Business Combinations – Keys to Getting the Valuation Components Right
1. Get Ahead of the Game
As someone close to client leadership, keeping an ear out for potential acquisitions is critical. Work to understand who management is including on its due diligence team as this will have ripple effects throughout the process. Often the M&A process includes preliminary tangible property, large financial receivable or asset valuation work as part of due diligence or negotiation process. While these value conclusions may not correspond with the exact definition of fair value under ASC 820, it is a starting point for the valuation specialists to consider.
2. The Right Stuff
Business combination and valuation are generally once-in-a-while events. The right people may not be in-house or at the ready to handle questions on identifying assets, calculating purchase consideration, valuing intangible or tangible assets or any of the other myriad challenges that come with business combination accounting. As the certainty around an acquisition increases, that’s the time to help the client identify folks internally and externally qualified to handle the accounting, auditing, and valuation aspects.
3. Eliminate Surprises
The purchase consideration is often more than just the cash and assumed liability amounts in the purchase agreement. Separately, the proper identification of assets to which one will allocate value is critical. A lot of time can be avoided if the client and the valuation specialists speak early on both these topics. A simple roundtable conversation on the acquisition’s story can lead to the identification of key documents, spreadsheets, data rooms or presentations which the auditors, back office accounting and valuation specialists can use to further streamline the discovery process.
4. Share the Pain
The identification of assets to which the purchase consideration is to be allocated, and the methodology used to estimate the purchase consideration and asset values is something everyone should have an opportunity to speak up on. All parties performing on behalf of the client, including auditors, management and specialists, should work iteratively, seeking buy-in as they go, until everyone agrees on the identified of assets/liabilities and likely valuation methodology.
5. The Intangible Assets
The nature of intangible assets automatically makes valuing them difficult. Intangible assets fall into one of five categories:
| a. Marketing-related intangible assets |
| b. Customer-related intangible assets |
| c. Artistic-related intangible assets |
| d. Contracted-based intangible assets |
| e. Technology-based intangible assets |
Valuing an intangible asset involves running through a series of questions specific to the benefit stream or observed value for that asset in the context of the category from which it came. The guidance calls for a value based on the highest and best use, and often involves some fairly complex math once identified to estimate a value. Please note that the value of certain intangible assets may be tied to the value of other assets as schedules are developed.
6. Earn-Out For What
The technical nature of contingent payments or the transfer of additional assets or equity interests to the former owners if certain conditions are met can be extremely tricky. Most earn-outs get thrown into deals as sweeteners or to provide risk mitigation strategies for buyers. Often thought by the transacting parties to be a nominal, additional amount possibly in play, the actual value can be significantly different depending on the facts and circumstances. Continuing on our communication theme with the first thought above, if the parties are thinking of including an Earn-out in the purchase agreement, it makes sense to get a value estimate as part of the negotiation process early on in the process.
This list is by no means comprehensive, but should drive home that communication early and often is critical to avoiding the hiccups that make an already costly proposition more burdensome.
Financial reporting rules regarding the recognition and measurement of acquired assets and liabilities are not straightforward —they require skill, expertise, and experience to correctly interpret and apply. WithumSmith+Brown can bring clarity to the complexities of these codes and regulations. Our professionals have performed a number of purchase price allocations for financial reporting and tax reporting under U.S. GAAP and various national standards.
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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
