That analysis is hard to do correctly if the company is not even generating revenue... Unfortunately it has now become standard practice to use what is basically goodwill (hype, or more charitably, brand equity) as the primary value proposition for many startups.
Goodwill is something you add to the value of a company to sweeten the pot during acquisitions but it should never be the primary value proposition.
Goodwill is something you add to the value of a company to sweeten the pot during acquisitions but it should never be the primary value proposition.
What? Goodwill is an accounting name for the excess paid to acquire a company beyond the fair market value of its assets. It's a "stub", basically used so that the books balance in terms of debits and credits (i.e. you paid X cash for the company, and that value splits between FMV of its assets and the rest is "goodwill".) Nobody ever says "I'm going to add some goodwill to sweeten the pot" when buying a company, nor would anyone attempt to use it for determining purchase price.
Are you referring to "Modern Meaning"? Maybe I'm not understanding what you're saying. It seems like you're implying that "goodwill" is a material part of the calculation of a purchase price prior to the deal being signed.
That is indeed what I am saying...what good will (no pun intended:) ) it be post-deal signing?...if you read that section "Modern Meaning" you see it alludes to brand,customers and IP...in the case of zero-revenue startups that translates to hype,users and maybe an iPhone app.
The gp is using the strict accounting definition of goodwill, you use it in its popular meaning. Strictly speaking nobody values goodwill before a deal, but it's often used as a word for 'the soft stuff we find hard to quantify'.
Maybe... but nobody really thinks of it that way, any more than they bother to worry about what fair market value of the assets (the other part of the purchase price) is for an early-stage tech company. They just care about the overall price, and they leave splitting that into FMV and goodwill as an exercise for the accountants after the deal is done.
A service company (i.e., a law firm) being acquired would almost exclusively depend on goodwill for the accounting of the transaction. There are few fixed assets beyond desks and chairs and possibly a property lease to include as assets. Accounts receivable and cash would of course play a role, but that is likely a fraction of the overall value paid. The difference between book value and the price paid is accounted for through book value.
Even in a steady-state in which Snapchat is earning serious money, were it to be acquired, the acquirer would likely need to account for it predominantly through goodwill. What tangible assets does snapchat have? Data center/infrastructure is likely the only area where a company like snapchat could invest in a way that would increase its book value... but snapchat is more likely to stay on the cloud...
The typical tech startup has few tangible assets, hence the necessity to account through book value.
Interesting analysis, but isn't goodwill a fudge-factor in the balance sheet? ie, its not a flow but a stock. This makes its estimation implicitly data-starved, because with a DCF at leat you are getting a time series of independent measurements.
No. Few companies are worth their exact book value. Accounting a balance sheet in of itself does little to tell you the true value of the company. For example, Google's book value is roughly 100B while its market cap (the implied value of the company) is 360B. Why the discrepancy? Accounting rules are strict on how assets are valued and don't (nor are they meant) to represent the future cashflow that can be derived from them. Future growth, intellectual property and brands are basically not included in the book value. When a company gets acquired, this difference is made up through goodwill. This is simply a representation that book value is not a good measure of true value.
Actually, in the case of a change of control (e.g.: acquisition), you will recognize fair value for brands and other identifiable intangible assets on the balance sheet. The Goodwill becomes the remaining difference between the consideration (purchase price) and the FV of the net assets.
Funny thing is that I'm actually working on a purchase price allocation right now.
> This makes its estimation implicitly data-starved, because with a DCF at leat you are getting a time series of independent measurements.
It isn't a data-starved number. It is often as simple as DCF calculation of value - the book value. DCF isn't used to calculate book value. Book value is simply the sum of the tangible parts.
Then goodwill isn't the right word for it, because goodwill has a precise definition that isn't fudged.
Additionally, the author made a good point in that many investors are not buying straight common shares. You can't simply value those shares by doing a DCF. You need to value each component of the instrument (an option, equity, debt,etc.) to get to a final number. He's right that extrapolating out that number is incorrect, but it's also incorrect to then deduce that anything beyond DCF is 'fudged'.
Comments
Share Price = Present Value of Future Cashflow...
