Goodwill

July 2002

What is Goodwill?

Goodwill is the portion of the purchase price greater than the fair market value (FMV) of the acquired assets, less any liabilities assumed.

How is Goodwill Determined?

Simply put, goodwill is determined by earnings. If a company has been in business for 50 years and is a close to breakeven operation, there generally is no goodwill. There are, of course, instances when, for example, a customer list or proprietary technology will demand a premium regardless of the seller’s earnings. In such a case, the value would be related to the anticipated earnings the buyer expects to receive as a result of the acquired list or technology. The value, however, is still related to earnings.

Goodwill is the portion of the purchase price greater than the fair market value of the acquired assets, less any liabilites assumed.

Example: Subject company is purchased for $3mm. The FMV of the assets acquired is $2.5mm. However, the buyer assumed loans against the assets in the amount of $1mm. Goodwill in this example is valued at $1.5mm

Goodwill and EBITDA?
The price of a company is often based on a multiple of EBITDA which is earnings before interest, income taxes, depreciation and amortization, adjusted for owner’s discretionary spending and non-recurring income and expenses not necessary for the operation of the business.

Assuming the subject company in the above example had an EBITDA of $500,000, the price multiple was 6X resulting in a $3,000,000 selling price. However, if EBITDA had been $400,000, an EBITDA multiple of 6X would have resulted in a selling price of $2,400,000. In this case, goodwill would have been valued at $900,000, which is the Purchase Price of $2,400,000 less the $1,500,000 Net FMV of the Assets.

What About Blood, Sweat and Tears?

Blood, sweat and tears have no value unless they result in tangible earnings that will create a value greater than the FMV of your assets less liabilities.

Does Goodwill Have Liquidation Value?

Goodwill does not have liquidation value in the absence of earnings, since its economic value depends on its ability to generate economic income.

We are pleased to inform you that Jack Fernstrum was 1 of 12 people in the nation to be awarded the new MMAI (Master Merger & Acquisition Intermediary) professional designation from The M&A SOURCE, the world’s largest international organization of middle-market intermediaries.