A Comprehensive Guide to Purchase Price Allocation (PPA) 2024
In the world of mergers and acquisitions (M&A), understanding the financial nuances of a transaction is crucial. One such key aspect is Purchase Price Allocation (PPA). This process helps determine how the purchase price paid for a business is allocated across its assets and liabilities. PPA is not just a technical accounting requirement—it plays a vital role in financial reporting, tax considerations, and strategic decision-making. At Betafin Partners, as experts in finance and strategy consulting, we’ve observed that a well-executed PPA can make a significant difference in how a business is valued post-acquisition. Let’s dive into the fundamentals and importance of Purchase Price Allocation. What is Purchase Price Allocation? When one company acquires another, the total purchase price paid needs to be allocated among the acquired assets and liabilities. This allocation is based on the fair market value of identifiable tangible and intangible assets, liabilities, and any residual consideration which may lead to the creation of goodwill. PPA is a requirement under accounting standards such as IFRS 3 (International Financial Reporting Standards) and ASC 805 (Accounting Standards Codification) for business combinations. These rules ensure that post-acquisition, the financial statements accurately reflect the value of what was acquired. The Key Steps Involved in PPA 1. Determine the Purchase Price The first step is determining the total purchase price, which includes not only the cash paid but also contingent payments, assumed liabilities, stock issued, or other financial instruments exchanged as part of the deal. 2. Identify and Measure Assets and Liabilities The next step is identifying and valuing all acquired tangible and intangible assets, as well as liabilities. Tangible assets include property, equipment, and inventory, while intangible assets might include patents, customer relationships, trademarks, and more. 3. Valuing Goodwill After allocating the purchase price to all identifiable assets and liabilities, any excess of the purchase price over the fair value of net assets is recorded as goodwill. Goodwill represents the premium paid for expected future benefits from the acquisition, such as synergies, market share, or other strategic advantages. 4. Amortization and Impairment Testing Certain intangible assets are amortized over their useful life, while goodwill is not amortized but subject to annual impairment tests to ensure it retains its value on the balance sheet. Why is PPA Important? 1. Impact on Financial Statements The way purchase price is allocated can have a significant impact on the company’s balance sheet and income statement. Understated intangible assets may inflate goodwill, while overstated assets may lead to excessive amortization, reducing profits in future years. 2. Tax Implications PPA can have tax implications for both the buyer and seller. For example, the allocation to tangible and intangible assets may impact depreciation and amortization, which in turn affects the company’s tax liabilities. 3. Transparency and Investor Confidence A well-documented and accurate PPA process helps in ensuring transparency and improving investor confidence. It provides clarity about the true value of the acquired assets and goodwill, giving investors and stakeholders a clearer picture of post-acquisition performance. Common Challenges in PPA – Valuing Intangibles: Identifying and valuing intangible assets such as brand names, technology, or customer relationships can be subjective and complex. This often requires expert appraisals and sophisticated valuation methodologies. – Impairment of Goodwill: While goodwill is not amortized, it must be tested for impairment annually. Significant impairments can negatively affect earnings and create uncertainty in the market. – Changing Accounting Standards: As global accounting standards evolve, the methods and rules around PPA may also change. Keeping up with these changes is critical for accurate financial reporting. Conclusion Purchase Price Allocation is a vital part of the M&A process, ensuring that the financials of an acquisition reflect the true value of the acquired assets and liabilities. At Betafin Partners, we help businesses navigate these complex waters, providing strategic insights and technical expertise to maximize value in any transaction. A robust PPA strategy not only ensures compliance but also lays the foundation for long-term financial health and investor confidence. For further insights on PPA or to explore how we can assist your business in M&A, strategy, or finance, feel free to contact us at Betafin Partners.
BetaFin Partners recently worked on the buy-side Financial Due Diligence in a recent deal in the education space – deal value undisclosed in the public domain If we conduct the Financial Due Diligence diligently, it is amazing how much value we can add to the client Consequent to our findings dossier, the adjustment to deal value ( to be kept in abeyance till the outcomes were decided by external events e.g. order by ITAT) were impactful. They were > 2% of the deal and 150X our fee Normally if you look at the FDD for M&A landscape, it is dominated by the Big 6 – normally investors want the brand assurance , but boutique firms have their own space under the sun If you can give a client 150X multiplier on your fee, it is absolutely fulfiling and repeat business comes relatively easier hashtag#duediligence hashtag#M&A
10 Steps for ESOP Rollout in your company
Section 62(1) (b) of the Companies Act,2013 and Rule 12 of Companies Rules 2014 governs the issuing of the ESOP. The procedure to issue the ESOP under these rules is similar to the procedure under SEBI Employee Stock Option Scheme Guidelines for listed companies.
