Com­pany buy­ers must ap­ply minds

In-depth anal­y­sis re­quired of the fair value of tar­get com­pa­nies

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - ROWAN MCDON­ALD

PRIOR to any ac­qui­si­tion, com­pa­nies are re­quired to ap­ply a more in-depth anal­y­sis of the fair value of the as­sets and li­a­bil­i­ties of a tar­get com­pany. Other items such as con­tin­gent as­sets, li­a­bil­i­ties and other in­tan­gi­ble as­sets may also be in­volved.

Gone are the days when good­will was cal­cu­lated by sub­tract­ing the at­trib­ut­able net as­set value of an ac­quired en­tity’s state­ment of fi­nan­cial po­si­tion from the pur­chase price. From now on, when­ever an en­tity ob­tains con­trol over an­other busi­ness, a pur­chase price al­lo­ca­tion (PPA) must be per­formed.

A PPA is the process of al­lo­cat­ing the cost of an ac­quired busi­ness to the fair value of the as­sets and li­a­bil­i­ties as­sumed. It also es­tab­lishes use­ful lives for iden­ti­fied as­sets and li­a­bil­i­ties.

This, how­ever, ap­plies only to com­pa­nies that com­ply with a fi­nan­cial re­port­ing frame­work, such as in­ter­na­tional fi­nan­cial re­port­ing stan­dards, South African gen­er­ally ac­cepted ac­count­ing prin­ci­ples or ac­count­ing stan­dards for small to medium-sized en­ter­prises, and ex­cludes busi­ness com­bi­na­tions un­der com­mon con­trol.

An ex­am­ple of this is when a busi­ness is sold to a fel­low sub­sidiary in a group of com­pa­nies. In these cir­cum­stances, any in­tan­gi­ble as­sets are seen as in­ter­nally gen­er­ated and can’t be recog­nised in terms of in­ter­na­tional fi­nan­cial re­port­ing stan­dards.

In­ter­na­tional Fi­nan­cial Re­port­ing Stan­dard (IFRS) 3 out­lines var­i­ous classes of in­tan­gi­ble as­sets as:

Cus­tomer-re­lated as­sets like cus­tomer re­la­tion­ships, or­der books and

A pur­chase price al­lo­ca­tion gives in­vestors a clearer picture of what ac­tual as­sets were pur­chased and where the value lies

cus­tomer con­tracts;

Mar­ket-re­lated trade­marks, brands and trade names;

Con­tract-based as­sets like royalty agree­ments, con­struc­tion con­tracts, lease and fran­chise agree­ments;

Tech­nol­ogy-based as­sets such as patented tech­nol­ogy, in­ter­nally gen­er­ated soft­ware and data­bases; and

Artis­tic-re­lated as­sets such as pho­to­graphs, plays, op­eras and mu­si­cal works.

A PPA gives in­vestors a clearer picture of what ac­tual as­sets were pur­chased and where the value lies. If sig­nif­i­cant value is at­trib­uted to cus­tomer re­la­tion­ships dur­ing the PPA, for ex­am­ple, this could give in­vestors com­fort re­gard­ing the sus­tain­abil­ity of the busi­ness and may even sub­stan­ti­ate a higher pur­chase price that was paid.

IFRS 3 pro­vides clear guid­ance on how to iden­tify in­tan­gi­ble as­sets and sug­gests ap­pro­pri­ate val­u­a­tion meth­ods. For ex­am­ple, a large good­will fig­ure may in­di­cate that man­age­ment has not fol­lowed due process in iden­ti­fy­ing po­ten­tial in­tan­gi­ble as­sets as well as as­cer­tain­ing the fair val­ues of all as­sets and li­a­bil­i­ties. Con­versely, a PPA in­di­cates that man­age­ment has closely man­aged the ac­qui­si­tion and are clear on what has been ac­quired.

As has been the case for many years, good­will is not amor­tised but rather as­sessed for im­pair­ment at least on an an­nual ba­sis. In con­trast, in­tan­gi­ble as­sets iden­ti­fied dur­ing the PPA will be amor­tised over their rel­e­vant use­ful lives. This means the in­tan­gi­ble as­sets’ amor­tised charges will have an im­pact on the ac­quirer’s fu­ture earn­ings by re­duc­ing the book value of ac­quired in­tan­gi­ble as­sets on the state­ment of fi­nan­cial po­si­tion. On a pos­i­tive note, this re­duces the risk of fu­ture good­will im­pair­ments. Such im­pair­ments may have a sig­nif­i­cant im­pact on profit dur- ing a sin­gle ac­count­ing pe­riod.

A com­mon mis­con­cep­tion is that the re­duc­tion in profit, through amor­ti­sa­tion of in­tan­gi­bles, will have a neg­a­tive im­pact on a com­pany’s per­ceived value. All an­a­lysts, how­ever, ex­clude these costs when as­sess­ing value.

A PPA is un­likely to re­sult in a zero good­will fig­ure be­cause cer­tain in­tan­gi­ble as­sets may not meet the recog­ni­tion cri­te­ria in terms of IFRS and will re­main in good­will, which could in­clude the value of the as­sem­bled work­force, among oth­ers.

Also, buyer and seller per­cep­tions of value of­ten dif­fer, and buy­ers are of­ten will­ing to pay a slightly higher price for a busi­ness in or­der to ex­ploit syn­er­gies.

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