That analysis is hard to do correctly if the company is not even generating revenue... Unfortunately it has now become standard practice to use what is basically goodwill (hype, or more charitably, brand equity) as the primary value proposition for many startups.
Goodwill is something you add to the value of a company to sweeten the pot during acquisitions but it should never be the primary value proposition.
What? Goodwill is an accounting name for the excess paid to acquire a company beyond the fair market value of its assets. It's a "stub", basically used so that the books balance in terms of debits and credits (i.e. you paid X cash for the company, and that value splits between FMV of its assets and the rest is "goodwill".) Nobody ever says "I'm going to add some goodwill to sweeten the pot" when buying a company, nor would anyone attempt to use it for determining purchase price.
http://en.wikipedia.org/wiki/Goodwill_(accounting)
Also, the parent post refers to "flipping" but that generally means quickly reselling something, not killing it after three years.
From that same article, if you read the third paragraph, you'll see what I am saying.
Are you referring to "Modern Meaning"? Maybe I'm not understanding what you're saying. It seems like you're implying that "goodwill" is a material part of the calculation of a purchase price prior to the deal being signed.
That is indeed what I am saying...what good will (no pun intended:) ) it be post-deal signing?...if you read that section "Modern Meaning" you see it alludes to brand,customers and IP...in the case of zero-revenue startups that translates to hype,users and maybe an iPhone app.
The gp is using the strict accounting definition of goodwill, you use it in its popular meaning. Strictly speaking nobody values goodwill before a deal, but it's often used as a word for 'the soft stuff we find hard to quantify'.
Maybe... but nobody really thinks of it that way, any more than they bother to worry about what fair market value of the assets (the other part of the purchase price) is for an early-stage tech company. They just care about the overall price, and they leave splitting that into FMV and goodwill as an exercise for the accountants after the deal is done.
A service company (i.e., a law firm) being acquired would almost exclusively depend on goodwill for the accounting of the transaction. There are few fixed assets beyond desks and chairs and possibly a property lease to include as assets. Accounts receivable and cash would of course play a role, but that is likely a fraction of the overall value paid. The difference between book value and the price paid is accounted for through book value.
Even in a steady-state in which Snapchat is earning serious money, were it to be acquired, the acquirer would likely need to account for it predominantly through goodwill. What tangible assets does snapchat have? Data center/infrastructure is likely the only area where a company like snapchat could invest in a way that would increase its book value... but snapchat is more likely to stay on the cloud...
The typical tech startup has few tangible assets, hence the necessity to account through book value.
Interesting analysis, but isn't goodwill a fudge-factor in the balance sheet? ie, its not a flow but a stock. This makes its estimation implicitly data-starved, because with a DCF at leat you are getting a time series of independent measurements.
No. Few companies are worth their exact book value. Accounting a balance sheet in of itself does little to tell you the true value of the company. For example, Google's book value is roughly 100B while its market cap (the implied value of the company) is 360B. Why the discrepancy? Accounting rules are strict on how assets are valued and don't (nor are they meant) to represent the future cashflow that can be derived from them. Future growth, intellectual property and brands are basically not included in the book value. When a company gets acquired, this difference is made up through goodwill. This is simply a representation that book value is not a good measure of true value.
Actually, in the case of a change of control (e.g.: acquisition), you will recognize fair value for brands and other identifiable intangible assets on the balance sheet. The Goodwill becomes the remaining difference between the consideration (purchase price) and the FV of the net assets.
Funny thing is that I'm actually working on a purchase price allocation right now.
...This difference is made up through goodwill is exactly why its a fudge factor, by definition.
Sorry if my point wasn't clear.
It isn't a data-starved number. It is often as simple as DCF calculation of value - the book value. DCF isn't used to calculate book value. Book value is simply the sum of the tangible parts.
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Then goodwill isn't the right word for it, because goodwill has a precise definition that isn't fudged.
Additionally, the author made a good point in that many investors are not buying straight common shares. You can't simply value those shares by doing a DCF. You need to value each component of the instrument (an option, equity, debt,etc.) to get to a final number. He's right that extrapolating out that number is incorrect, but it's also incorrect to then deduce that anything beyond DCF is 'fudged'.