The first 90 days of an acquisition gives the buyer a vital window to lock down some key facts and figures and establish a solid foundation for future operations. The buyer’s due diligence process should have exposed any potential red flags and given the buyer an accurate look at the current financial health of the company. There are normally a few key items to still be examined and agreed to between the buyer and the seller shortly after the transaction closes.
While not all transactions are structured the same way, a majority of middle-market transactions will have a few common issues that need to be addressed within a typical 90-day onboarding period:
- Completing the working capital settlement and opening balance sheet accounting
- Monitoring seller add-backs and seller expenses post-transaction
- Tax elections and predecessor period tax returns
1. Financial snapshot
The ease of completing opening balance sheet accounting and working capital settlements is largely dependent upon the company’s historical financial processes and team in place. Transaction closing dates in the middle of the month, as opposed to a month-end cutoff, can also cause additional procedures to be necessary to complete working capital and opening balance sheet calculations.
Working capital settlements generally have true-up periods ranging from 90 days to 180 days, depending on the transaction and nature of the business. Ideally, the working capital target, or private equity group (PEG), established in the purchase agreement was based upon historical activity during the due diligence process using assumptions and methodologies that are easily re-performed and analyzed.
When the purchase agreement contains a dollar-for-dollar settlement between a buyer and seller, as opposed to a range around the PEG, getting the opening balance amounts right can be the difference in a significant payment multiple shifts, depending upon which direction settlement payment is due. While the key measure of the liquidity of a company at a specific moment in time, working capital settlements can also contain other true-up mechanisms from a purchase agreement, such as for differences in cash delivered at closing or debt payoff amounts.
Buyers should attempt to minimize estimates as much as possible in completing this settlement. Oftentimes opening balance sheet audit procedures may also be applied in the working capital settlement process. This can serve a dual purpose:
- serve as support for the year-end audit, and
- provide a level of assurance on the working capital amounts.
It is worth noting that given the limited time period after a transaction and required working capital settlement period, it is likely that the amount in the working capital settlement may change by the year-end audit.
For example, healthcare accounts receivable have a significant component of estimation that may not be realized until after the working capital settlement period is complete. These changes to accounting for opening balance sheet amounts can be made through goodwill, as opposed to through the income statement, for a period up to one year after the acquisition date.
Buyers also need to contemplate the need for independent valuation work performed on intangible assets acquired during a transaction. Private company accounting rules issued in recent years have made this process less onerous; however, buyers still need to make an assessment of whether any identified intangible assets (other than goodwill) were acquired and need to be valued. Buyers also need to consider the potential impact of rollover equity issued in a transaction, and any significant differences that may need to be accounted for business combination accounting standards, which generally requires that all acquired assets and liabilities be recognized at fair value.
2. Why is the seller’s child still using a company credit card?
Another key issue to examine and monitor during this 90-day period, and possibly beyond, is post-transaction activity by the seller. Most transactions generally have some level of seller add backs identified to derive a normalized level of earnings. These could consist of changes to seller’s compensation, elimination of family members on the payroll (without any significant contribution to the company), and personal expenses previously paid through the company. Buyers should take a few steps to address these issues near closing:
- Are there credit card account holders still using their cards? We recommend terminating all previous company credit cards and reissuing new cards under the buyer’s procurement program.
- Review payroll records to ensure that employees expected to be eliminated have actually been terminated in the payroll system.
- Monitor accounts payable for vendor invoices that relate to legacy seller expenses. Sellers may have transaction-related expenses, such as legal bills, that show up several weeks after the transaction has closed and should be the seller’s responsibility to pay. Notify the check approvers to flag any such invoices to ensure they can be sent to the seller for payment. For any payments made incorrectly, you should be able to identify such amounts for repayment within the working capital settlement mechanism.
3. And then there is the IRS
The tax situation of the acquisition also needs to be assessed, agreed upon and locked down in this 90- day period. If proper tax diligence and tax structuring steps were completed during the due diligence period, the buyer should already have a plan of attack to ensure the transaction has been structured to maximize deductibility of purchase price and associated transaction expenses. There are numerous types of acquisitions for tax purposes, all with their own set of complexities as far as elections and filings are concerned. However, they are generally categorized into asset purchases and stock purchases. In the case of a taxable asset purchase, the buyer gets to make new tax elections of accounting periods and methods. But with a stock purchase, the buyer has no choice but to continue to use the seller’s entity’s tax elections.
Both buyer and seller may need to make certain tax filings after purchase. In an asset acquisition, for example, both parties must file IRS Form 8594, or the asset acquisition statement with their individual income tax returns. Both will have to report the sales price and agree on the breakdown of funds allocation to different asset classes. Depending on the nature of the transaction and type of filing entity, both parties will need to understand which party is responsible for tax returns to be filed and any associated liabilities during the predecessor and successor periods.
