Business Goodwill vs. Blue Sky, is there a difference?

For practical purposes, regarding business valuations, there is a distinction between Goodwill and Blue Sky.

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 illustration purposes, we can say that there is a positive goodwill of $400,000.

A key point to the above example is that 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 be 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 there was not any buyer demand for the above business at $1,000,000, but that the buyer demand is about $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.?We sometimes see this with RV dealers, where there is an acquiring dealer looking for certain product lines or looking to move into a key market.

For example:

Let’s say there is an RV dealer 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 key competitor willing to meet that price to significantly increase market share and pick up a strong manager, desired product lines, etc.…?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 that competitor than to another RV dealer.

Business Valuation:

At the end of the day each situation is unique. Obtaining a business valuation or opinion of value 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 team @ www.rvbusinesssolutions.com