M&A and the importance of a strategic view of Purchase Price Allocation

The global economic downturn that began in 2022 continues in 2023, which has greatly slowed international merger and acquisition (M&A) activity according to Pitchbook data. The era of liquidity / “cheap” money is over. But, despite all the limitations imposed by the economic scenario, foreign strategic players mainly and financial investors have taken opportunities and invested in Brazil, as well as some Brazilian companies have acquired companies in other countries, such as USA, both of them envisioning growth opportunities in new jurisdictions and complementary business opportunities. 

Our team at HLB Brazil has been busy working with a diverse range of clients, from industry-leading groups, private equities, major Brazilian conglomerates to small and medium-sized enterprises. Our projects cover various areas, from Initial Public Offerings (IPOs), disputes, distressed assets, M&As, to valuing private equity portfolios. Most of these assignments involved certain levels of complexity, dealt with by our senior Brazilian team, sometimes teamed up with other HLB offices in some cross-border transactions, such as recently with Withum, a member of HLB in the USA. 

The importance and purpose of Purchase Price Allocation

However, we would like to draw attention to a specific type of valuation, the Purchase Price Allocation (PPA), which is little known to some entrants in the M&A market as well as its importance for the buying company, shareholders and investors. 

The purpose of the PPA is to provide a clearer view on the financial and strategic position of the acquired business (be it a company, a conglomerate or a part of company, in any case called “cash-generating unit”), by defining the fair value of its various components at the acquisition date, be it a tangible asset or liability, an intangible asset or a contingency. 

For many geographies, it is necessary to comply with accounting regulations, such as IFRS 3 or local equivalents, and also tax norms. A well-prepared PPA can help acquirers to better understand the value of the acquired company and the assets they are acquiring. It can also help to identify potential risks and opportunities and help reduce legal issues and disputes with shareholders. 

Beyond regulatory compliance: PPA as a strategic tool

Many investors value accurate valuation and allocation of an acquired company's assets, but management often overlooks this due to their focus on operational integration. Besides the regulatory issues, the PPA can provide critical information on the financial health and future perspectives of the acquired company. By understanding how the purchase price was allocated, management and investors can have insights into the target's strengths and weaknesses, as well as potential areas of growth and risk, as well as the potential synergies with their own operations. Also, the PPA can help to understand better strategy, impact on tax, financial statements and disclosure of information. 

Complexities in valuing intangible assets in PPAs

Part of the PPA is the identification and valuation of intangible assets, such as customer relationships, patents, brands/trademarks, non-compete agreements, among others, and finally the resulting goodwill (which sometimes can result negative - and this is a case that adds more complexity to the PPA process). 

The valuation of intangible assets can be particularly complex due to the subjective nature of their identification and their valuation (which involves methods, assumptions, and underlying information). The experience of the appraiser, including their understanding of the PPA process, familiarity with business processes/environment, and knowledge of the financial market, should not be overlooked. Among other aspects, the chosen valuation method to estimate the fair value of these intangible assets - be it the income approach, the market approach, or the cost approach - should be carefully considered.

For example, the appraiser must be able to properly value intellectual property assets, such as patents and software, which can be a challenging task due to a lack of market comparables. In the same sense, brand value for some companies or value of customer relationships can be hard to have their value calculated due to certain particularities of the acquired company (lack of relevant historical information, for example). Specialists can help companies to accurately value the acquired company, identify potential risks and opportunities, comply with accounting and tax regulations, as well to discuss with the auditor’s specialists. 

How HLB can help

Overall, a proper PPA can help companies to save time, organise documents for impairment tests and ensure that intangibles are allocated properly, making the whole process more transparent and safer.

At HLB, we have extensive expertise in PPA valuations across a range of industries, including technology, professional services, education, energy, industrial companies and others. We can help your company to conduct this process with the necessary agility, with substance and assistance for the audit review, and with confidence in the accuracy of the valuation.