{"id":20294,"date":"2019-04-04T09:00:19","date_gmt":"2019-04-04T14:00:19","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/kb\/%kb_category%\/how-to-calculate-goodwill-in-ma-deals-and-merger-models-1733\/"},"modified":"2024-09-11T07:05:50","modified_gmt":"2024-09-11T12:05:50","slug":"how-to-calculate-goodwill","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/how-to-calculate-goodwill\/","title":{"rendered":"How to Calculate Goodwill in M&#038;A Deals and Merger Models (17:33)"},"content":{"rendered":"<p><div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">How to Calculate Goodwill in M&amp;A Deals and Merger Models<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/how-to-calculate-goodwill\/#First_What_Is_Goodwill\">First, What Is Goodwill?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/how-to-calculate-goodwill\/#How_to_Calculate_Goodwill_in_More_Detail\">How to Calculate Goodwill in More Detail<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/how-to-calculate-goodwill\/#How_to_Calculate_Goodwill_Added_Complexities_in_Real-Life\">How to Calculate Goodwill: Added Complexities in Real-Life<\/a><\/li><\/ul><\/nav><\/div>\n<br \/>\n<strong>Table of Contents:<\/strong><\/p>\n<ul>\n<li><strong>1:21:<\/strong> Goodwill \u2013 Why It Exists and Simple Calculation<\/li>\n<li><strong>6:59:<\/strong> More Realistic Goodwill Calculation<\/li>\n<li><strong>11:47:<\/strong> How to Determine the Percentages in Real Life and Added Complexities<\/li>\n<li><strong>16:07:<\/strong> Recap and Summary<\/li>\n<\/ul>\n<p>In this tutorial, you\u2019ll learn why Goodwill exists and how to calculate Goodwill in M&amp;A deals and merger models \u2013 in both simple and more complex\/realistic scenarios.<\/p>\n<p>This topic matters because you&#8217;ll often have to complete this exercise on the job and answer questions about it in interviews.<\/p>\n<div class='code-block code-block-2' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/04\/24164120\/adv-fm-tile.png\" alt=\"PowerPoint Pro\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Financial Modeling for Investment Banking With <strong>BIWS Core Financial Modeling<\/strong><\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Become a financial modeling pro<\/h4>\n              <p>158 videos, detailed written guides, Excel files, quizzes, and more<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 10+ detailed global case studies<\/h4>\n            <p>These include both the theory and the practical applications<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Prepare for your internship or full-time job<\/h4>\n            <p>Gain the skills you need to \u201chit the ground running\u201d on Day 1\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/core-financial-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Core-Financial-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div><\/div>\n\n<h2><span class=\"ez-toc-section\" id=\"First_What_Is_Goodwill\"><\/span>First, What <em>Is<\/em> Goodwill?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><strong>Goodwill<\/strong> is an accounting construct that exists because Buyers often pay more than the Common Shareholders\u2019 Equity on Seller\u2019s Balance Sheets when acquiring them in M&amp;A deals, which causes the Combined Balance Sheet to go out of balance.<\/p>\n<p><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.amazonaws.com\/108-14-How-to-Calculate-Goodwill-Slides.pdf\" target=\"_blank\" rel=\"noopener noreferrer\">Click here to get the slides and explanation in PowerPoint<\/a>, and <a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.amazonaws.com\/108-14-How-to-Calculate-Goodwill.xlsx\" target=\"_blank\" rel=\"noopener noreferrer\">here to get the Excel file<\/a>.<\/p>\n<p>By creating Goodwill, we ensure that Assets = Liabilities + Equity, i.e., that the Balance Sheet remains in balance.<\/p>\n<p>For example, if a Buyer pays $1000 for a Seller, and the Seller has $1500 in Assets, $600 in Liabilities, and $900 in Equity, the Balance Sheet will go out of balance immediately after the deal closes.<\/p>\n<p>If the Buyer spends $1000 in Cash, its Assets side will increase by $500 total ($1500 increase in Assets from the Seller, and $1000 decrease from the Cash usage), and its L&amp;E side will increase by $600 due to the Seller\u2019s Liabilities.<\/p>\n<p>Therefore, the Balance Sheet goes out of balance by $100, as shown below:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter size-full wp-image-20036\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075851\/how-to-calculate-goodwill-01.jpg\" alt=\"How to Calculate Goodwill - Why It Exists\" width=\"980\" height=\"737\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075851\/how-to-calculate-goodwill-01.jpg 980w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075851\/how-to-calculate-goodwill-01-300x226.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075851\/how-to-calculate-goodwill-01-768x578.jpg 768w\" sizes=\"(max-width: 980px) 100vw, 980px\" \/><\/p>\n<p>We fix this problem by creating $100 of Goodwill on the Assets side.<\/p>\n<p>The basic calculation is:<\/p>\n<p><strong>Goodwill<\/strong> = Equity Purchase Price \u2013 Seller\u2019s Common Shareholders\u2019 Equity + Seller\u2019s Existing Goodwill +\/- Other Adjustments to Seller\u2019s Balance Sheet<\/p>\n<p>Here&#8217;s the Balance Sheet from the example above, with $100 of Goodwill added to fix this problem:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter size-full wp-image-20039\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075851\/how-to-calculate-goodwill-02.jpg\" alt=\"How to Calculate Goodwill - Balance Sheet Fix\" width=\"979\" height=\"729\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075851\/how-to-calculate-goodwill-02.jpg 979w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075851\/how-to-calculate-goodwill-02-300x223.