Accounting For Business Combinations Vrc

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ASC 805, business combinations

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Accounting For Business Combinations Vrc

  1. 1. Current Issues in Accounting for Business Combinations March 23, 2010
  2. 2. Valuation Research Corporation • Formed in 1975, VRC has eight U.S. offices and eight international affiliates. • VRC provides M & A advisory services, fairness and solvency opinions in support of corporate transactions, and valuations of intellectual property and tangible assets for financial reporting and tax purposes purposes. • VRC maintains relationships with corporations, lenders, accountants, investment banks, private equity firms, and law firms. • VRC was instrumental in forming the Appraisal Issues Task Force (AITF), a valuation industry group that meets quarterly with representatives from the FASB, the SEC, and the PCAOB to discuss valuation issues surrounding financial reporting. Valuation Research Corporation 2
  3. 3. P.J. Patel, CFA • Mr. Patel specializes in the valuation of businesses, assets and liabilities for financial reporting purposes. In particular, he has focused on the valuation of intellectual property/intangible assets such as trademarks, technology, software, customer relationships and IPR&D. • Mr. Patel is an active member of the AITF and is currently a member of the Appraisal Foundations Working Group, which is preparing a Practice Aid for valuing customer relationships. • Mr. Patel is a frequent presenter on valuation issues for financial reporting purposes and has recently presented on valuation issues relating to ASC 805 (SFAS141R), ASC 350/360 (SFAS142/144), ASC 820 (SFAS157) and other emerging issues. In addition, Mr. Patel was on the Fair Value Panel at the 2008 AICPA SEC Conference. He has been quoted numerous times in the press regarding valuation issues. Valuation Research Corporation 3
  4. 4. Edward Hamilton • Mr. Hamilton specializes in the valuation of businesses, assets and liabilities for financial reporting purposes. In particular, he has focused on the valuation of intellectual property/intangible assets such as trademarks, technology, software, customer relationships and IPR&D. He also values business interests for tax purposes. • Mr. Hamilton is an active member of the AITF and is currently involved with the Appraisal Foundation Working Group preparing a Practice Aid for the valuation of customer relationships. • Mr. Hamilton is a frequent presenter on valuation issues for financial reporting purposes and has recently presented on valuation issues relating to ASC 805 (SFAS141R), ASC 350/360 (SFAS142/144), ASC 820 (SFAS157) and other emerging issues. Valuation Research Corporation 4
  5. 5. Agenda Discussion of Current Issues in Accounting for Business Combinations, in a case study format. Issues to be discussed are as follows: • Valuing Contingent Consideration • Valuing Non-controlling Interests • Valuing Assets and Liabilities in a Bargain Purchase • Valuing Fixed Assets in a Capital Intensive Business • Most Common Audit questions • Summary of Key Issues Valuation Research Corporation 5
  6. 6. Background • SFAS141R (now ASC 805) issued December 2007 • Low M&A activity through 2008 and 1st half of 2009 • Second half of 2009 and early 2010 M&A activity increasing although increasing, the economic environment is still challenging and significant uncertainty remains regarding the future • Increased deal activity together with economic challenges has led to new and sometimes difficult issues in valuing assets and liabilities in a business combination • Evolving interpretation of the meaning of Fair Value ASC 820 (SFAS 157) Valuation Research Corporation 6
  7. 7. Valuing Contingent Consideration - Overview • Contingent consideration is generally a future obligation of the acquirer to transfer additional assets or equity to the selling shareholders. • Contingent consideration can be structured in many ways, for example: • Revenue or earnings threshold • % of revenue or earnings • Milestones Valuation Research Corporation 7
  8. 8. Valuing Contingent Consideration Case Study: Company A was acquired by Company B, a strategic buyer with similar, though more geog ap ca y d spe sed, ope a o s Key factors a e oug o e geographically dispersed, operations. ey ac o s are summarized below: • Acquisition Rationale: Company A has substantial overlap with Company B. q p y p p y As such, there are significant operational synergies. • Initial consideration: $125 million. • EBITDA: 2007 – $35 million, 2008 – $34 million, 2009 – $22 million. • Buyer projects 2010 EBITDA of $30 million. Seller expects a more significant improvement. • The buyer and seller disagreed about value as they disagreed about “normal” performance. A such, utilized contingent consideration to bridge “ l” f As h tili d ti t id ti t b id the gap. • Contingent Consideration: 6.0x 2010 EBITDA less $125 million. Valuation Research Corporation 8