Key Consideration for ESOP Accounting
It is that part of the year when a lot of unlisted startups are finalising their books of accounts for ESOP Expenses This is governed by Guidance Note on Accounting for Sharebased Payments issued by ICAI, 2020 / Ind AS 102/ IFRS 2/ US GAAP ASC 718 Under the Black Scholes Model, the variables that influence the Fair value of the option are: • Exercise Price • Fair value of Shares / Market Price • Current Expected dividend yield • Risk free rate of return • Expected option Life • Volatility of the stock Generally, the key things to watch out for are The framework says that the valuation of options will be as on the grant date- so one has to clearly map the valuation matrix during the entire year, if grants have happened throughout. Often for practical purposes, auditors allow a Valuation report as on 30th September i.e. middle of the year; to be used for the entire year CCPS Issuance prices are Level 1 inputs and the most preferred in the Fair Value Hierarchy (Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date) The question is how do we get the implied Equity Value? A lot of companies have a view that they can consider issuance price of CCPS as the fair value of equity- assuming 1:1 conversion ratio. In other cases, they assume an standard number, say 15%, based on judgement i.e. equity will be 15% lower than CCPS- which essentially has no rational But the key questions remain that CCPS as a class of instruments needs to be valued higher than equity because of superior rights such as anti-dilution clause, liquidation preference. So preferably an exercise of applying the OPM Backsolve method should be followed. Since the ESOP Plans usually carry restrictions around transferability of the shares, the fair value of equity to be considered for BSM should be adjusted for DLOM. Chaffe is a widely accepted method for this The ESOP costs to be booked should be adjusted for e. The higher the attrition rate, the lower will be the cost to be charged to P&L – hence the CFO would be happy to have the attrition number to be optimised Ind AS – 102 – Share-based Payment does not specifically mandate the method for calculating attrition and hence it is open to wide interpretation If you go by the historical attrition, you can take the annualised value of average Monthly Attrition i.e. Exits during April / ( Opening + Closing ) /2 , Exits during May / ( Opening + Closing ) /2 …. Else, you can take Exits during April-March / ( Opening of April + Closing of March) /2 If we take a cue from AS 15 and Ind AS 19, one needs to make an assumption about how many people are expected to leave the service of the employer in future. So, its a futuristic assumption and not about the past. The past experience should only be used as a guide to set the assumption. So, let us say the past attrition was 20% but now the company has a Retention Scheme in place, it can jolly well expect that attrition be only 10%. The attrition number is also to be adjusted for any redundancies planned in the future, say layoffs in a startup that are planned And then match the expected attrition for whether it matches with the attrition assumed in the Gratuity and Leave Encashment actuarial reports. Auditors generally check for that When the options have a graded vesting schedule (for example, 25% vesting each year over four years), they should be treated like multiple grants and the fair value of each grant is amortised over the respective vesting period (the separate grant approach). Practically it needs some care to code it properly Best to source from listed peers else the industry averages Interest rate that is adopted should not be discrete but be continually compounded i.e. YTM of a Zero-Coupon Bond for the given tenure This is an important point of judgement- what is the management’s expectation on the expected dividend. In a loss-making startup, it is assumed to be zero. You could average their historical dividend yield (typically zero) with the average dividend yield of a relevant and comparable peer group.
