What is in the Purchase Price?
It is all Based on Your Perspective
The purchase price of a transaction can look vastly different. Therefore, when considering the prices of various transactions, it is important to know how those prices have been calculated so that one has a consistent perspective and is not comparing apples to oranges This article illustrates the various perspectives that may emerge in connection with a purchase price.
With football playoff season on the horizon, I cannot help but think about September 24, 2013â€”a night that many football fans will not soon forget. The Seattle Seahawks were playing the Green Bay Packers on Monday Night Football. The game was going down to the wire and Seattle trailing 12â€“7 with only a few seconds remaining. With time expiring, Seattle quarterback Russell Wilson heaved a 24-yard pass to receiver Golden Tate in the endzone. Green Bay defensive back M.D. Jennings positioned himself in front of Tate and elevated to intercept the pass. Thunk! Jennings ended up with the ball tightly secured against his chest on the way to the ground â€¦ with Tate desperately grasping at the ball from behind Jennings as he lay underneath him in the endzone. After numerous replays, the referees (who happened to be replacement officials since the regular officials were on strike) ruled that Tate had caught that ball for a touchdown even though Jennings had it securely in his grasp. The ruling may go down as one of the worst calls, if not the worst, in NFL history.
That was a great night to watch football for the casual fanâ€”a close game with a dramatic and controversial finish. For Seattle Seahawks fans, it must have been a night of wild ups and downs with the game ending on a resounding upswing. It was likely one the worst nights in recent years for Green Bay Packers fansâ€”losing a game due to a blatantly incorrect call with no time left on the clock. The biggest winners of all may have been the NFL referees, with whom the NFL quickly reached an agreement on a lucrative new contract in the days following this replacement refereeing debacle.
This game shows that a single outcome can mean many different things to different people based on their perspective. The same concept applies to transaction purchase prices. A single purchase price can be presented in many ways, each with its own meaning, yet all based on the same agreed-upon amount. Below are three common ways that a single purchase price may be calculated and presented:
- Cash Paidâ€”This is the simplest approach to presenting a purchase price but looking at this alone can be misleading. It is not uncommon for purchases to be reported based on the amount of cash paid at closing but doing so does not consider other components of the purchase price that may end up being well in excess of the cash paid at closing.
- GAAP Purchase Priceâ€”The purchase price of a transaction under generally accepted accounting principles (GAAP) includes not only cash paid at closing, but also the value of any stock issued to the seller, deferred payments or contingent consideration. Contingent consideration is often structured in the form of an earnout in which the buyer must make additional payments to the seller if certain targets or thresholds are met. GAAP requires that the fair value of any contingent consideration be determined as of the transaction date and recorded as a liability on the acquirerâ€™s balance sheetâ€”effectively treating it as part of the purchase price.
- Enterprise Valueâ€”Enterprise value is used as another derivation of purchase price. It is based on the GAAP purchase price plus the value any interest-bearing debt assumed in the transaction. Enterprise value is often considered the value of a company, regardless of how it is financed.
Based on these three different perspectives, the purchase price of a transaction can look vastly different. Letâ€™s assume that a transaction calls for $10 million in cash to be paid up front, $50 million in stock to be issued to the sellers, an earnout of 5% of revenue from the sale of an in-process research and development project capped at $100 million (the fair value of which was determined to be $35 million), and the assumption of $150 million in debt. The various purchase price amounts would be as follows:
- Cash Paidâ€”$10 million
- GAAP Purchase Priceâ€”$95 million ($10 million cash + $50 million stock + $35 million fair value of contingent consideration)
- Enterprise Valueâ€”$245 million ($95 million GAAP purchase price + $150 million in debt assumed)
As evidenced by the example above, a single purchase price can be interpreted in many ways, much like the outcome of the Seahawksâ€“Packers game. Therefore, when considering the prices of various transactions, it is important to know how those prices have been calculated so that you have a consistent perspective and are not comparing apples to oranges (or footballs).
Sean Saari, CPA, ABV, CVA, MBA, is a partner in the Advisory Services group. He assists valuation and litigation support clients by developing credible and defensible analyses and he has testified as a financial and valuation expert numerous times. He has a practice concentrated in the areas of business valuations, litigation advisory services, domestic disputes, shareholder disputes, financial reporting, complex damages analysis and modeling, strategic planning, succession and estate planning, and mergers and acquisitions. On the business advisory side, Mr. Saari helps clients proactively manage their businesses to plan and prepare for growth while staying on top of their tax and accounting compliance requirements. He is a frequent author and speaker on valuation, litigation advisory, business management, and other financial topics.
Mr. Saari can be contacted at (440) 459-5865 or by e-mail to Sean.Saari@marcumllp.com.