  9. 9. Valuing Contingent Consideration - Issues Issues: • Is the future payment contingent consideration or employee compensation? • What is the market participant perspective on the fair value? • What methods are used to determine the fair value? • What is the fair value? Valuation Research Corporation 9
  10. 10. Valuing Contingent Consideration – Is it Consideration? Is it consideration? ASC 805-10-55-24/25 provides guidance. • Continuing employment • Duration of continuing employment • Level of compensation • Incremental payments to employees • Number of shares owned • Linkage to valuation • Formula for determining consideration Valuation Research Corporation 10
  11. 11. Valuing Contingent Consideration – Fair Value Considerations 820-10-35-3 A fair value measurement assumes that the asset or liability is exchanged in an orderly transaction between market y g y participants to sell the asset or transfer the liability at the measurement date. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. Therefore, the objective of a fair value measurement is to determine the price that would be received to sell the asset or paid to transfer the liability at the measurement date (an exit price). Valuation Research Corporation 11
  12. 12. Valuing Contingent Consideration – Determining the Fair Value • Most common approach is an income approach/probability adjusted present value. • Methodology considers expected cash flow attributable to contingent consideration and then determines the present value. Probability 2010 EBITDA Payment 2.5% 22.50 10.00 7.5% 25.00 25.00 20.0% 27.50 40.00 40.0% 40 0% 30.00 30 00 55.00 55 00 20.0% 32.50 70.00 7.5% 35.00 85.00 2.5% 37.50 100.00 Expected Value 30.00 55.00 Discount Factor (13 months @ 15%) 0.86 Present Value 47.27 Valuation Research Corporation 12
  13. 13. Valuing Contingent Consideration – Determining the Fair Value Alternate Examples An alternative scenario: • Earnout of $10 million if EBITDA is $30 million. • What if deal model projects $28 million? Is the fair value zero? • What if the deal model projects $32 million? Is the earnout “certain?” Valuation Research Corporation 13
  14. 14. Valuing Contingent Consideration – Alternate Examples Probability 2010 EBITDA Payment • Deal model implies contingent consideration 2.5% 26.00 0.00 is paid. 7.5% 28.00 0.00 20.0% 30.00 10.00 • Management assisted VRC in determining a 40.0% 40 0% 32.00 32 00 10.00 10 00 range of potential outcomes. 20.0% 34.00 10.00 • Payment is still considered fairly likely. 7.5% 36.00 10.00 • Buyer and seller were in agreement. 2.5% 38.00 10.00 Expected Value 32.00 9.00 Discount Factor (13 months @ 15%) 0.86 Present Value 7.74 Probability 2010 EBITDA Payment 2.5% 22.00 0.00 • Deal model implies no contingent consideration consideration. 7.5% 24.00 0.00 • Management assisted VRC in determining a range 20.0% 26.00 0.00 of potential outcomes. 40.0% 28.00 0.00 • There is a modest, though finite, likelihood of 20.0% 30.00 10.00 payment. 7.5% 7 5% 32.00 32 00 10.00 10 00 2.5% 34.00 10.00 • Buyer and seller were in agreement. Expected Value 28.00 3.00 Discount Factor (13 months @ 15%) 0.86 Present Value 2.58 Valuation Research Corporation 14
  15. 15. Valuing Contingent Consideration – Additional Considerations • Expected Contingent Consideration • Why did the transaction utilize contingent consideration? • What is the buyer’s expectation? Seller? • What is the range of potential outcomes? Does the business exhibit stable or volatile results? • If volatile results, are there extreme values? If extreme values, are they are on the upside or downside? • Determining the range of estimates? Management expectations? Historical observations? Market observations? • Discount Rate • IRR • Industry discount rate • WACC Valuation Research Corporation 15
  16. 16. NCI in a Business Combination - Overview NCI • Non-controlling interest • The portion of equity ( p q y (net assets) in a subsidiary not attributable, directly or ) y , y indirectly, to the parent • An NCI was formerly called a minority interest • ASC 810 (SFAS 160) requires fair value of NCI to be determined and included as part of equity or in some cases as a liability • Occurs when less than 100% of a business is acquired (i.e. control is acquired thus consolidated but percentage is less than 100%) Valuation Research Corporation 16
  17. 17. Valuing Non-Controlling Interests Case Study: Company A acquires 70% of Company B for a purchase price of $70 million. Post transaction, the selling shareholders retain 30% of , g Company B but can “put” the shares to Company A at their Fair Market Value. Issues: • What is the value of the 30% NCI? • Should the fair value of the NCI reflect adjustments for lack of control and lack of marketability? Valuation Research Corporation 17
