Blue Sky

What does it mean

Blue Sky is a term meant to encompass the additional value in a business beyond the combined costs of all assets owned by the business. 

To better explain this concept, here is an example. 

Think of two businesses that are nearly identical. Both businesses have the same equipment, same facility and same capital structure. The only difference between the two businesses is that one business is already operating and generating a profit. In this scenario, which business would you be willing to pay more for? The correct answer is the business that is operating and generating a profit. The additional cost of the operating business above the non-operational business is the Blue Sky value. 

Why does it matter

The reason that this concept matters is because people like to buy businesses and they are willing to pay more for an established business with a customer list that is generating a profit.  In many instances, these people would like to finance this purchase. 

The reason it is difficult for Community Banks to finance Blue Sky is that there is limited collateral value in Blue Sky at the point you (as the bank) need that value to be there (at the point of liquidation). Much of the additional value is due to the current profit being generated by the business. If all things go well, then you’re fine, but if the business becomes less profitable or begins operating at a loss, this is when the value of Collateral becomes most important, and if this value is tied to profits, the Blue Sky value disappears when you most need it. 

In situations where a bank wants to finance a transaction with Blue Sky, the collateral risk can be lowered through the use of one of the following:

• Government Guarantee (SBA)
• Seller Carryback
• Outside Personal Collateral

Other Relevant Terms

• Balance Sheet
• Small Business Association (SBA)
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