Merger Model - Advanced Flashcards
What’s the difference between Purchase Accounting and Pooling Accounting in an M&A deal?
In purchase accounting the seller’s shareholders’ equity number is wiped out and the premium paid over that value is recorded as Goodwill on the combined balance sheet post-acquisition. In pooling accounting, you simply combine the 2 shareholders’ equity numbers rather than worrying about Goodwill and the related items that get created.
99% of M&A deals you will use purchase accounting.
Why do deferred tax liabilities (DTLs) and deferred tax assets (DTAs) get created in M&A deals?
These get created when you write up assets - both tangible and intangible - and when you write down assets in a transaction. An asset write-up creates a deferred tax liability, and an asset write-down creates a deferred tax asset.
You write down and write up assets because their book value - what’s on the balance sheet - often differs substantially from their “fair market value.”
An asset write-up creates a deferred tax liability because you’ll have a higher depreciation expense on the new asset, which means you save on taxes in the short-term - but eventually you’ll have to pay them back, hence the liability. The opposite applies for an asset write-down and a deferred tax asset.
Could you get DTLs or DTAs in an asset purchase?
No, because in an asset purchase the book basis of assets always matches the tax basis. They get created in a stock purchase because the book values of an asset are written up or written down, but the tax values are not.
What’s a section 338(h)(10) election and why might a company want to use it in an M&A deal?
A 338(h)(10) election blends the benefits of a stock purchase and an asset purchase.
Legally it is a stock purchase, but accounting-wise it’s treated like an asset purchase.
The seller is still subject to double-taxation - on its assets that have appreciated and on the proceeds from the sale.
But the buyer receives a step-up tax basis on the new assets it acquires, and it can depreciate/ amortize them so it saves on taxes.
What is an exchange ratio and when would companies use it in an M&A deal?
An exchange ratio is an alternative way of structuring a 100% stock M&A deal, or any M&A deal with a portion of stock involved.
Let’s say you were going to buy a company for $100 million in an all stock deal. Normally you would determine how much stock to issue by dividing the $100 million by the buyer’s stock price, and using that to get the new share count.
With an exchange ratio, by contrast, you would tie the number of new shares to the buyer’s own shares - so the seller might receive 1.5 shares of the buyer’s shares for each of its shares, rather than shares worth a specific dollar amount.
What are the most important terms of a Purchase Agreement in an M&A deal.
Purchase price
Forms of consideration
Transaction Structure
Treatment of Options
Employment Retention
Reps & Warranties
No Shop / Go Shop
What’s an Earnout and why would a buyer offer it to a seller in an M&A deal?
An Earnout is a form of “deferred payment” in an M&A deal - it’s most common with private companies and start-ups, and highly unusual with public sellers.
It is usually contingent on financial performance or other goals
What are the main 3 transaction structures you could use to acquire another company?
Stock purchase, asset purchase, and 338(h)(10) election
Would a seller prefer a stock purchase or an asset purchase? What about the buyer?
A seller almost always prefers a stock purchase to avoid double taxation and to get rid of all its liabilities. The buyer almost always prefers an asset deal so t can be more careful about what it acquires and to get the tax benefit from being able to deduct depreciation and amortization of asset write-ups for tax purposes.
How do you account for transaction costs, financing fees, and miscellaneous expenses in a merger model?
You used to capitalize these expenses and then amortize them; with the new accounting rules, you’re supposed to expense transaction and miscellaneous fees upfront, but capitalize the financing fees and amortize them over the life of the debt.
Now, they come out of retained earnings when you adjust the balance sheet, while capitalized financing fees appear as a new asset on the balance sheet and are amortized each year according to the tenor of the debt.