  18. 18. Valuing Non-Controlling Interests – What is the Fair Value? What is the value of the NCI? • NCI is equal to is fair value at the closing date of the transaction • Purchase price of $ million for 70% ( p p $70 (implied EV of $ $100 million) is ) generally a good starting point • Need to do other calculations to substantiate that value estimate is reasonable • DCF, guideline company and comparable transaction approaches • Adjust for lack of control and lack of marketability, as appropriate Valuation Research Corporation 18
  19. 19. Valuing Non-Controlling Interests – Lack of Control Adjustment Factors to consider in determining adjustments for lack of control, include but are not limited to the following: • Is the shareholder disadvantaged relative to the controlling shareholder? • Do the controlling shareholders receive an inordinate share of returns? • Is the company managed inefficiently? • Can the controlling shareholder make decisions that are to the detriment of other shareholders? • Can shareholder remove top management? • Are minority shareholders involved in the management of the company? • Can a vote of minority shareholders still influence the board of directors? Valuation Research Corporation 19
  20. 20. Valuing Non-Controlling Interests – Marketability Adjustment Numerous factors affect marketability adjustments for equity interests that are non-public or not actively traded. Factors include, include but are not limited to the following: to, • “Put” rights; • Dividends or distributions; • Size of potential market of buyers; • Prospects for going public or being acquired; • Restrictive transfer provisions; • Size and financial strength of the subject company; • Size of the interest in question. Valuation Research Corporation 20
  21. 21. Valuing Non-Controlling Interests – Determining the Fair Value Value of NCI • Enterprise Value was determined to be $100 million based on valuation calculations and purchase price of $70 million for 70% • Other valuation calculations support a value an enterprise value of $100 million • Fair Value of 30% NCI determined to be $30 million, if marketable • Value was not adjusted for a lack of control as the NCI was deemed to have the same rights as the controlling shareholders • NCI deemed marketable due to the presence of a put option • Alternatively, Alternatively value would be $30 million if NCI is publicly traded • If deemed non-marketable, fair value of NCI is adjusted for lack of marketability Valuation Research Corporation 21
  22. 22. Bargain Purchase – Overview Bargain purchase • ASC 805 definition: Total acquisition-date fair value of the identifiable net assets acquired exceeds th fair value of the consideration t t i d d the f i l f th id ti transferred plus f d l any non-controlling interest in the acquiree. • Presence of a bargain purchase requires the acquirer to recognize the excess as a gain gain. • In contrast, SFAS 141 required appropriate reduction to the assets acquired. Valuation Research Corporation 22
  23. 23. Bargain Purchase – Is it a Bargain Purchase? 805-30-25-4 Before recognizing a gain on a bargain purchase, the acquirer shall reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed and shall recognize any additional assets or liabilities that are identified in that review. See paragraphs 805-30-30-4 through 30-6 for guidance on the review of measurement procedures in connection with a reassessment required by this paragraph. 805-30-30-5 Paragraph 805-30-25-4 requires the acquirer to reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed before recognizing a gain on a bargain purchase. As part of that required reassessment, the acquirer shall then review the procedures used to measure the amounts this Topic requires to be recognized at the acquisition date for all of the following: a. The identifiable assets acquired and liabilities assumed b. The non-controlling interest in the acquiree, if any c. c For a business combination achieved in stages the acquirer’s previously held equity interest in stages, acquirer s the acquiree d. The consideration transferred. Valuation Research Corporation 23
  24. 24. Bargain Purchase – Is it a Bargain Purchase? Factors to Consider • Is there a reason to believe it was a bargain purchase? • Is th I the purchase price significantly below th value of t h i i ifi tl b l the l f tangible assets? ibl t ? • Is the purchase price significantly below working capital? • Is the purchase price significantly below observed market multiples? Transaction multiples? • Was the seller financially distressed? • Was the seller unaware of the value of the business? • If goodwill is modestly negative were there assets/liabilities not measured negative, appropriately or was an asset/liability omitted? Valuation Research Corporation 24
  25. 25. Valuing Fixed Assets in a Capital Intensive Business Case Study: Company A acquires Company B for a purchase price of $100 million. Key metrics are summarized below: • Acquisition rationale: relatively inexpensive entry (4x EBITDA) into the market/region • Revenues – 2007 – $350 million, 2008 – $300 million, 2009 – $250 million • EBITDA – 2007 – $60 million, 2008 – $40 million, 2009 – $25 million illi illi illi • Book value of acquired working capital $20 million • Book value of acquired PP&E $80 million • No owned real estate Issues: • What is the market participant perspective on the value of fixed assets? • Is there any value associated with the trademark and customer intangible assets? y g • Is this a bargain purchase? Valuation Research Corporation 25
