How a firm's goodwill is more like soft snow than a hard asset
If you’ve ever heard a story about a company selling for billions of dollars, you might have asked yourself -- what are they actually getting for all that money?
An accountant would say that a company’s total value is the sum of its net assets plus goodwill.
Net assets are the things that the company could sell if it went bust and had a yard sale: that’s equipment, real estate and the brand name. Goodwill is everything else. It’s what accountants call the intangible assets: the staff, who can walk out the door any time they please... along with their ideas and their skills. And the company’s reputation.
It’s the stuff that can just melt away.
Think about a cable car operation on a mountain. Let’s call it Mt. Woe. The owner, Ellen, bought a gondola for $1 million, and the right to use it on the mountain for another million. Her business ferrying skiers up and down the mountain goes gangbusters, and a businessman offers her $50 million to buy her out. Ellen is stoked!
But the next day, she wakes up to find there’s no snow. Global warming has come to Mt. Woe. She calls the businessman, but his offer has now fallen to just $2 million: the cable car itself, plus the right to use it on the mountain. The rest of the value of Ellen’s company -- the goodwill -- was the staff and the skiers, but most importantly, the snow; it has melted away, never to return.
Leaving Ellen very badly needing a drink.