An acquisition or sale of company is a very exciting time in the corporate life of an organization, and there are a lot of things going on. Most people don’t immediately think about the valuation implications that a change of control transaction might have, but valuation should not be forgotten. In order to comply with public accounting principles, it is very important to quantify the amount paid or what is also called the “consideration transferred”. The consideration transferred may be very simple and consist of only cash, but oftentimes, there are additional layers of consideration in the form of roll-over equity or contingent consideration.
Determining consideration transferred
In today’s environment, we see many transactions that consist not only of a cash payment for the organization, but include rollover equity, meaning that the sellers retain a portion of the equity in the acquired company, or they may be issued equity in the buyers’ organization. This is intended to incentivize the sellers to continue to contribute to the future success of the acquired company. We also have some buyers using incentive payments that are paid out if the organization meets certain performance targets. A lot of these are tied to revenue, customer retention, or cashflow, usually on EBITDA. For example, if the target company currently has $100 million in annual EBITDA, the buyer may commit to make an additional payment if the company achieves $120 million in EBITDA over the next year. This type of mechanism results in a contingent payment, and there is very specific guidance to determine the fair value of that contingent payment at the time of acquisition. The higher the fair value of the contingent payment, the higher the overall consideration transferred.
Identifying and reconciling assets
Once the consideration transferred is determined, one must then allocate that payment to various identifiable assets and liabilities. Essentially a walk down the balance sheet of an organization is needed to allocate the consideration. Certain balance sheet items are relatively simple, like cash and receivables. Fixed assets – equipment, for example – would also be restated at their fair values versus their depreciated net book value. Some asset-intensive businesses, like an ambulatory surgery center or an imaging center, for example, may encounter situations where fair value and book value are materially different. In some situations, the concept of economic obsolescence also needs to be considered. Economic obsolescence occurs when a facility has been “over built” for its use – for example, an ASC with four operating rooms when patient volumes are at a level where only two rooms are needed. In addition, accounting principles also require that certain intangible assets are recognized. Most people are familiar with intellectual properties such as trade names, copyrights, and patented technologies. In a business valuation context, we also encounter other intangible assets, for example, software, internal knowhow, customer relationships, trained and assembled workforce, and many others. For example, a software company has spent money and resources on developing a software technology, and that would be recognized as an intangible asset on the organization’s books. In healthcare, we may see a trade name for example, where physicians have spent decades building a brand and a local market, and patients associate that name with quality care. There is value to that brand, so that would also be recognized on the organization’s books. There might be a customer-related intangible asset, meaning we have built up a customer base that we can serve and there’s value to that customer base. We may have non-compete agreements that would also be potentially identifiable. There are many potential intangible assets that should be considered and recorded at fair value.
Once the consideration is allocated to identifiable assets and liabilities, any residual amounts are recorded as goodwill.
Private companies and non-profit organizations can elect an accounting alternative that allows certain intangible assets to be subsumed into goodwill. This eliminates valuation requirements for certain intangible assets and hence reduces the complexities of a purchase price allocation.
In summary, once an acquisition or change of control transaction occurs, the acquired company will need to determine both the amount of the consideration transferred and the fair value of assets and liabilities that were acquired.