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The Crucial Role of Purchase Price Allocation in Business Acquisitions

The process of acquiring a business involves intricate financial considerations.  One necessary and complex aspect of the acquisition process is Purchase Price Allocation (PPA). PPA is not merely a financial accounting requirement (per ASC 805, “Business Combinations”), but is integral and plays a pivotal role in providing transparency, fair valuation, and strategic decision-making for both acquiring and acquired entities. It’s a complicated process involving accounting rules, professional standards, and specialized procedures.  In this blog post, I delve into the reasons why Purchase Price Allocation is necessary in a business acquisition and how PPA works.


Financial Reporting Compliance:

Purchase Price Allocation is a regulatory necessity that aligns with accounting standards such as ASC 805 (U.S. GAAP) or IFRS 3. These standards require that the proper allocation of the purchase price to the identifiable assets and liabilities acquired in the transaction be performed. Adhering to these guidelines ensures that financial statements accurately reflect the economic reality of the acquisition.


Tax Implications:

Proper allocation of the purchase price has significant tax implications. It affects the amortization of intangible assets over time, impacting taxable income. A strategic view of PPA can help in minimizing tax liabilities and optimizing the financial structure of the combined entity, contributing to the acquirer’s tax efficiency in the long run.


“Fair Value” Valuation of Assets and Liabilities:

An allocation of the purchase price allows for a fair valuation of both tangible and intangible assets acquired in the business. The standard of value required is “Fair Value”, per ASC 820.  This is crucial for presenting an accurate financial position post-acquisition. It helps stakeholders, including investors and creditors, in understanding the true value and potential risks associated with the acquired assets and liabilities.


Investors, in particular, need to look at the deal structure both historically and prospectively. This is often done by developing pro forma financial statements, using the value conclusions from the Purchase Price Allocation. These analyses are used in a prospectus or offering memorandum, which provides the investor the information needed to make an informed decision concerning a contemplated investment.


Strategic Planning and Decision-Making:

Purchase Price Allocation aids in strategic decision-making for the acquiring company. By understanding the fair value of each asset and liability, the acquirer can make informed choices about resource allocation, integration planning, and future strategic planning. This insight is invaluable for optimizing the synergy between the two entities and maximizing the overall business value.


Transparent Communication with Stakeholders:

Communication with stakeholders is vital in any business acquisition. Purchase Price Allocation provides a clear breakdown of how the purchase price is distributed among assets and liabilities. This transparency fosters trust among investors, employees, and other stakeholders, facilitating a smoother integration process.


Assessment of Intangible Assets and Goodwill:

It is estimated that 84% of all business value in the United States relates to intangible value (value beyond tangible assets recorded on a company’s, balance sheet). Through the purchase price allocation process, specific intangible assets can be identified and recognized at the time of acquisition. Excess intangible value resulting from the fair value of the purchase price minus all identified assets (tangible and intangible), is represented by Goodwill (if negative, then “bargain element”).  PPA enables a detailed analysis of intangible assets and goodwill, helping management understand the drivers behind it. This insight is crucial for evaluating the success of the acquisition and making adjustments to the business strategy, if necessary.


Post-Merger Integration Planning:

Understanding the value of acquired assets and liabilities is fundamental to effective post-merger integration planning. PPA insights guide the integration team in aligning people, processes, and systems, and ensuring a seamless transition and maximizing the benefits of the acquisition.


The Valuator's PPA Process:

A team approach is crucial. When a company is contemplating or planning to acquire another company, a team of advisors should be assembled at the earliest stages. This team should include a business valuation expert knowledgable in PPA, along with: auditors, M&A consultants, legal, SEC compliance (if publicly traded or registered), acquirer’s management team, and acquiree’s management team.


The four steps of the acquisition method:

  1. Identify the acquirer,

  2. Determine the acquisition date (aka “Measurement Date”),

  3. Recognize and measure the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the inquiry,

  4. Recognize and measured Goodwill or a gain from a bargain purchase.


To identify the acquirer, the valuator will look to the documents, such as purchase agreements, draft or executed, or LOI (letter of intent).  The acquisition date can be found in these documents as well although often that date is tentative. The true acquisition date is the date acquirer takes possession of the assets and has the legal right to do so, e.g. board approval.


The measurement period starts with the acquisition date and extends one year after.  In the interim, the valuator often will provide provisional amounts to auditors and other members of the acquisition team, then fine-tune the value conclusions during the measurement period (after acquisition date).  Fair value can be adjusted during the measurement period, but only if the facts and circumstances were known or knowable at the time of the acquisition date. If new information occurred after the acquisition, these changes may represent a possible impairment loss to the intangible asset.


The recognition of working capital and other tangible assets is obvious and fairly straightforward, however, that recognition needs to be made at the fair value of those assets. The valuator will follow standards and procedures that ascertain those values. The intangible assets on the other hand are more tricky and required tremendous amount of research and analysis.


The Financial Accounting Standards Board (FASB) produces a table of intangible asset types in ASC 805.  This document, along with the deal documents, can assist in identifying possible intangible assets. A mapping is created between these two documents, along with information provided by management during a management interview, to establish which intangible assets should be recognized.

Additional intangible assets could include restructuring costs and acquisition related costs.  Restructuring provisions could be a recognizable intangible asset, post-closing, once the plans have been announced, and committed to.  Acquisition related costs are not included as part of the purchase price or the cost of the acquisition. Rather, these costs are accounted for as expenses in the periods in which the costs are incurred, and services received.


In non-taxable transactions, such as share acquisitions, the tax basis of the assets and liabilities, carry over to the acquirer, however, as required by ASC 805, the acquirer must record most assets and liabilities at acquisition date.  Owing to fair value measurements, the book value of the assets which are now recorded will be different from the tax basis of the assets.  Therefore companies often recognize the deferred tax assets and deferred tax liabilities, arising from these temporary differences.


Finally, after all of the intangible assets have been identified and recognized, the difference between those identified asset values, and the fair value of the purchase price would be recognized as Goodwill or the bargain element.


Conclusion:

If business acquisition is not complicated enough, Purchase Price Allocation adds additional layers of complexity to the acquisition process. Nevertheless, PPA is an extremely important part of business acquisition.  It’s the linchpin, holding together financial compliance, fair valuation, strategic decision-making, and transparent communication. Not only is it a regulatory requirement, but it is a tool for businesses to navigate the challenges of M&A successfully.  Because of its necessity and complexity, Purchase Price Allocation should only be performed by credentialed business valuators with this specific skill set.

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