“Balancing Perspectives: To Bridge Share Purchase Agreement with Accounting Treatment” – What to look out for or consider during deal structuring?
Mergers and acquisitions (M&A) refer to transactions between two companies combining in some form which usually is for several reasons, such as the unlocking of synergies, achieving higher growth, diversification, or even stronger market power.
M&A deals in Asia Pacific have hovered around 7,000 marks between 2019 to 2021 and had declined to 4,300 deals till September 2024 since Covid-2019. The ever-challenging macroeconomic conditions, marked by inflation, rising interest rates, and declining discretionary spending worldwide, placed significant strain on the profit margins that affect the growth. Concurrently, heightened geopolitical and economic uncertainties, alongside increased financing expenses, dampened M&A acquisition activities in the market.[1] With inflation easing and deal appetites rising, we probably can expect a modest increase in M&A activity in 2025.
After a deal is completed, a Purchase Price Allocation (PPA) exercise is generally required to determine the fair value of the purchase consideration and net assets acquired when the Acquirer obtains control of the acquiree in accordance with Singapore Financial Reporting Standard (International) SFRS(I) 3 – Business Combination. If it is not in accordance with SFRS(I) 3 but entails Investments in Associates and Joint Ventures in accordance with SFRS(I) 1-28, it still requires a PPA to be done. The eventual resultant goodwill will also need to be accounted under annual impairment assessment in accordance with SFRS(I) 1-36 – Impairment of Assets.
What are the key steps to consider for a typical PPA:
From a business standpoint, the primary focus in an M&A transaction is strategic alignment and value creation. Business leaders are simply concerned with synergies (potential cost savings and revenue enhancements), growth prospects (ability of acquisition to boost growth via new markets expansion or leveraging target company’s strengths) and competitive advantages (economies of scale, enhanced market power).[2] The PPA is simply a necessary step in accounting regulations, to determine the fair market value of the company post-M&A transaction. With regards to the PPA process, there is an increased focus on areas such as purchase considerations and contingent considerations because these areas directly impact the financial and operational outcomes of the acquisition.
Common pitfalls when performing the PPA exercise or things to consider when drafting the Share Purchase Agreement (SPA):
Upon executing the letter of intent and completion of due diligence work, both seller and buyer would proceed to draft the SPA in acquiring the business/entity or assets of the target. The buyer may need to discuss with the auditors and consider applying the simplified assessment process for the acquisition, that is, the optional ‘concentration test’ to assess whether the transaction meets the business combination definition before going through the vigorous process with the engaged valuer.
A concentration test is an assessment to determine if a newly acquired set of activities and assets constitutes a business or an acquisition of assets. The test is considered met if a substantial portion of the fair value of the acquired assets is concentrated in a single identifiable asset or a group of similar assets. If the test is successful, the acquired set of activities and assets are not considered a business and further evaluation is unnecessary. In other words, this is a shorter way of concluding the acquisition is not a business if the criteria in the concentration test are met.
Acquirer needs to be mindful when preparing the PPA exercise as accounting standard specifies for valuation to be performed on the date the control is obtained, which typically is the date the acquirer legally transfers the consideration, and assets and liabilities. However, the acquirer might obtain control on a date that is earlier or later than the closing date and this would be stipulated within the SPA.
A purchase consideration is the total agreed value to be paid by the acquirer to acquire another company or business. The composition of a purchase consideration varies depending on the agreed upon terms of the acquisition. Evidently, this has a significant impact on the profits that go to the seller, and the value generated by the acquirer. The common components of a purchase consideration include cash payments, equity instruments, stock options and most importantly, contingent considerations (earn-outs or milestone payments).
Purchase consideration comprising of shares in a listed company with inactive trading has to be valued by analysing the income projections instead of relying on the stock price of the acquirer.
i) Contingent Consideration/Earnouts
A contingent consideration is an additional consideration (usually in the form of cash or shares) that will be transferred to the former owners of an acquiree if the specified future conditions or performance targets are met. Contingent consideration is applied in two situations: if the buyer and seller cannot agree on the value of the acquired business, or if the buyer and seller wish to share the risk of changes in the value of the business or of a particular project. Earnouts serve as an incentive to the seller to optimize the performance of the post-acquisition business. However, it will cause complexity in estimating the fair value which management may consider assigning probabilities to different profit outcomes in case of contingencies.
Contingent consideration has to be accounted and appropriately fair valued as at acquisition date as goodwill is only determined once with any future adjustments remeasured in cash earn out through income statement. Fixed shares settlement for earnout payment has to be fair valued based on forward price as at acquisition date which is classified as equity instrument.
ii) Call / Puts and Forward Contracts
Some SPA may even consider call or put options or forward contracts to acquire the remaining interests of the entity from the non-controlling interests (NCI), which allows more time for the buyer to obtain a better understanding of the financial effects of the acquisition. The accounting treatment of the respective contracts to purchase additional shares in the acquiree is dependent on whether ownership benefits are transferred to the acquiree as at acquisition date. If it is transferred to acquirer, it is considered as part of the business combination which is included within the controlling interests. If it is not transferred to acquirer, it will be accounted as a separate transaction and is classified and measured in accordance with SFRS(I) 1-32 – Financial Instruments: Presentation.
With the whole PPA exercise and conclusion of goodwill that is determined once at completion of transaction, the acquirer must also be mindful of the risk of goodwill impairment post-acquisition. The acquirer is responsible for conducting annual impairment tests to determine if the carrying amount of goodwill exceeds its recoverable amount. This requires a thorough analysis of the acquired business’s performance and future cashflow projections. If the impairment is identified, the acquirer must adjust the carrying amount of goodwill, which can have a significant impact on the financial statements.
Acquirer is required to account for the acquisition of a foreign operation in the functional currency of the foreign operation instead of the currency stipulated in the SPA. This may affect the subsequent re-measurement of the currency if it is volatile which may affect the operating results of the financial statements.
Conclusion
Ultimately, a PPA exercise requires a harmonious blend of strategic vision and meticulous financial analysis. Business leaders and accountants can work together to achieve a seamless and accurate PPA, driving the success of the M&A transaction and creating lasting value for the combined entity. So, be it a business leader excited about new growth opportunities or an accountant meticulously piecing together the financial puzzle, remember that balancing both commercial and accounting requirements is the key to unlocking the full potential of your M&A endeavour.
With the above concerns, business owners may engage specialists like us to perform due diligence and pre-acquisition PPA exercise to gauge the indicative goodwill or intangible assets value to assess for any post-acquisition adverse financial impact.
At CLA Global TS, our team of dedicated professionals are equipped with the relevant knowledge and experience across various industries to assist business owners in their potential acquisitions and financial reporting requirements.
Footnotes
[1] Growing confidence: Consumer M&A Outlook 2024 – KPMG Global
[2] Mergers and Acquisitions (M&A): Types, Structures, Valuations (investopedia.com)
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Grace Lui Co- Advisory Leader, Director, Valuation, Transaction Services & Outsourcing gracelui@sg.cla-ts.com |
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Karen Lau Associate Director, Valuation & Transaction Services karenlau@sg.cla-ts.com |