Goodwill

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What is 'Goodwill'

Goodwill is an intangible asset that arises as a result of the acquisition of one company by another for a premium value. The value of a company’s brand name, solid customer base, good customer relations, good employee relations and any patents or proprietary technology represent goodwill. Goodwill is considered an intangible asset because it is not a physical asset like buildings or equipment. The goodwill account can be found in the assets portion of a company's balance sheet.

BREAKING DOWN 'Goodwill'

The value of goodwill typically arises in an acquisition when one company is purchased by another company. The amount the acquiring company pays for the target company over the target’s book value usually accounts for the value of the target’s goodwill. If the acquiring company pays less than the target’s book value, it gains “negative goodwill,” meaning that it purchased the company at a bargain in a distress sale.

Goodwill is difficult to price, but it does make a company more valuable. For example, a company like Coca-Cola (who has been around for decades, makes a wildly popular product based on a secret formula and is generally positively perceived by the public), would have a lot of goodwill. A competitor (a small, regional soda company that has only been in business for five years, has a small customer base, specializes in unusual soda flavors and recently faced a scandal over a contaminated batch of soda), would have far less goodwill, or even negative goodwill.

Because the components that make up goodwill have subjective values, there is a substantial risk that a company could overvalue goodwill in an acquisition. This overvaluation would be bad news for shareholders of the acquiring company, since they would likely see their share values drop when the company later has to write down goodwill. In fact, this happened in the AOL-Time Warner merger of 2001.