When developing a Business Valuation or OOV (Opinion of Value) for our clients, we often get asked what the difference is between Goodwill and Blue Sky. The terms Goodwill and Blue Sky are often used interchangeably, primary because it is assumed that they mean the same thing. For practical purposes, regarding business valuations, there is a distinction between the two terms.
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:
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$1,000,000 Asking Price
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$600,000 in tangible equipment and inventory
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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 wasGoodwill, 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.
Roger L. Nuttall served as President of Camping World, Inc. from January 2011. Prior to that, he was the Chief Operating Officer of FreedomRoads, LLC from January 2009 to January 2011, and the Executive Vice President and Chief Financial Officer of FreedomRoads, LLC from November 2003 to December 2015. From 1981 to 1983, Mr. Nuttall was a partner at McKay, Nuttall, and Reid, an accounting and consulting firm. Before that, he held various staff and management positions at Grant Thornton LLP from 1974 to 1981. From 1983 to 2003, Mr. Nuttall served as Chief Financial Officer and board member of Blaine Jensen & Sons, Inc., a multi-dealership RV company. He received a B.A. from Weber State University.
Mike has almost 30 years’ experience in the Recreational Vehicle (RV) Industry and provides advisory and consulting services to clients within that industry.
Scott Degnan is the Partner and Co-founder of RV Business Solutions and President of Degnan Management Group, Inc., a consulting firm.
Dom Bookman is the Chief Operating Officer and Investor Relations lead at RV Business Solutions. With 12 years of experience in the tech industry, Dom is a serial entrepreneur specializing in business development, marketing, and growth strategies for leading brands. He has successfully piloted startups and facilitated multiple exits for early-stage companies.