Why are Goodwill & Other Intangibles created in an LBO?

• A. They represent premium paid to fair market value of the company and act as a plug to balance the balance sheet.
• B. They are tax shields.
• C. They represent cash on hand.
• D. They are not created in LBOs.

Answer: (A)

In an LBO, the purchase price you pay is usually above the fair value of the target’s identifiable net assets. When you allocate that price, you assign fair values to tangible assets and identifiable intangible assets, and you record liabilities at fair value. The leftover amount—the difference between the total purchase price and the fair value of those net assets—becomes goodwill (and possibly other intangible assets). Goodwill functions as the balancing plug on the balance sheet, reflecting the premium paid for expected synergies, brand value, customer relationships, and other unidentifiable value. It’s not a cash reserve and not a tax shield—the latter comes from debt interest deductions. So yes, goodwill and other intangibles are created in LBOs because they represent the premium over identified net assets and serve to balance the accounting equation.