Asset Acquisition vs Business Combination: Which is the Right Strategy for Your Business?
This article states the pros and cons of asset acquisition and business combination.
Choosing whether to buy a group of the target’s assets or its actual business is one of the crucial choices a buyer must make when buyers and sellers are negotiating a transaction. This decision will influence how the buyer accounts for the transaction and its financial statements. Business Combinations present the relevant guidance to account for the transaction and provide an entity with the criteria to determine if a transaction will fulfill the definition of an asset acquisition versus a business combination. This article states the pros and cons of asset acquisition, the pros, and cons of business combination, and the importance of choosing the right business strategy.
Asset acquisition and business combination
In a business combination, the acquirer accounts for assets and liabilities using the cost accumulation and allocation technique, while in an asset acquisition, the acquirer uses the fair value method, with a few limited exceptions.
What is asset acquisition?
Asset acquisition is the purchase of a company by purchasing its assets rather than its stock. It often includes the assumption of certain obligations in the majority of jurisdictions. However, the transaction can be far more particular in its structure and conclusion than a merger, combination, or stock acquisition because the parties can negotiate which assets will be bought and whose obligations would be undertaken.
Types of asset acquisition strategies
Acquisition strategies are the fundamental plans for carrying out the strategy, and they should be created and submitted in advance to secure approval for more in-depth planning. The acquisition strategy is not a contract it is an accepted plan. Acquisitions for a high-growth company essentially fall under one of three categories team buys, product buys, and strategic buys. Businesses have a fourth option for acquisitions, known as a synergistic acquisition.
Pros of asset acquisition
The Financial Accounting Standards Board released an accounting standards update (ASU 2017-01) in 2017 that clarified the definition of a business. The amended definition increased the likelihood that an acquisition of a set of assets (or assets and liabilities) would be accounted for as an asset acquisition rather than a business combination. The revised definition will be applied to financial statements for private companies with fiscal years ending in 2019, but many have chosen to implement it early due to the possible advantages of doing so. Now let us look into the pros of asset acquisition
- Control over specific assets – Specific assets are those that are significantly more valuable within a specific transactional relationship compared to what they are outside of it. Asset acquisition brings control over those specific assets.
- Lower risks – Asset purchase has a lower risk of obtaining unwanted liabilities. Hence due diligence is required lesser than a business combination.
- Simpler transaction process – The buyer is not required to accept any liabilities of the Target Company. They only need to select the most desirable assets, leaving the target’s undesirable assets alone. The seller keeps complete control of the target company and is not required to exchange ownership with the buyer. All these guarantees an easy transaction process.
Cons of asset acquisition
The re-assignment of individual assets makes asset purchases considerably more complicated than stock purchases. The major cons of asset acquisition are discussed below.
- Limited scope – The asset’s value may decrease over time and end up being worth less than what the buyer initially paid for it. Hence there is limited scope for the same.
- No synergies – Assets that are recognized based on cost could have a cost basis that is higher than their actual value. As the extra cost is amortized, depreciated, or otherwise expensed, this could lead to future impairments or harm net income and EBITDA in subsequent quarters. Hence there are no synergies in asset acquisition.
- Limited access to resources – The buyer can access only the specific asset of the target company. Only the underlying asset can be accessed. Hence there is limited access to resources.
What is the business combination?
A business combination occurs when one or more enterprises are controlled by one company. The most common business merger is a purchase transaction, in which the buyer acquires the net assets or equity stakes of the target company in exchange for cash or stock.
Types of business combination
The five most frequently used business combination types are conglomerate mergers, horizontal mergers, vertical mergers, market extension mergers, and product extension mergers.
Pros of a business combination
A key advantage of a business combination is economies of scale which means lowering the cost of production per unit.
- Increased scope – When businesses come together, they form a big organization. Such a significant entity would have a lot of money. Using the resources, a company can hire qualified and experienced staff, purchase the most recent technology, and implement the best business processes. This business combination results in increased scope.
- Synergies – When two businesses combine, it helps both of them grow their customer bases and market reach. Thus, synergies can enable a company to dominate the sector or industry to which it belongs and become a dominant player in that industry.
- Access to new resources – Businesses can explore new markets, reach new consumer segments, conduct research, and create new goods by joining forces. As a result, sales and earnings rise.
Cons of a business combination
Combining businesses creates a monopoly in the market, which could be detrimental to society. It results in the concentration of wealth in the hands of a few people.
- Higher risks – Business combinations have significant resource investments and are rather large. If a combination fails, a significant number of shareholders (loss of investment), employees (loss of jobs and means of subsistence), suppliers (loss of future business), and creditors (loss of loans granted) suffer significant losses.
- Complex transaction process – In a business combination, there isn’t a long-term cumulative turnover and shared experience. Hence it is challenging to access bank loans and auctions. The transfer of purchase consideration requires a complicated transaction process as well.
