• 081 10/28/2018
    The purpose of this post is to translate the language surrounding purchase accounting into a financial template with instructions that cover the balance sheet adjustments for most control transactions.
     
    The template available for download reflects the elimination of cash under Target Company Adjustments below and all of the Purchase Price Adjustments. These are items that will be required in almost every transaction. The remaining items listed under Target Company Adjustments may or may not be required.
     
    Note: This post does not contemplate situations where the purchase price is not a premium to the net identifiable assets (i.e. negative goodwill).
     
    This post is divided into two parts:
    1. Target Company Adjustments: Adjustments made to prepare the target company’s balance sheet for the transaction.
    2. Purchase Price Adjustments: Adjustments made to record the acquisition of the target company.

    -

    TARGET COMPANY ADJUSTMENTS
    The list that follows is not comprehensive, but instead focuses on the most common adjustments that might be required to prepare the target company’s balance sheet for a transaction. 
     
    Eliminate Cash for a Cash-Free Transaction: Most transactions are contemplated on a cash-free basis, which is to say that the sellers intend to keep the cash. To reflect this change eliminate cash on the balance sheet and reduce retained earnings by the same amount.
    Debit: Retained Earnings
    Credit: Cash
     
    Eliminate Old Goodwill: The purchase price is allocated to the net identifiable assets of the company. Goodwill, which is not an identifiable asset, is eliminated to facilitate the calculation of net identifiable assets. To reflect this change eliminate goodwill on the balance sheet and reduce retained earnings by the same amount.
    Debit: Retained Earnings 
    Credit: Goodwill
     
    Move Current Portion of Long-Term Assets and Liabilities to Long-Term Balance: The most common example relates to long-term debt. If a target company shows a senior debt balance under liabilities it is likely that the amount of principal amortization due that year will appear under Current Portion of Senior Debt as a current liability. To reflect this change eliminate the current portion and add it to the long-term balance. 
    Debit: Current Portion of Senior Debt
    Credit: Senior Debt
     
    Adjusting Assets and Liabilities to Fair value: This can apply to nearly any asset or liability on the balance sheet, but in this post we are only going to focus on Accounts Receivable and Inventory.
     
    Accounts Receivable: If you believe the AR balances might not be collected an adjustment may be required.
    Debit: Retained Earnings
    Credit: Accounts Receivable
     
    Inventory: If the business has been poorly managed it is possible that the inventory balance will not be accurate. If it is overstated it should be written down. 
    Debit: Retained Earnings
    Credit: Inventory
     
    If inventory is understated and needs to be written up the tax consequences need to be considered. 
    Debit: Inventory
    Credit: Deferred Tax Liability (Amount Written Up x Tax Rate)
    Credit: Retained Earnings (Amount Written Up x (1 – Tax Rate))
     
    PURCHASE PRICE ADJUSTMENTS
    By accurately adjusting the Target Company balance sheet for the items described the calculations for the purchase price adjustment are made simple. The first objective should be to identify the sources of capital used to make the acquisition. Once you have these figures totaled you can subtract all uses to arrive at Seller Proceeds. For example:
     
    Sources and Uses Table
     
    This makes the goodwill calculation pretty straightforward. Goodwill is equal to Seller Proceeds less the net identifiable assets of the target company. Net identifiable assets is equal to identifiable assets less liabilities, which per the accounting equation is equal to shareholders’ equity.
     
    Goodwill Calculation
     
    With these values calculated we can make the required balance sheet adjustments. To provide context, I think it is helpful to think about this in the following steps (download the template to work through the list):
     
    1. Eliminate OldCo Equity Accounts
    2. Eliminate OldCo Debt Balances
    3. Add NewCo Equity Accounts
    4. Add NewCo Debt Balances
    5. Expense Transaction Expenses
    6. Adjust for Financing Fees* (see note at bottom of post)
    7. Add Goodwill Calculation
    8. Add Cash at Close
     -
     

    Pro Forma Balance Sheet Adjustments

     

    Full Balance Sheet Adjustments Image (click on the image for fullscreen view):

     

    LBO Balance Sheet Adjustments

     

    NOTES:

    1. Under GAAP the financing fee is no longer on the asset side of the balance sheet. A recent accounting update requires that this sum be subtracted from the corresponding debt line item. I prefer to see the total principal balance outstanding on the balance sheet and continue to use the old approach for this reason. You can find a video covering the update here (subscriber content).

     

 



  • 080 10/16/2018

    Template available for download: Download Template

    Providing an initial due diligence list is often a great way to initiate transaction-related dialogue with a CEO or management team interested in exploring a capital raise or sale of the business. Typically a due diligence list will evolve and expand as interest in a transaction grows, but it can be intimidating if the initial list provided is too thorough. Collecting a large amount of company data and presenting it in a shareable format takes considerable effort, which makes a short diligence list a helpful introduction. The template available for download contains two such due diligence lists.

    The workbook also has a tab that provides an overview of the deal process. Developing a due diligence plan and identifying the third parties that will help execute on this plan are critical steps in any transaction. 

    Pasted below is the text from the shorter of the two (DD List_Max Reduced):

    Accounting and Financial

    • Monthly financial statements (P&L, balance sheet,) for the last 12 months.
    • Copies of all written reports by auditors or third party accountants regarding the financial statements of the Company. 
    • One year projection of revenues derivative of new customers by account.
    • Annual financial statements for last 3 years.

     -

    Property & Equipment

    • Summary of significant capital investments (with value in excess of $100,000) made for each year within the last 5 years.
    • Summary of planned capital expenditures.
    • Customers, Sales and Accounts Receivable
    • Sales and profitability by customer for the top 20 customers for each of the last 5 years (shorter period also fine).
    • Current accounts receivable aging and agings for the year end period for each of prior 3 years.

     -

    Legal, Regulatory and Organization

    • List of Shareholders and respective ownership.
    • Describe any pending or threatened litigation (include an estimate of the outcome of each).
    • List any violations of regulatory or legal requirements within the last 5 years.

     -

    Taxes

    • All Federal, state and municipal returns for the last five years.

     -

    Market Analysis

    • Provide list of competitors in your geographic area.
    • Describe how the Company differentiates its products and/or services.

     -

    Management

    • Detailed biographies on all senior officers, directors, owners and key personnel, including but not necessarily limited to:  age, business experience, business affiliations, education, relationship to other members of management, time to be devoted to the Company and degree of ownership of the Company.

     -

    Download Template

    Click HERE to have posts like this one sent directly to your inbox.

     

     

    Short Due Diligence List

 



  • 079 08/26/2018

    If you are working with dozens of worksheets that are formatted in identical fashion (think of a company that has multiple locations with the same line items), then the ability to list all of these worksheets on one tab can be extremely helpful. As you will see in the template available for download, this permits retreiving data with the =INDIRECT function from each individual worksheet.

    To create a list of tab names in your workbook follow these two steps:

    Step 1:

    Name the following formula "Sheets"

    =(GET.WORKBOOK(1))&T(NOW())

    Note: If you are not familiar with this process select Formulas > Name Manager > New and then input the formula.

    Step 2:

    Then use this formula to retreive all worksheet names:

    =INDEX(MID(Sheets,FIND("]",Sheets)+1,255),ROW(A1))

     

    Download Template

     

    List all Worksheets in a Workbook.

     

    For more information on the =INDIRECT function: Referencing Data on a Specific Worksheet with =INDIRECT.

 




 



Models are:
 
A) really boring
B) pretty sweet
C) super important
D) somewhat easy
E) kind of hard
F) fun
G) all of the above

 

 


*Answers a, b, c, d, e, f and g are all correct.