You did it! You successfully got the deal to the finish line! Once the buyer signs that dotted line purchasing a company, what happens next? Allocation happens next (well, maybe first a celebration, but closely thereafter comes allocation). The amount paid for the business gets allocated between the assets acquired and liabilities assumed – all valued as part of the transaction.
At the acquisition date, the business is revalued based on the consideration outlined in the purchase agreement, and the value of the assets and liabilities transferred gets recorded on the financial records at fair value as of that date. Part of this revaluation includes identifying intangible assets – think tradenames, customer lists and goodwill – and assigning an estimate of fair value to those assets at day 1. The value of the intangibles can be determined by a number of valuation methods, such as:
- Income approach
- Market multiple
- Relief from royalty
The value of the enterprise is considered in allocating value to each of the intangibles and goodwill based on the purchase price.
If you don’t get incredibly excited about different valuation methods like our team does, let’s break it down a bit as to what this means. When you are looking for a company to buy, it’s important to understand the value of the net assets being purchased. The allocation of the purchase price is based on the value on the transaction date – so determining the fair value of the net assets soon after the deal closes is crucial (if you take anything away from this article…). Working capital account balances often approximate fair value, but the following are examples of assets and liabilities that will most likely require fair value adjustments at the transaction close date:
- Employment agreements
- Computer software
- Intellectual property
- Customer lists
- Noncompete agreements
The Nitty Gritty
A valuation to allocate a deal’s purchase price isn’t just a nice to have – in most instances, to conform with GAAP, you must revalue net assets to their acquisition date fair value. When your financial statements are audited by your accounting firm, this is information they will require and review. The best advice we can give is to have your valuation performed immediately upon the closing of the purchase of a new business (either a platform investment or an add-on) and to use a reputable, trusted valuation professional for the job.
The Risks (We Have to Address Them)
This valuation can be performed months after a purchase, but it creates complications and unnecessary headaches (and often costs more). The more time that passes after a sale is finalized, the harder it is to determine a company’s past value. It becomes a process wrought with more assumptions than hard facts. Honestly, who can remember details past yesterday? Further, auditors often require inventory or fixed assets to be observed by a third party, and if that is not done at the acquisition date, it is typically difficult and costly to determine what inventory and fixed assets existed at the acquisition date.
Information Gathered – Get it Ready
While a purchase price valuation covers everything you’ll need for your audit, it also provides the facts and details your lawyers and tax accountants need to perform their jobs. Having this information is critical. Plus, it makes you look good.
Performing Allocation Purchase Price Due Diligence
Our transaction advisors have worked on both sides of this scenario: performing the valuation of a company just purchased and reviewing the valuation as the company’s auditors. Bottom line: we’ve been there, we’ve done that. And we are ready to help you during this step, too. To learn more, contact our pros.