> The purchaser now has something they paid $15m for. The actual assets are only $10m. How you you account for that in double-ledger accounting? You put $5m down to goodwill.
This is the part I don't understand that makes it all seem shady. Surely, that $5M is a loss for the purchaser, and profit for the seller, no?
Why the weird "goodwill" accounting?
You don’t know that. In theory a company pay a premium because of future growth expectations. I don’t think land is a good example though because it’s relatively easier to value.
If you look at publicly traded companies most have a market cap higher or way higher than their book value (tangible/“real” assets). If another company ends up acquiring a public company that difference will simply be accounted as “goodwill” on their balance sheet
Sure I do. It's right there in the basic math.
> In theory a company pay a premium because of future growth expectations.
Yes, but until that growth happens, it doesn't exist. So it doesn't change the fact that, at the time of the sale, a loss was incurred.
To treat the expectations of future growth as a current asset is what seems shady to me. It's just making things up.
> current asset is what seems shady to me
Why? How? Do you believe all the things you don’t understand are somehow shady? Goodwill depreciates over time so you just incur the same loss just spread out over multiple years.
> at the time of the sale, a loss was incurred.
An asset is worth what a purchaser is willing to pay for it. There is no loss incurred until you sell it.
Because why would you buy a business for more than it is worth?
To be clear, we're talking about money spent over the value of the product/service. Value is obviously kind of an amorphous thing, in that depending on various market forces the value of a single thing can swing wildly. But assuming there is a known market value, and a purchaser chooses to pay over that market value, that should - in financial terms - be considered a waste, shouldn't it? If the government knew a contractor would take $50M for a contract, and paid them $100M anyway, just for the hell of it, that would be a waste, not goodwill.
I think to call it "goodwill" should imply charity, and thus be required to conform to the same rules and regulations of any charitable donation. Otherwise we should call it waste. This should make it clearer exactly what's being purchased and why. Shareholders might perk up their ears if they hear the company they invest in just wasted $50M.
e.g. we can agree that most software companies are worth more than the total value of the chairs, desks and laptops they own? Most of that value is intangible (know-how, employees, products themselves) after an acquisition this becomes goodwill. Obviously these things are notoriously hard to value but that does not mean that they are totally worthless as you keep implying for some reason…
Evaluating most businesses which spend a lot on R&D is hard, estimating future growth is hard to. Look at public companies, majority of the market cap of all(?) tech companies is made up of goodwill rather than backed by tangible assets
e.g. look at Apple it’s worth 46x it’s book value if someone somehow hypothetically acquired Apple at it’s current market price (it’s and oversimplification but more or less accurate) ~97% of what they paid for would be accounted as goodwill
The net assets are basically $15,000 worth of IT gear like a laptop and some servers. There is current month to month contracted revenue spread across a diverse base of users paying $5-100/mo each.
How much would you offer me for this company? How much would you take for this company if you currently owned it?
Something is worth what someone else is willing to pay for it. Obviously whatever the company sells for is worth exactly that amount at that moment in time. Valuing such a business at $15k would be absurd, just as valuing it at $15m would be.
Thus, the difference in asset value vs. what you paid is just called "goodwill" - perhaps the name hangs people up a lot.
If you then turn around and sell the same company later for a loss, you take a write down on that goodwill.
Certainly not perfect, but there aren't too many other ways you can express the present value of a company other than what it sells for.
That 100k/yr, though, is tangible and pricing it is straightforward. That's a very different situation that doesn't require making numbers up.
> Thus, the difference in asset value vs. what you paid is just called "goodwill" - perhaps the name hangs people up a lot.
The name absolutely doesn't help, but I don't think that's what I'm hung up on. I'm hung up on the idea of making up a monetary figure out of whole cloth and pretending it's real in some way.
This disconnect confuses me greatly, and the only way I can make it make sense in my head is in the sense of "creative accounting". Which just explains why I didn't choose a career in finance, and highlights why I view the financial world generally with tremendous skepticism.
You can absolutely assign a value to that stream. That's how you arrived at the purchase price in the first place! But that income hasn't been realized yet and it's not written in stone. The income could be higher or lower depending on what happens in the future.
I will say that while I don't think goodwill is sus in and of itself, your intuition that people doing things with the goodwill value can be sus. If I buy a company with $10m in assets and $5m in goodwill, and a year later announce I'm writing down the goodwill to $1m, something is definitely up! I may have mis-managed the company into the ground. It may be that the premium I paid was based on fraudulent assessment of the intangibles (e.g. a bunch of future sales that never existed), things like that.
I said in an earlier comment that I didn't think I was getting hung up on the name, but I had a thought that hints that maybe I am.
If it were called "slop" instead of "goodwill", I think I would be less bothered by it. don't get me wrong, it would still bother me -- and I wouldn't understand it any better -- but it would feel less like a term someone would use when trying to pull a fast one.
> It's just that accounting wants both sides of the ledger to balance
Yeah, you and a couple of other people keep saying that, but I don't really understand what that means. I mean, I know what having both sides of the ledger balance means, but this sort of example seems bizarre and extremely suspect to me. It just looks for all the world like people making stuff up.
That's OK. I can't understand everything, and this isn't something that's actually important for me to understand.
Before the purchase, I had some pile of assets worth $A. After the purchase, I still have some pile of assets worth $A. The purchase balances.