabilities, so that makes

its Balance Sheet go out of balance when a deal closes

• We create Goodwill to fix this imbalance and ensure that

Assets = Liabilities + Equity on the Combined Balance Sheet

• Basic Calculation: Goodwill = Equity Purchase Price – Seller’s

Common Shareholders’ Equity + Seller’s Existing Goodwill +/- Other Adjustments to Seller’s Balance Sheet

Why Goodwill Exists – Simple Example

• EX: Buyer pays $1000 in Cash for the Seller, and the Seller has

$1500 in Assets, $600 in Liabilities, and Common Equity of $900

• Next: Seller’s Common Equity is written down in the deal, and

the Buyer’s Assets go down by $1000, then up by $1500, for a net increase of $500 – but its Liabilities go up by $600! Imbalance!

• To fix this imbalance, we create 2 new Assets in M&A deals:

Goodwill and Other Intangible Assets

• Other Intangible Assets are for specific, identifiable items that have

value, such as trademarks, patents, and customer relationships – these do not always get created, and we’ll cover them later

Why Goodwill Exists – Simple Example

• Goodwill is for everything else – the “plug” to make the BS balance
• Simple Calculation: Equity Purchase Price – Seller’s Common

Shareholders’ Equity + Seller’s Existing Goodwill

• Why: Seller’s Existing Goodwill is also written down in the deal!

So, the new Goodwill must include the entire old amount of Goodwill plus the incremental new portion

• This ignores Other Intangible Assets – we’ll show their impact in

the next example

How to Calculate Goodwill – More Detail

• In all M&A deals, under both IFRS and U.S. GAAP, Buyers are

required to re-value everything on the Seller’s Balance Sheet

• So, if the Seller’s factories, land, inventory, etc. are worth more or

less than their Balance Sheet values, they must be adjusted

• Many items that represent timing differences – Deferred Rent,

Deferred Tax Liabilities/Assets, etc. also go away because these temporary differences are reversed and reconciled in M&A deals

• And: A new Deferred Tax Liability (and sometimes other new items)
• ften gets created in the deal (see our separate video on this one)

How to Calculate Goodwill – More Detail

• So… a real Goodwill calculation might look more like this:
• Goodwill = Equity Purchase Price – Seller’s Common Shareholders’

Equity + Seller’s Existing Goodwill – Asset Write-Ups + Asset Write- Downs – Liability Write-Downs + Liability Write-Ups

• Rule: If an item increases Assets or reduces L&E, that means less

Goodwill is needed to boost Assets – so we subtract that item

• This is why we subtract items such as PP&E and Inventory Write-Ups,

and why we also subtract Liability Write-Downs such as DTLs that go away in the deal

How to Calculate Goodwill – Even More Detail

• QUESTION: “OK, but how do you determine the exact amount of

PP&E and Intangibles to write up? What about the new DTL?”

• ANSWER: You don’t have enough information to do this “the real

way” if you only have access to the Seller’s public filings…

• But you can make some approximations based on recent deals for

similar acquired companies in this market

• Example: If we want to create Goodwill for a potential acquisition
• f a high-growth software company, we can look at Atlassian’s

$384 million acquisition of Trello and use those %’s

How to Calculate Goodwill – Even More Detail

• Results: Other Intangibles are ~33% of the Equity Purchase Price,

and Goodwill is ~75%; no write-up for PP&E

• Newly Created DTL is ~37% of the new Intangible Assets – but that

~37% is not necessarily the tax rate for our Buyer

• Our Deal: We might create Other Intangibles such that they

represent ~33% of the Equity Purchase Price, record the other items as is, and create the new DTL based on the Buyer’s tax rate

• And: We’d check that the Goodwill is a significant portion of the

Equity Purchase Price (e.g., 60-80% range rather than 5-10%)

Last N Note: Even More Complexities

• Other Items: Deferred Rent, Deferred Revenue, Inter-Company

AR/AP, and more

• Different Deal Types: Deferred Tax line items work differently

depending on whether it’s a Stock, Asset, or 338(h)(10) deal

• More Intangibles: Definite vs. Indefinite-Lived, etc.
• Industry-Specific Items: In-Place Lease Value and Above/Below-

Market Leases in Real Estate

• And: Don’t forget about Earn-Outs and other Contingent Payments

Recap and Summary

• Goodwill: Exists to “plug the gap” when a Buyer pays more than

the Seller’s Common Shareholders’ Equity in an M&A deal

• Goodwill = Equity Purchase Price – Seller’s Common Shareholders’

Equity + Seller’s Existing Goodwill +/- Other Adjustments to Seller’s Balance Sheet

• Added Complexities: PP&E and Intangible Write-Ups and

Write-Downs and Write-Ups of Deferred Tax line items

• And Even More: Deferred Rent/Revenue, Inter-Company Items,

Different Deal Types, Different Intangibles, Industry-Specific Items and Earn-Outs…