How to Calculate Goodwill in an LBO
If you were asked in an interview "How do you calculate goodwill in an LBO" what would you respond? It seems pretty complicated and it depends on how you structure the S&U, it seems
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Well proforma goodwill is simply the amount paid for the equity of the company minus net book value of the target (excluding any existing goodwill)
Sorry for the simple question but what does proforma book value look like? Are there any major adjustments made BEFORE calculating goodwill - I know asset writeups, etc, but what about fees and things of that nature?
In calculating goodwill generated, yes you will also need to consider the amount of excess spent to purchase equity over existing book value that is being allocated to write-ups and intangibles.
But pro forma book value is a slightly different concept - goodwill here is an input and not an output. Fees and others will be deducted off your retained earnings / new equity (this would be the purchase equity amount).
Ah so just to make sure I got it, the fees, and paydown of debt have no impact on goodwill?
Really depends on what you consider equity purchase price and how you calculate it. For most modelling test, they are likely to give you one of the below:
Offer share price x NOSH. This is simple because the product of both would give you the equity purchase price. In this case, debt paydown or fees will not affect your goodwill calculation since goodwill = equity purchase price - net book value. I would like to caveat here that there is no revaluation of PPE or intangibles in this case for simplicity.
They give you a multiple and you apply it to LTM EBITDA. If they say this is applied on a debt-free, cash-free basis, then it should be fine to assume this amount is the equity purchase price. Else, you may potentially assume this is enterprise value and then you adjust it for existing pre-LBO cash and debt. Key thing is just to state your assumptions clearly since mechanically the model will work the same, you will just get different returns. In this example, you will see "debt paydown" or what I like to call refinancing of existing debt will have an impact of goodwill.
Hope this is clear.
Seller proceeds - net identifiable assets
Price paid for equity (including premium) above the fair market value of net assets
If you have a LBO where there is no debt but cash, the equity value at entry would be highert han the TEV at entry. Which would you use in the goodwill calculation and in the S&U?
I have seen some practice models add transaction fees to the equity purchase price for goodwill calculations, anyone know the logic behind that or if it is correct?
Purchase value of equity (based on base case valuation; if public company then do offer price x FDSO etc.; if private company then do mult * EBITDA and bridge to equity value; N.B. no need to substract transaction fees here)
less: pre-existing book value of equity (this is the central tenant of the calculation - finding the difference between fair / purchase / market value of equity and book value of equity to "plug the gap"; N.B. book value of equity = book value of assets - book value of liabilities)
plus: pre-existing goodwill on B/S (so as not to double count goodwill)
= Step up of equity
less: write-up of intangible assets (we usually assume this is 10% of step up of equity; does not matter whether or not the business has pre-existing intangibles on its B/S)
plus: deferred tax liability (ETR * write-up of intangible assets; we are creating a deferred tax liability to compensate for the fact that our writeup of intangibles will mean we have more amortisation going forward and thus a lower GAAP taxes)
= pro forma goodwill
then on your closing balance sheet you would wipe the pre-existing goodwill account and add on the pro forma goodwill calculated above; similarly you would be sure to add on the DTL created and newly written up intangibles
hope this helps and let me know if you disagree!
Any idea what to do if Purchase Equity Value of target is lower than Book Value of Equity? This is giving me a negative step up. I am applying a 25% premium to the last close price and using FDSO.
Why do we add back the pre existing goodwill?
you don't, i also caught that, you would subtract it instead, otherwise you would be double accounting.
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