Why is Goodwill used in an LBO?

Shareholders’ Equity typically increases substantially in an LBO.

This increase is reflective of a premium paid to the “fair market value” of a company.

Let’s put on our balancing caps. This change in Shareholders’ Equity must be reflected on the Assets side to ensure everything balances.

So Goodwill is used as a plug. Let’s use an example quickly:

Total Assets = $100

Total Liabilities = $50

Total Shareholders’ Equity = $90

A = L + SE:

$100 = $50 + $90

$100 = $140

Well, that’s not good.

Goodwill = $140 - $100 = $40

New A = L + SE:

$140 = $50 + $90

$140 = $140

Much better.