ESOP Taxation
In case of ESOPs, employees might want to exercise the ESOPs so that the shares hit their demat and they can eventually sell them, say when there is an IPO in the future A client of ours rushed to us that he had got a hefty tax bill from his Accounts/Taxation team on exercising the ESOPs and since the sale had not yet happened, he simply did not have the money to foot the tax So, a major liquidity crunch comes when they have to pay tax on exercising the ESOPs without actually getting the cash on sale 🙁 This is at the Leg 1 stage of the ESOP taxation cycle Leg 1 The first leg of taxation under the head “Income from Salaries” u/s 17(2) of Income Tac Act is when the employee exercises the ESOPs to buy the shares. The difference between the Fair Market Value (FMV) of the shares on the exercise date and the exercise price is treated as a perquisite and is taxed accordingly. Leg 2 The second leg of taxation under the head “Capital Gains” is when the employee decides to sell the shares acquired through the ESOPs. It is the difference between the sale price and the FMV of the shares on the exercise date Of course, one would want to exercise the option at a given date and optimise taxes on the gain between that date and the sale. e.g. you exercise shares at Rs 5/- per share when FMV is Rs 50/- . This gap gets taxed Income from Salaries in Leg 1. But appreciation from Rs 50/- to Rs 200/- on actual sale gets taxed at 20% with indexation as a Long Term Capital Gain – So the Leg 2 is actually more tax efficient Is there any way of optimising the first leg of the taxation- from a liquidity perspective ? In some of our clients at BetaFin Partners , the company buys back the ESOPs, cancels the same – and the amount paid is taxable under the head Salaries (Union Budget 20202- employees of ‘eligible’ startups were given an option to defer their tax on ESOPs by five years from the date of exercise or at the time of departing the company or at the time of sale of those shares whichever happens earlier. The eligible startups are determined by a body called the Inter-Ministerial Board set up under the department for the promotion of industry and internal trade (DPIIT). But not everyone is a DPIIT. As on 31.12.2023, out of 1,17,254 startups, only 2,975 startups were given this beenfit Will having an ESOP Trust help in deferring the incidence of taxation? Yes, it does For Employees: If an ESOP structure requires the trust to hold the shares for and on behalf of the employees upon exercise. The exercise happens when the valuation is still less at a lesser perquisite tax. Then, the delta of value growth up to liquidity event/ IPO is generally taxed as capital gains at a lower rate. For the Trust:The trustees of the ESOP trust are not personally responsible for any tax liabilities. The tax implications for the trust typically involve capital gains taxes. For the Company: The tax is to be handled by the trust and the employees involved. The company hs no tax liability from trust transactions particularly when the trust is irrevocable. So, this was a analysis of the current law of the land w.r.t. ESOP Taxation
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Valuing Your Vision: Best Practices for Startup Valuation in India
The Indian startup ecosystem thrives on innovation, but determining a startup’s true worth can be a complex task. Unlike established companies, startups often lack a long track record of profitability. So, how do you assign a fair value to a company built on future potential? This blog post dives into the best practices for startup valuation in India, equipping you with the knowledge to navigate this crucial step. Understanding the Landscape: There are three main valuation methodologies used in India: Choosing the Right Method: The best valuation method depends on your specific circumstances. Here’s a breakdown to help you decide: Beyond the Numbers: While financial metrics are important, Indian valuation also considers qualitative factors: Getting Help: Valuation can be intricate, so consider seeking professional guidance. A registered valuer can provide an objective assessment and ensure compliance with Indian regulations. Remember: Valuation is not an exact science. It’s a negotiation based on data, future projections, and investor perception. By understanding the best practices and highlighting your startup’s unique strengths, you can secure a valuation that reflects your true potential and propels you towards success.
Funding Your Dreams: Innovative Ways for Indian Startups to Raise Capital
The Indian startup scene is booming, brimming with young entrepreneurs brimming with innovative ideas. But a common hurdle for many is that initial push – securing funding to bring their visions to life. Let’s break away from the traditional methods and explore some fresh approaches to bankroll your startup dream in India. 1. Revenue-Based Financing: This investor provides capital in exchange for a share of your future revenue, rather than equity. This is a win-win – you only pay when you make money, and the investor benefits from your success. Platforms like Klub and Pipe are revolutionizing revenue-based financing in India. 2. Angel Networks with a Twist: While angel investors are a tried-and-tested route, some networks are adding a twist. Super Angel invests in multiple startups at the seed stage, spreading the risk and providing valuable mentorship. This can be a good option for startups with high-growth potential but limited traction. 3. Strategic Crowdfunding: Crowdfunding platforms aren’t just for raising small amounts. Platforms like Fundable and Catapooolt allow startups to raise larger sums from a wider pool of investors. The key here is to offer investors not just equity, but also perks tied to your product or service. 4. Venture Debt with a Focus on Innovation: Venture debt providers are increasingly recognizing the need to support innovative startups. InnoVen Capital offers debt financing tailored to early-stage startups, considering factors beyond just traditional financial metrics. This can be a great option for startups with a strong business model but requiring capital for scaling up. 5. Grant Hacking: Government grants and innovation challenges are a fantastic source of non-dilutive funding. Don’t just focus on well-known schemes. Research grants offered by public sector undertakings (PSUs) or industry-specific ones might be a perfect fit for your startup’s niche. Remember: The key to success with these innovative methods is to tailor your approach. Do your research, understand the specific interests of each investor group, and craft a compelling pitch that highlights the unique value proposition of your startup. Bonus Tip: Consider incorporating alternate revenue streams into your business model. This could be a freemium model with premium features, or offering consulting services alongside your core product. This can not only make your startup more attractive to investors but also provide a safety net while you secure funding. By thinking outside the box and utilizing these innovative funding options, Indian startups can bridge the financial gap and turn their groundbreaking ideas into successful businesses.
