What is Blue Sky?

"Blue sky" is a colloquial term that means, according to Merriam-Webster, "having little or no value" and "not grounded in the realities of the present." The term is often used in reference to the intangible value of a business, but that doesn't sound like the definition! Business usage of "blue sky" terminology is probably best replaced with the term "goodwill" which does specifically refer to the intangible value of a business.

Goodwill is defined as the difference between the purchase price of a business and the tangible assets being acquired. It represents the total intangible assets of a business.

Purchase price (or fair value) - tangible assets = goodwill

Goodwill may consist of customer and vendor relationships, branding, trade name, intellectual property, or any other asset not capitalized on the balance sheet.

The concept of goodwill does not entail nebulous speculation about what a customer list or business name might be worth. Arriving at a goodwill figure first requires the total fair market value or actual sale price of the business. Then tangible assets are subtracted, leaving the difference as goodwill value.

Although business appraisers estimate goodwill as part of fair market valuations, actual goodwill is not known or recorded on the balance sheet until a private company is sold. Post-sale the company now has the two variables necessary to calculate goodwill, which is then recorded as an asset item on the balance sheet. As an intangible asset, goodwill is amortized as an expense over a period of years.

We recommend the term goodwill over blue sky because it has a precise business definition that leads to a better understanding of valuation.