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075851\/how-to-calculate-goodwill-02-768x572.jpg 768w\" sizes=\"(max-width: 979px) 100vw, 979px\" \/><\/p>\n<p>In real life, we normally create two Assets to deal with this problem:<\/p>\n<p><strong>1) Other Intangible Assets<\/strong> for specific, identifiable items that have value, such as patents, trademarks, and customer relationships; and<\/p>\n<p><strong>2) Goodwill<\/strong>, which is the &#8220;plug&#8221; for everything else that ensures balancing.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"How_to_Calculate_Goodwill_in_More_Detail\"><\/span>How to Calculate Goodwill in More Detail<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>In all M&amp;A deals, under both IFRS and U.S. GAAP, Buyers are required to re-value everything on Sellers&#8217; Balance Sheets.<\/p>\n<p>So, if a Seller\u2019s factories, land, inventory, etc. are worth more or less than their Balance Sheet values, they must be adjusted \u2013 and those adjustments will also factor into the Goodwill calculation.<\/p>\n<p>Many items that represent timing differences \u2013 Deferred Rent, Deferred Tax Liabilities\/Assets, etc. \u2013 also go away because these temporary differences are reversed and reconciled in M&amp;A deals.<\/p>\n<p>Finally, new <a href=\"https:\/\/breakingintowallstreet.com\/tutorials-deferred-tax-liabilities-in-ma\" target=\"_blank\" rel=\"noopener noreferrer\">Deferred Tax Liabilities in M&amp;A<\/a> often get created because of the write-ups of PP&amp;E and other Fixed Assets as well as Other Intangible Assets.<\/p>\n<p>So, if you want to know how to calculate Goodwill in real life, the calculation might look like this:<\/p>\n<p><strong>Goodwill<\/strong> = Equity Purchase Price \u2013 Seller\u2019s Common Shareholders\u2019 Equity + Seller\u2019s Existing Goodwill \u2013 Asset Write-Ups + Asset Write-Downs \u2013 Liability Write-Downs + Liability Write-Ups<\/p>\n<p>You can see an example of a &#8220;real&#8221; Goodwill calculation with some of these additional items below:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter size-full wp-image-20043\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075850\/how-to-calculate-goodwill-03.jpg\" alt=\"How to Calculate Goodwill - More Complex Example\" width=\"932\" height=\"443\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075850\/how-to-calculate-goodwill-03.jpg 932w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075850\/how-to-calculate-goodwill-03-300x143.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075850\/how-to-calculate-goodwill-03-768x365.jpg 768w\" sizes=\"(max-width: 932px) 100vw, 932px\" \/><\/p>\n<p>If an item increases Assets or reduces L&amp;E, that means less Goodwill is needed to boost Assets \u2013 so we subtract that item. This explains why we subtract Asset Write-Ups as well as Liability Write-Downs such as the DTLs that get eliminated.<\/p>\n<p>Here&#8217;s the Balance Sheet with these additional items included:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter size-full wp-image-20044\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075850\/how-to-calculate-goodwill-04.jpg\" alt=\"How to Calculate Goodwill - Full Balance Sheet\" width=\"973\" height=\"726\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075850\/how-to-calculate-goodwill-04.jpg 973w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075850\/how-to-calculate-goodwill-04-300x224.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2019\/02\/19075850\/how-to-calculate-goodwill-04-768x573.jpg 768w\" sizes=\"(max-width: 973px) 100vw, 973px\" \/><\/p>\n<p>To determine the percentages for these write-ups, you could look at the percentages allocated to similar companies that were acquired in this market recently.<\/p>\n<p>For example, if you&#8217;re acquiring a high-growth software company, you might look at a deal like Atlassian\u2019s $384 million acquisition of Trello and use the percentages allocated to Other Intangibles and the other line items there as a reference.<\/p>\n<p>In that deal, Other Intangibles represented ~33% of the Equity Purchase Price, so you might use that as a reference in your Goodwill calculation as well.<\/p>\n<p>Goodwill represented ~75% of the Equity Purchase Price, and there was no PP&amp;E Write-Up, so you might aim for similar percentages if you&#8217;re completing the purchase price allocation process for a similar deal.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"How_to_Calculate_Goodwill_Added_Complexities_in_Real-Life\"><\/span>How to Calculate Goodwill: Added Complexities in Real-Life<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>The Goodwill calculation in real life gets even more complex because you must deal with items such as Deferred Rent and Deferred Revenue and their possible elimination or write-down, as well as inter-company receivables and payables.<\/p>\n<p>Also, the Deferred Tax line items work differently in different deal types (Stock vs. Asset vs. 338(h)(10)).<\/p>\n<p>There are different categories of Intangibles, such as Definite vs. Indefinite-Lived ones, and there are also industry-specific items such as In-Place Lease Value and Above\/Below-Market Leases in real estate.<\/p>\n<p>And don\u2019t forget about Earn-Outs and other Contingent Payments \u2013 they show up on the Balance Sheet and also affect Goodwill.<\/p>\n<p>All these items follow the same rules; it\u2019s just that you calculate them a bit differently for use in the Goodwill calculation itself.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>In this tutorial, you\u2019ll learn why Goodwill exists and how to calculate Goodwill in M&amp;A deals and merger models \u2013 in both simple and more complex\/realistic scenarios.<\/p>\n","protected":false},"featured_media":29353,"template":"","class_list":["post-20294","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-ma-and-merger-models"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/20294","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/29353"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=20294"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}