- Loss of control – A business combination may result in the concentration of controlling power in the hands of a single corporation. As a result, one of the parties will lose control.
Difference between asset acquisition and business combination
Asset acquisition refers to the buyer purchasing the company’s assets. The buyer combines or merges with the business when there is a business combination. In an asset acquisition, the acquirer accounts for assets and liabilities using the cost accumulation and allocation technique, while in a business combination, the acquirer uses the fair value method, which may give rise to goodwill with a few limited exceptions.
Importance of choosing the right strategy for your business
The CFO and members should discuss various aspects of their business and decide on the right strategy for the business. Depending upon the facts and circumstances they will decide which strategy (either business combination or asset acquisition) will be favourable. If the members believe that the company should avail the synergy benefits then they will go for business combination. They should also ensure that the company has the potential to complete the business combination procedure successfully as a failure in the same would lead to significant losses for a larger group. Hence while choosing a strategy the members and experts should ensure that it suits their business.
Factors to consider while choosing the right strategy for your business
The strategist must handle three essential aspects at the same time. They are values, opportunities, and capabilities. Evaluate each of these elements to comprehend how the firm can implement a successful strategy.
- Business goals – A company’s business goals are the objectives that it expects to accomplish within a certain time frame. For the entire corporation as well as for certain departments, workers, management, and clients, you can specify business goals. Goals frequently describe the larger purpose of a company and try to define the final objective that employees are expected to work towards. The period for which you establish your objective determines whether it is deemed short-term or long-term.
- Short-term vs long-term goals – Short-term goals are often ones that can be completed in one or two working quarters (between three and twelve months), and occasionally even in one year, depending on how dedicated the organization is. Furthermore, a long-term goal is often one that has a deadline to be met in a year or more.
- Growth objectives – The growth objectives serve as a guide for decision-making so that a company can reduce the discrepancy between projected profits from present products and markets and the overall objectives. The needed and desired performance outcomes must be attained using methods other than the current products and markets.
- Market expansion – Market expansion is a growth strategy that tries to make a product or service available in new markets when old ones become saturated. For example, a corporation may introduce a new type of mouthwash to its existing product line. Businesses can also add services to their offerings to reach a wider market, such as product warranties or insurance.
- Financial resources – Financial resources, also known as operating capital or working capital, are the funds that keep a firm intact. The money and other resources used to finance an organization’s operations and investments are known as financial resources. There are several ways for a business to acquire and make use of its financial resources.
- Availability of funds – When you can access the money you have deposited in your bank to pay bills, make purchases, and handle daily expenses, it will be termed as the availability of funds. With few exceptions, money deposited in a savings account is usually not immediately available.
- Debt capacity – Debt capacity is a measurement of the total amount of debt that a lender is ready to offer your company. The amount of debt that each lender lends to borrowers is governed by their respective policies. This is influenced by a variety of variables, including balance sheet items, cash flow stability, enterprise value, and even top-line revenues.
- Impact on financial statements – The value of a company’s shares can change dramatically in response to financial reporting. When making investment decisions, a lot of investors consider the financial statements. The stock price may increase or decrease if information in a financial statement is revealed that is better or worse than anticipated.
- Industry trends – Market or industry trends are modifications or advancements taking place in a specific industry. They can take many different forms, such as new technologies or changes in consumer behavior. Additionally, they can present organizations with both possibilities and difficulties.
- Competitive landscape – A competitive landscape is a business study method that identifies direct and indirect competitors to understand better their purpose, vision, core values, specialized market, strengths, and weaknesses.
- Regulatory environment – Regulations and institutions that control the admission, development, and dissolution of businesses, such as those governing registration, licensing, inspections, property rights, and others, are crucial for fostering competitive marketplaces that sustain productivity growth.
- Customer behavior – The study of people, groups, or organizations and all the behaviors connected to the acquisition, consumption, and disposal of products and services is known as customer behavior. It refers to how a person’s feelings, attitudes, and preferences influence their purchasing decisions.
- Company culture – Company culture can be defined more simply as an organization’s shared ethos. It’s how people feel about their work, the values they hold, where they see the firm headed, and what they’re doing to get there. These characteristics collectively represent an organization’s culture or personality.
- Compatibility with potential targets – The potential target is any entity that the borrower intends to acquire, directly or indirectly, the equity interests in or all or almost all of its assets through a permitted acquisition. Any two targets can be compatible if they can communicate with one another.
- Integration challenges – The following difficulties are the most frequently experienced by businesses while integrating a new acquisition. It includes the loss of clients as a result of changes connected to integration. Unexpected and unforeseen costs associated with acquisitions and modifications harm cash flow.
- Organizational structure – An organizational structure is a framework that specifies how certain tasks are to be carried out to accomplish an organization’s objectives. These activities may include guidelines, job descriptions, and accountability.
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