Goodwill is 83% of net assets - standard/normal in tech or simply outrageous?
The software developer Atlassian acquired swedish "mindville" for $36.4 mln in 2020, where $30+ mln of the transaction is attributed to Goodwill. For reference, intangibles are worth $9.6 mln and there doesn't seem to be anything else of value.
Now, I know the swedes are hard negotiators and can bullshit their way out of anything - just look at the number of start-ups they have and the country's credit rating.
I would love to hear your take on this:
-Is Goodwill this large as a % normal?
-How can CEO's justify paying these amounts?
Cheers!
In an acquisition, Goodwill is just the difference of the buying price - tangible assets.
A software company will have very little in terms of tangible assets. Even if you capitalize an expense to make it look like an asset, that cost does not even come close to the real value. For example, let’s say I invest 500k into building a piece of software and once it is done I record that as a 500k asset in my balance sheet. If that software is now generating cash flows of 100k a month then the actual valuation of that piece of software is much more than the 500k cost. Someone looking to acquire me would have to pay me a lot more to get me to sign the papers. In this case it would not be uncommon for this good will to be over 90% of the transaction.
As a nice example we all should know, Microsoft paid $ 25 B for LinkedIn but LinkedIn only had $ 4 B in assets (in it’s balance sheet) so that’s 84% good will. Why? Because your balance sheet does not reflect the real valuation of your assets. I can’t do a DCF on my own assets and put that on my balance sheet. But an acquirer will do just that and value me at much more than the cost of building my software.
Hoelder,
In an acquisition, Goodwill is not the difference of the buying price - tangible assets.
Goodwill is the difference between the equity purchase price and the seller's common BV(-), the write-off of existing goodwill(+), write-up of tangibles (-), write-up of intangibles(-), write-down of deferred tax liability (-), new deferred tax liability (+). Notice the important variable "intangibles", and what we do with it - we write it up. This write up can be significant (20%+). We do this exactly as you said - the balance sheet does not reflect the real valuation of my assets. The intangible assets we write up are specific assets we can point at and value. Goodwill is the plug. It is the accounting solution we use, such that the premium we paid for the company does not throw our balance sheet out of balance.
It is strange to me that someone would have 83,4%+ allocated to Goodwill, when there is nothing to point to.
The acquisition of Linkedin is similar, but it can be an outlier. My initial question was whether this is the norm and how CEO's justify these numbers?
With a DCF, even when you write up intangibles (which is accounted for by cash flow), you’re forecasting revenues based on the current scope of the startup. When a large company such as JPM or FB acquires a startup and integrates the service, the number of customers exposed to the service increases tremendously, thus assuming things hold constant, the profit generated and corresponding projected value of the acquisition increases tremendously post-acquisition.
Another angle is that big businesses buy startups not for revenue generation but for their intellectual property, which gives them a competitive edge in the marketplace. That is much more difficult to precisely value, and if the technology is seen as significant, the CEO can justify a large purchase price.
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