As the deal progresses, issues undoubtedly arise and it is important for each party to reconsider their positions, as well as to understand potential risks and how these risks, if determined material, can be mitigated.
As our earlier blogs noted, due diligence findings should be used to shape the transaction so it can still deliver value and operational teams should be involved in confirming the validity of assumptions and assessment of synergies.
The question of valuation is invariably brought into focus as parties assess and refine a deal. Due diligence findings can ultimately impact the price of a deal as earnings are validated and purchase price adjustments are considered. Working capital, the link between profit and cash in a business, is one such purchase price adjustment that can have a material impact on the amount of cash that is exchanged in a transaction.
Our Working Capital Centre of Excellence highlights the importance of considering working capital both in deal structure and valuation. Misunderstandings as to how working capital will be treated in the transaction can be material to value and potentially terminal to the success of the transaction.
Australian accounting standards require buyers to allocate the consideration paid in a business acquisition to all assets acquired and liabilities assumed, including both tangible and intangible assets, for financial reporting purposes. This exercise is often undertaken post-deal, however the consideration of the purchase price allocation (PPA) during deal assessment is important given Board decision makers are commonly concerned with whether or not the deal will be earnings per share (EPS) accretive or dilutive and can impact the approach to communications the deal.
An important consideration in the assessment of EPS is the intangible assets that will potentially be acquired as a part of the deal. The acquisition of intangibles which amortise to the P&L (such as software or customer arrangements), while being non-cash, will impact earnings and therefore EPS. We have discussed the impact of PPAs on EPS in an earlier McGrathNicol blog.
PPAs may result in new assets being recognised post-deal and existing assets being restated to fair value. In addition to the future amortisation impacts already highlighted, intangible assets considered to have indefinite useful lives (such as brands and goodwill) require regular impairment testing which can have future profitability impacts. Assets that are restated to fair value (such as inventory and deferred revenue) may also materially impact future reported earnings. Early consideration of such impacts enables strategic communication to shareholders and can assist in managing expectations after deal completion.
Thorough deal assessment involving a coordinated team approach results in a more informed position as the deal moves through to the negotiation stage of the transaction life cycle and helps to avoid any surprises post-deal.
This article is five of the ‘Transaction lifecycle’ series.
Part one: Don’t let a poorly planned transaction destroy value, or your business
Part two: Assessing the strategy – why transact?
Part three: Assessing synergies – when is a combined business more valuable than the sum of the parts?
Part four: Driving success (and minimising risk) of transactions with focussed due diligence