Earn your certification as a Financial Modeling & Valuation Analyst (FMVA)®. Register today!

M&A Considerations and Implications

Considering the factors and complications of mergers

M&A – top considerations and implications

In M&A transactions there are several important factors that executives, investment bankers, and other stakeholders have to consider, including:

  1. Form of consideration (cash vs. shares)
  2. Accounting
  3. Tax treatment
  4. Synergies
  5. Strategic rationale
  6. Intangibles

 

M&A - most important considerations

 

#1 Form of consideration for the M&A deal

In order for a company to consider a merger or acquisition, there are a few things that need to be reviewed.

 

Cash vs. Stock Consideration Mix

The first item that needs to be considered is how sellers get paid and the buyers pay. There are many ways that a business seller can be compensated in regards to a merger or acquisition. These compensation methods can be extensive and complex.

The payment normally includes cash, company stock, a payable note, or a combination of all three. The buyer normally sources the cash via debt or equity.

Whether a buyer uses company stock, cash, or a note can depend on a number of factors.

 

Impact on Pro-forma EPS and Ownership

The next item is the impact that the purchase will have on the acquirer after the transaction as opposed to before. The financials of the two merged companies will need to be analyzed using a merger model.

The goal of this analysis is to determine how the buyer’s earnings per share (EPS) will change due to the merger. An increase in EPS is called Accretion and a decrease is called Dilution.

This analysis will consider whether the merger or acquisition will be financially beneficial to the new owner’s bottom line.

 

Impact on Credit Statistics

Another item to consider when thinking about how the buyer will purchase the company at hand is what effect their payment method could have on the company or owner’s credit. Just with any large purchase, if using a note or even cash that was taken from a loan, a credit report will be pulled and the business will acquire debt. This will, in turn, decrease the credit rating.

 

#2 Accounting in M&A transactions

Mergers and acquisition require many financial and tax reports.

 

Purchase Price Allocation

Acquisition accounting includes a purchase price allocation (PPA) which is pretty much just what it says – an allocation of the purchase price paid to the assets and liabilities that are included in the transaction. It is importnat becuase it is how Goodwill is determined in M&A transaction (i.e. Purchase Price less Net Identifiable Assets = Goodwill).

The application of allocation happens when one company (the acquirer) purchases the second company and allocates the purchase price into the assets and liabilities. These are used for both financial and tax purposes.

 

New Depreciation and Amortization from Write-Ups

Tying directly into the purchase price allocation of the acquired net assets, the write-up values of the tangible and intangible assets that are collected must be depreciated and amortized over time and reported on the income statement as such.

 

Creation of Goodwill

Goodwill, from an accounting perspective, is an intangible asset that comes from a business buying another firm. The money paid to buy the business divided by the business’s assets and liabilities is the goodwill.

Goodwill is not subject to periodic amortization and includes things like the value of the business’s brand name in the marketplace, patents, and technology owned by the company. It also includes customer relations, the customer base and a stable workplace.

Goodwill cannot be seen or touched which is why it is considered an intangible asset. This is incredibly important when merging or acquiring another company as the goodwill will also be transferred and could change the worth of the company based on its positive or negative branding.

The formula for goodwill in an M&A transaction is:

  • Goodwill = Purchase Price – Net Identifiable Assets

 

#3 Tax treatment in M&A

 

Asset Sale

Asset sales are pretty straightforward when it comes to taxes. Asset sales are favorable to buyers when it comes to taxes as the assets will get the benefit of depreciation deductions, in turn reducing the buyer’s taxes going forward.

 

Stock Sale

Tax will almost always be minimized if the transaction is treated as a stock sale rather than an asset sale. The reason being is because the seller pays immediate tax on its gain when the sale involves assets; therefore, this is not the favorited option by the seller. The individual assets retain their character, bases, and holding periods with stock sales.

 

Stock Sale with 338 or 338(h)(10) Elections

In this case, the tax consequences of an asset sale is achieved in the form of a stock transfer transaction. This is ideal if it is preferred to do a stock sale for commercial purposes because it avoids the need to transfer the ownership of all individual assets.

 

#4 Synergies in M&A deals

Synergy itself is the added value generated by combining two companies – creating opportunities that would not have otherwise been available to these firms operating individually. Synergies are ways to increase profit and earnings per share through either an acquisition or a merger (aka why companies merge in the first place).

 

Estimating and Valuing synergies

Estimating and valuing synergies in mergers and acquisitions are based on measuring the value of benefits that various synergies will bring (aka it is the value enhancement of the buyer). For example, though an operating synergy may not have any monetary value, it could reduce the costs of sales, thereby increasing profit margin.

For a synergy to affect value, it must influence the firm in at least one of the following ways:

  • Lengthen the growth period
  • Lower the firm’s cost of capital
  • Increase cash flows from existing assets
  • Increase the firm’s expected growth rates

 

#5 Strategic rationale for M&A

Adding value to a company through combining it with another will create synergies that make sense.

  • Financial synergy
  • Operating synergy
  • Growth
  • Market Power
  • Corporate Tax Savings
  • Retirement
  • Tax Incentives
  • Market/ Business/ Product Line Issues
  • Acquire Needed Resources (customers, manpower, etc.)
  • Diversification

 

#6 Transaction “intangibles”

Intangibles are assets that are not physical in nature. In this case, some M&A transaction intangibles may include the following:

  • A patent
  • Customer lists
  • Employee five-year non-compete agreements
  • Tech that is unpatentable
  • Trademarks
  • Copyrights
  • Business methodologies
  • Goodwill
  • Brand recognition

 

Read more about M&A

  • Tax-Free Reorganizations
  • Type A Reorganization
  • Section 368
  • DCF Modeling Guide
  • Financial Modeling Best Practices

Valuation Techniques

Learn the most important valuation techniques in CFI’s Business Valuation course!

Step by step instruction on how the professionals on Wall Street value a company.

 

Learn valuation the easy way with templates and step by step instruction!