  26. 26. Valuing Fixed Assets - Issues • There is value to the intangible assets? • Given a purchase price of 4x EBITDA, the likelihood of a bargain purchase seems remote, rather it appears that the buyers, implicitly or explicitly, factored in an adjustment to the value of the fixed assets • Which scenario, or combination of scenarios, reflects the fair value of PP&E? PP&E - Book PP&E – Value PP&E – Account Value In-Use In-Exchange Purchase Price $100 $100 $100 Working capital 20 20 20 PP&E 80 90 20 Trademark 0 5 5 Customer Relationships 0 10 10 Goodwill 0 (25) 45 Valuation Research Corporation 26
  27. 27. Valuing Fixed Assets – Fair Value Guidance • Review ASC 820 for any appropriate guidance • Basics: • Fair value definition • The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date • Establishes a framework for measuring fair value • The price • Principal/most advantageous market • Use of market participant inputs rather than company-specific inputs • Application to assets • Application to liabilities • Characteristics of the asset or liability Valuation Research Corporation 27
  28. 28. Valuing Fixed Assets – Fair Value Guidance The Price 820-10-35-3 A fair value measurement assumes that the asset or liability is 35 3 y exchanged in an orderly transaction between market participants to sell the asset or transfer the liability at the measurement date. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date considered from the perspective of a market participant date, that holds the asset or owes the liability. Therefore, the objective of a fair value measurement is to determine the price that would be received to sell the asset or paid to transfer the liability at the measurement date (an exit price). Valuation Research Corporation 28
  29. 29. Valuing Fixed Assets – Fair Value Guidance Application to Assets 820-10-35-11 Because the highest and best use of the asset is determined based on its use by market participants the fair value measurement considers participants, the assumptions that market participants would use in pricing the asset, whether using an in-use or an in-exchange valuation premise. Valuation Research Corporation 29
  30. 30. Valuing Fixed Assets – Determining the Fair Value Conclusion • In this circumstance, the value of PP&E was based on an in-use premise and then adjusted for economic obsolescence. As such, the value in-use estimate was adjusted for the time to regain full utilization of the assets PP&E – PP&E – PP&E – Adjusted for Book Value In- In-Exchange economic Account Value Use obsolescence Purchase Price $100 $100 $100 $100 Working capital 20 20 20 20 PP&E 80 90 20 55 Trademark 0 5 5 5 Customer 0 10 10 10 Relationships Goodwill 0 (25) 45 10 Valuation Research Corporation 30
  31. 31. Most Common Audit Questions • How is ASC 820 reflected in your fair value calculations? • Is the earn-out contingent consideration or compensation? • Is there a previously held equity interest in the target company? If yes how was it valued? Valuation Research Corporation 31
  32. 32. Contact Information PJ Patel Email: ppatel@valuationresearch.com Direct: 609 243 7030 609.243.7030 Mobile: 609.240.1337 Ed Hamilton Email: ehamilton@valuationresearch.com Direct: 609.243.7018 Mobile: 609.221.8174 Valuation Research Corporation 32
  33. 33. U.S. Office Locations Boston Milwaukee San Francisco 101 Federal Street 330 East Kilbourn Avenue 50 California Street , Suite 3050 Boston, MA 02110 Milwaukee, WI 53202 San Francisco, CA 94111 617.342.7366 414.271.8662 1 2 1 8662 415.277.1800 1 2 1800 Chicago New York Tampa 200 W. Madison Street 500 Fifth Avenue 777 S. Harbour Island Blvd. Chicago, IL 60606 New York, NY 10110 , Tampa, FL 33602 813-463-8510 312.957.7500 212.983.3370 Cincinnati Princeton 105 East Fourth Street 200 Princeton Corporate Center Cincinnati, Cincinnati OH 45202 Ewing, NJ 08628 513.579.9100 609.452.0900 Valuation Research Corporation 33
  34. 34. International Affiliate Office Locations Buenos Aires London Monterrey Vuelta de Obligado 2728 90 Chancery Lane Ricardo Cantu Leal #115 Piso 2 so London, WC2A 1EU Colonia LTH Buenos Aires C1428 ADT Col. Florida Argentina Luxembourg Monterrey, N.L. 31 Boulevard Marcel Cahen C.P. 64830 Frankfurt L-1311 Luxembourg Mexico Rennbahnstraße 72-74 60528 Frankfurt am Main Madrid M d id Paris P i Germany Alcalá, 265, Edificio 2 127, Rue des Dames 28027 Madrid 75017 Paris Hong Kong Spain France 22nd Floor, Siu On Centre 188 Lockhart Road Melbourne São Paulo Wanchai, Hong Kong Level 10, 470 Collins St. Rua Alvarenga 1757 Butantã Melbourne, Victoria 3000 05509-004 São Paulo SP Australia Brazil Valuation Research Corporation 34

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