In developing a fair value conclusion, taxes potentially impact (i) the tax basis of acquired assets and associated balance sheet accounts, (ii) net free cash flows and (iii) applied discount rates. Although such impacts would likely cause an after-tax valuation to fall below a pre-tax valuation, there are numerous offsetting factors such as potential amortization benefits and lower after-tax discount rates worth considering within this framework as well.
Accounting Standards Codification Topic 820 – Fair Value Measurements and Disclosures (formerly referred to as Statement of Financial Accounting Standard No. 157) states that in applying present value techniques to determine fair value, “after-tax cash flows should be discounted using an after-tax discount rate. Pretax cash flows should be discounted at a rate consistent with those cash flows.” That said, the determination of whether after-tax and/or pretax valuation approaches should be applied is often a function of the subject company and considerations regarding the most likely acquirer and transaction structure. Such considerations may include:
(i) The tax position and status of likely acquirers: acquiring entities may be located offshore or subject to different tax treatment than the subject company itself. Further, acquiring entities may mitigate tax exposure through various accounting, financial or structuring techniques. Such considerations must be incorporated into the determination of fair value;
(ii) The amount of capital available to the subject company: consideration of the subject company’s existing and optimal capital structure has a direct impact on the applied discount rates and their sensitivity to the applied tax rates;
(iii) The tax basis of the contemplated transaction: the assumption of a taxable vs. nontaxable transaction has a direct impact on forecast cash flows. Further, a taxable transaction structure would result in a gross-up of the acquired assets to their fair value as of the transaction date on the acquirer’s balance sheet. In developing the concluded fair value of the subject company, the tax benefit associated with the amortization of the grossed-up value of such assets must be considered; and
(iv) The potential net operating loss carryforwards available to the subject company: depending on the nature and structure of the transaction, the subject company’s existing NOL may be subject to limitations. In the context of evaluating the merits of a potential transaction a financial advisor should consider that a subject company’s existing NOL may represent value in the status quo, however, such value may be substantially less in the event of a change of control transaction.
The considerations detailed above may potentially vary over time based on capital market considerations and/or industry- and market-specific trends.
As a corollary to the concepts above, within the context of a Goodwill Impairment testing analysis, the guidance suggests that the contemplated transaction structure should be considered. Consistent with guidance provided in EITF 02-13, a valuation practitioner should contemplate whether the fair value of a reporting unit should be estimated by assuming that the unit would be bought or sold in a taxable versus nontaxable transaction. The Emerging Issues Task Force noted that the application of a taxable versus nontaxable transaction must be assessed on a case-by-case basis, with consideration of market place participants, feasibility of the applied tax structure and the highest economic value to the seller.
Given the potential material variance between a pre-tax and after-tax valuation, we believe that the considerations above, among others, should be contemplated by professionals with an appropriate understanding of and ability to reconcile between Financial Accounting Standards and the capital markets. Such expertise is further enhanced by experience across a wide range of engagements from accounting-oriented impairment testing to collateral and transaction-driven analyses.
Contact Information
| Roy A. Salter | Eric C. Briggs | Patrick A. Russo |
|---|---|---|
| rsalter@saltergroup.com | ebriggs@saltergroup.com | prusso@saltergroup.com |
Salter Group
Salter Group is a leading independent financial and strategic advisory firm specializing in providing business and intangible asset valuations, financial opinions, financial and strategic analysis, forecasting, and transaction support covering a broad spectrum of industries, geographies and situations from early stage, middle market and Fortune 500 companies and capital market constituents.
Our extensive experience in developing asset and business forecasts, and assessing a company’s value and viability in light of current industry trends and global market conditions, enhances the value of our transaction opinions (such as fairness, solvency and collateral valuation opinions), financial opinions (such as purchase price allocation, goodwill impairment and fund portfolio valuation opinions), tax-related opinions, financial and strategic analysis, and transaction support services for parties seeking greater insight and comfort than what is often provided by competing firms.
The Salter Group, LLC gathers its information from sources it considers reliable. Salter Group does not guarantee the accuracy or completeness of the information provided within this publication. The views presented reflect the current judgment of the authors and are subject to change. Salter Group makes no warranties, express or implied, regarding the accuracy of this information or the subjective views expressed by the authors. Principals, employees and affiliates of Salter Group may have positions in the securities of the companies described. This newsletter does not constitute a recommendation with respect to the securities of any company discussed herein, and it should not be construed as such. Salter Group and its affiliates may from time to time provide financial and strategic advisory services to these companies. The authors of this publication receive compensation from Salter Group.
