Consideration or purchase price is a crucial aspect of any business combination or amalgamation. It refers to the amount paid or agreed to be paid by the acquiring company to the acquired company or companies for acquiring their assets and liabilities, and thereby, gaining control over their business operations.
There are several factors that influence the consideration or purchase price for amalgamation or business combination, such as the size and financial performance of the companies involved, the value of their assets and liabilities, the synergy expected from the amalgamation, the market conditions, and the prevailing regulatory environment.
Factors that determine the consideration or purchase price for amalgamation:
- Size and financial performance of the companies: The size and financial performance of the companies involved in the amalgamation play a crucial role in determining the consideration or purchase price. Generally, a larger and financially stronger company would command a higher price compared to a smaller or weaker company.
- Value of assets and liabilities: The value of the assets and liabilities of the companies involved in the amalgamation also plays a significant role in determining the consideration or purchase price. The acquiring company would be willing to pay a higher price if the acquired company has valuable assets, such as intellectual property, patents, and trademarks, and if its liabilities are manageable.
- Synergy expected from the amalgamation: Synergy refers to the benefits that the acquiring company expects to derive from the amalgamation, such as cost savings, economies of scale, and increased market share. The greater the synergy expected from the amalgamation, the higher the consideration or purchase price.
- Market conditions: The prevailing market conditions, such as the demand and supply of similar businesses, the prevailing interest rates, and the availability of financing, also influence the consideration or purchase price.
- Regulatory environment: The regulatory environment, such as the competition laws, tax laws, and accounting standards, also play a crucial role in determining the consideration or purchase price. For instance, if there are strict regulations governing the amalgamation, the acquiring company may have to pay a higher price to comply with the regulations.
Methods of Determining Consideration or Purchase Price
There are several methods of determining the consideration or purchase price for amalgamation or business combination. The most common methods are as follows:
- Net asset method: Under this method, the consideration or purchase price is determined based on the net assets of the acquired company. The net assets are calculated by deducting the liabilities of the acquired company from its total assets. The acquiring company pays a price equal to the net assets acquired.
- Earnings multiple method: This method involves calculating the value of the acquired company based on its earnings or profits. The acquiring company pays a price based on a multiple of the earnings of the acquired company. The multiple used depends on various factors, such as the growth prospects, industry norms, and prevailing market conditions.
- Discounted cash flow method: Under this method, the value of the acquired company is determined based on its future cash flows. The cash flows are discounted back to their present value, taking into account the time value of money and the risk involved. The acquiring company pays a price equal to the present value of the future cash flows.
- Market value method: This method involves determining the value of the acquired company based on the prevailing market conditions. The value is determined by comparing the price of similar businesses in the market. The acquiring company pays a price based on the prevailing market value of the acquired company.
There are other forms of consideration that may be used in an amalgamation or business combination. These include:
- Contingent consideration: This is a form of consideration that is based on the future performance of the business. It may be in the form of additional payments, shares or other securities, or a combination thereof. For example, the purchase price for an amalgamation may include an initial payment and additional payments based on the future profits of the amalgamated company.
- Earn-out: This is a type of contingent consideration where a portion of the purchase price is deferred and is contingent upon the achievement of certain performance targets by the acquired company. For example, the purchase price for an acquisition may include an initial payment and an earn-out component based on the future revenue or earnings of the acquired company.
- Escrow: This is a mechanism used to hold a portion of the purchase price in trust for a certain period of time, typically to cover any indemnification claims that may arise. For example, a portion of the purchase price may be held in escrow to cover any claims for breaches of representations and warranties made by the selling company.
- Purchase price adjustment: This is a mechanism used to adjust the purchase price based on the actual financial performance of the acquired company, compared to the projections or estimates used to determine the purchase price. For example, if the actual revenue or earnings of the acquired company are lower than the projections, the purchase price may be adjusted downward.
The determination of the purchase price or consideration for an amalgamation or business combination requires careful analysis and consideration of various factors. It is important to ensure that the purchase price reflects the fair value of the assets and liabilities being acquired, as well as the potential synergies and benefits that may be realized from the transaction. A thorough due diligence process and valuation analysis can help ensure that the purchase price is appropriate and reasonable.
Accounting Treatment for Consideration or Purchase Price
The accounting treatment for consideration or purchase price in an amalgamation or business combination involves allocating the purchase price paid to the acquired assets and liabilities of the target company. The purchase price allocation process involves the following steps:
Determine the fair value of the net assets of the target company:
The first step is to determine the fair value of the net assets of the target company at the acquisition date. This involves valuing the assets and liabilities of the target company at their fair values.
Calculate the goodwill or bargain purchase gain:
Once the fair value of the net assets is determined, the excess of the purchase price over the fair value of the net assets is calculated. This excess represents either goodwill or bargain purchase gain.
Allocate the purchase price to the assets and liabilities:
The purchase price is then allocated to the identifiable assets and liabilities of the target company based on their fair values. The residual amount is allocated to goodwill or bargain purchase gain.
Record the accounting entries:
The accounting entries are then recorded to reflect the purchase price allocation. The acquired assets and liabilities are recorded at their fair values, and any difference between the purchase price and the fair value of the acquired assets and liabilities is recorded as goodwill or bargain purchase gain.
The accounting treatment for goodwill or bargain purchase gain depends on the accounting standards followed by the company. Under International Financial Reporting Standards (IFRS), goodwill is capitalized and amortized over its useful life, whereas under US Generally Accepted Accounting Principles (US GAAP), goodwill is not amortized but is tested for impairment annually.