BVX calculates goodwill using the residual method as follows:
Goodwill = Purchase Price
+ Acquisition Expenses
- Net Assets
- Personal Goodwill
Goodwill is amortized over 15 years in an Asset purchase and is deducted from taxable income. It is not amortized in a Stock purchase.
Negative Goodwill: Goodwill can be negative if the business has too many assets relative to the profit it generates. More specifically, goodwill is negative if the sum of net assets plus non-compete, plus personal goodwill, plus consulting, exceeds the purchase price plus acquisition expenses. In an Asset purchase negative goodwill increases income and decreases cash flow.
Negative goodwill suggests that one should seriously consider liquidation option. The value realizable through liquidation may be higher than the value realizable through income based valuation.
Negative goodwill also indicates that the business is using its assets in an inefficient manner. Financial consultants are using BVX to quantify balance sheet targets to achieve efficient asset management. From M&A perspective, the seller can maximize the net proceeds to him by liquidating or selling off excess assets. The cash generated by liquidating or selling off excess assets will remain with the seller. And, on top of this, paring down assets, in many cases, increases the value of the business, because a leaner balance sheet means less reinvestment of profits for growth (e.g. a business with high turning inventory is better than the one with low inventory turns).