Definition
Goodwill is the premium paid over the fair value of a company’s net identifiable assets. It reflects intangible elements like brand reputation, customer loyalty, and expected synergies from the acquisition.
Goodwill arises when an acquisition involves paying more than the sum of the identifiable Net Assets. In private equity transactions, it indicates that the acquirer believes there are additional future economic benefits that cannot be directly measured through traditional accounting metrics.
Accounting Treatment and Impairment
- Initial Recognition: Goodwill is recorded as an asset on the post-acquisition balance sheet.
- Subsequent Testing: Under IFRS, instead of systematic amortization, goodwill is subject to periodic impairment tests to ensure its carrying value remains justified. Under HGB, goodwill gets amortised.
- Investor Impact: Impairment losses can reduce earnings, affecting the overall return profile of the investment.
Modeling
In transaction models, goodwill is typically calculated and analyzed as follows:
- Purchase Price Determination: Start with the agreed acquisition value, as discussed in Entry Valuation and Enterprise Value to Equity Value Bridge
- (+) Net Identifiable Assets Valuation: Add the fair value of the company’s identifiable net assets — this usually reflects the current equity value as recorded on the balance sheet.
- (-) Existing Goodwill: Subtract any pre-existing goodwill already recorded on the target’s balance sheet to prevent double counting of intangible value.
- (=) Step Up of Equity: The resulting figure represents the equity step-up, which is the premium paid over the existing book value of net assets.
- (-) Write-up of Assets: Deduct any write-ups of assets. These adjustments reflect the fair value increase of certain assets over their historical book values and are accounted for separately. In models these are typically are calculated as a % of the step up of equity
- (+) Deferred Tax Liability: Add any deferred tax liabilities that arise due to the temporary differences between the revalued (written-up) asset amounts and their tax bases. Typically this is calculated as the asset write-up multiplied with the tax rate.
- (=) Pro Forma Goodwill: The final balance after these adjustments, representing the goodwill that will be recorded on the post-transaction (pro forma) balance sheet.
Goodwill serves as a key metric to evaluate the premium paid for non-quantifiable assets and anticipated synergies, offering insights into the strategic rationale behind the transaction.
Example Calculation
Where:
- Acquisition EqV is coming from the Enterprise Value to Equity Value Bridge
- Existing EqV and existing Goodwill are coming from the balance sheet