Articles Comments

Just Elementary, Inc. » Business Valuation » Difference Between Goodwill & Blue Sky in regards to business valuations

Difference Between Goodwill & Blue Sky in regards to business valuations

The terms Goodwill and Blue Sky are often used interchangeably. A primary reasons for this is that it is assumed that they are the same thing.  For practical purposes, in regards to business valuations, there is a distinction between the two terms.

Goodwill:

Let’s start with Goodwill.  A conventional definition of Goodwill would be the amount of money paid for an on-going business beyond its book value.  A simple example is a business that has $600,000 in tangible equipment & inventory, but sells for a $1,000,000.  There could be other intangible items that make up the $400,000 difference in price versus tangible items, such as the value of a special contract, however, to keep things simple for discussion purposes, we can say that there is a positive goodwill of $400,000.

A key point to the above example is is there is sufficient demand from prospective buyers to justify the price of $1,000,000 for the business.  If so, we can say that in this case the Goodwill is economically justified.

Blue Sky:

To illustrate Blue Sky, Let’s modify the above example as follows:

$1,000,000 Asking Price
$600,000 in tangible equipment and inventory
Business Valuation supports an asking price of $750,000

In this case we can say that $150,000 in Goodwill is economically justified ($750,000-$600,000) and the additional $250,000 ($1,000,000-$750,000) is not economically justified, so that amount would be considered Blue Sky.  To put it into words, Blue Sky would the amount asked for by the seller of a business beyond the book value of a business that isn’t justified economically.

take the case where was not any buyer demand for the above business at $1,000,000, but that the buyer demand is in the neighborhood of $750,000 based on economic factors determined in a business valuation.  Then, we can say that $150,000 in Goodwill is justified, and the additional $250,000 above that would be Blue Sky.

Strategic Acquisitions:

One more example is a common situation that will illustrate why Goodwill and Blue Sky get mixed up is the following.  Sometimes there are situations where a premium will be paid for a business above an economically justified amount for extenuating circumstances.  These extenuating circumstances can be buying out a competitor to gain controlling market share, or to facilitate the increase in margins, or to acquire a special intangible asset and more.

For example:

Let’s say there is a manufacturing business that has a fair market value of $5,000,000 based on a business valuation and has tangible items worth $3,000,000.  If the seller demands $7,500,000 for that business, then we can say that seller is asking for $2,500,000 in Blue Sky, because only the difference ($2,000,000) between $3,000,000 tangible items and asking price of $5,000,000 is economically justified under normal circumstances.  However, there may be a competitor willing to meet that price to significantly increase market share and pick up key staff and intellectual property.  In this case, the line is blurred and it can be said that the additional $4,500,000 beyond book value was Goodwill, since the business has more value to the competitor than to an ordinary buyer.

Business Valuation Services:

At the end of the day each situation is unique, obtaining a business valuation is paramount to knowing the fair market value of a business, whether it is yours or for a potential acquisition.  You can inquire with our office about Business Valuation Services by contacting our Client Care Manager, Sonia Chhabra, at (888) 926-9193 or email cs@justelementary.com

Filed under: Business Valuation · Tags: , ,

Comments are closed.