In M&A transactions there are several important factors that executives, investment bankers, and other stakeholders have to consider, including:
Form of consideration (cash vs. shares)
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 how 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 (seller financing), 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 deal-specific 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 is closed. 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 buyer’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 may, in turn, decrease the acquirer’s credit rating.
2. Accounting in M&A transactions
Mergers and acquisition require many financial and tax reports.
Purchase Price Allocation
Acquisition accounting includes a process known as purchase price allocation (PPA). This is an allocation of the purchase price to the assets and liabilities that are included in the transaction. This allocation marks the acquired assets and liabilities to fair market value (FMV). If the purchase price is still greater than the FMV of net assets (assets minus liabilities) then the excess is an intangible asset known as Goodwill.
Purchase price allocation happens when one company (the acquirer) purchases the second company and allocates the purchase price into the assets and liabilities. This process is used for financial records, and sometimes, 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
As discussed above, goodwill is an intangible asset that comes from a business buying another firm.
Goodwill is not typically subject to periodic amortization and includes things like the value of the business’s brand name in the marketplace, customer relations, 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 be transferred to the buyer.
The formula for goodwill in an M&A transaction is:
Goodwill = Purchase Price – FMV of Net Identifiable Assets (FMV of assets minus FMV of liabilities)
Considerations for engaging in M&A consist of many of the following: using cash or stock to acquire the target, accounting implications, tax treatment, etc.
Purchase price allocation is the process of allocating the target’s assets and liabilities to fair market value.
Acquisitions structured as asset sales are generally more favorable for the buyer, relative to acquisitions structured as stock sales.
3. Tax treatment in M&A
Asset sales are favorable to buyers when it comes to taxes as the assets will get the benefit of higher depreciation deductions (due to fair market value write-ups), which will reduce the buyer’s cash taxes going forward. This is because many tax authorities allow the target’s tax records to be marked to fair market value, just as the acquirer would do when calculating the purchase price allocation under GAAP or IFRS rules.
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 an immediate tax on its gain when the sale involves assets; therefore, this is not the favored option by the seller. The individual assets retain their character, tax basis and holding periods with stock sales. Most tax authorities do not allow the tax records of the target to be changed in a stock sale, although there are exceptions (see next paragraph).
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. The 338 or 338(h)(10) is the United States-specific law for classifying a stock transaction as an asset transaction for tax purposes. Other jurisdictions are likely to have something similar in place.
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 (in other words, this is why companies merge in the first place).
Estimating and Valuing synergies
Estimating and valuing synergies in mergers and acquisitions is based on measuring the value of benefits that various synergies will bring (aka it is the value enhancement of the buyer). For example, an acquirer buys a target. The acquirer already has a CEO so the target CEO would be let go, thereby increasing the 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.
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