Normally when lenders like banks make a loan to you to acquire another business; they will lend money against tangible assets. Those include but aren’t limited to accounts receivable, inventory, furniture, fixtures and equipment, vehicles, equipment or real estate.
Goodwill is an intangible asset and is the combination of brand, market penetration, customer list, length of time in the marketplace. Goodwill is the “sweat equity” the business has built. What a willing seller is willing to sell these intangible assets for to a willing buyer is the value of the goodwill.
Banks won’t normally finance intangible assets like goodwill. Either you must provide that source of cash for goodwill yourself at closing, or the seller must finance the goodwill themselves in a separate note.
Often banks include intellectual property into the category of goodwill. Patents, trademarks, and proprietary formulas are examples of intellectual property. Patents are normally valued by calculating the cost to conduct the legal work and authoring of the patent (but not the research and development that went into it). When a company must defend a patent in court, the legal costs of the defense can be included in the value. A few lenders will lend money against intellectual property when the value has been defined using one of the two methods above.
In order to pay a seller for the goodwill and intellectual property of a company, a buyer must normally pay the cost of goodwill themselves. This becomes part of their equity investment into the purchase. Sometimes the lender will want to see the borrower make a larger down payment than just the cost of goodwill.
Some sellers are willing to carry a note that is subordinate to the primary lender’s for some of the goodwill and intellectual property. Covenants in the first lender’s loan agreements usually require a seller’s note to be subordinate to theirs. These types of covenants normally allow the buyer to pay the seller interest and a small amount of principal each month or quarter, but require the first lien to be paid off before the second lien is. Such terms are negotiable with the lender depending on the strength of the transaction.
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