more-arw search

Q&A Forum

Best practice for consolidating and closing fincl. stmts. for private company operating in 3 nations/3 currencies in prep for M&A activity?

I am a M&A advisor, not accountant, so would like to get expert opinion on whether my planned counsel to a client is appropriate advice, please. Situation: Client is contemplating complete sale of the small (under $15 million revenue) privately-held, C-Corporation. This California company also has operations in two foreign countries, each of which provide labor inputs into the products the company sells through its U.S. operation. The foreign ops do not sell products independently. When founded years ago, they were advised for tax reasons to set up the two foreign operations as separate companies in each of the two respective, developing nations. Now, they operate with 3 accounting firms in 3 countries, 3 currencies, producing 3 sets of financial statements, which are either Audited (NOT IFRS, local audit standard) or Compiled, varying by origin. For pre-M&A valuation input, I did a consolidation, using the past 52 week average currency exchange rate to USD as of the close date. (They didn't want to send to CPA yet) My recommendation: Create CONSOLIDATED financial statements and IFRS-standard AUDITED fin. stmts to close the fiscal year in prep for company sale. Questions: 1. How important would it be to use one accounting firm with offices in each country (IF such exists!)? 2. Would affiliated firms accomplish same? 3. Or, should it be OK to have a reputable U.S. firm do the U.S. audit and consolidation, from books audited by two separate foreign companies, if IFRS or GAAP-c

Answers

Topic Expert
Nathan Curtis
Title: CPA
Company:
(CPA, ) |

Dick,

I'll answer your specific questions and then provide some additional observations:

1 & 2. I don't think it's critical to use one firm with offices in each country. Depending on where the two foreign subs are, this may limit you to the Big 4 and one or two other firms. Most regional accounting firms belong to an organization that will have affiliates or member firms in most countries who could assist with this work. Depending on the size and complexity of the foreign subs, it's also possible the US accounting firm could audit the books remotely. The more complex and/or material the foreign subs are, the more likely a local firm would need to be engaged for either certain procedures, such as observing inventory, or for the entire audit.

3. The US firm will need to decide how comfortable it is with a local firm doing the audit of the foreign subs and then relying on their work when auditing the consolidated financials. If the local firm is somehow affiliated with the US firm, this shouldn't be a problem. If there's no connection between the firms, it can become more problematic and costly to complete the audit, as the US firm has to get comfortable with the quality of work performed by the foreign firm and that their audit is performed consistently with US auditing standards. The further off the beaten path the foreign subs and the local accounting firms are, the more difficult this process will become if the firms aren't connected.

I would consider who the potential buyers are before deciding whether to prepare US GAAP or IFRS financial statements. If a US company is the likely acquirer, I would prepare US GAAP financials rather than IFRS. In my recent experience, even when a foreign company that has already adopted IFRS or is using another accounting standard is acquiring a US company, they usually look for US GAAP financials or are comfortable with US GAAP financials.

In general, when preparing for an acquisition, it is useful to have audited or reviewed financial statements to share with potential acquirers, as it conveys the image of a company with sophisticated operations and will help the acquirer become more comfortable with the financial information. That being said, an audit is not a requirement and I see some acquisitions where audited financial statements are not required as part of the acquisition. If you're already talking to potential buyers, I'd ask them if an audit would be required, or if reviewed financials would be sufficient. The acquirer may instead choose to have their own auditors or due diligence team perform specific tasks to verify the information they'e been provided.

Also, this wasn't the main point of your question, but on the translation and consolidation, the income statement is generally translated on a monthly or at least quarterly basis using the average exchange rate for the period, as over the course of a year, foreign currences can change dramatically and using a rate for the entire year might produce misleading results. This is especially true for developing countries. Most balance sheet items would be translated using the exchange rate as of the balance sheet date. For the purposes you noted, the method you used may well have been sufficient, but for the audit of the consolidated financial statements, a more in-depth approach would be required.

Mike Adhikari
Title: Owner
Company:
(Owner, ) |

Dick

I did not realize you are part of this wonderful group.
You are posing an interesting question that I have not thought of before.
Two comments; one for valuation, second for M&A.
Valuation: Consider valuing each business unit separately and then add them together. This would reduce currency issues. This approach assumes that inter-company policies are relatively stable. I know the valuation tool you are using. It should be easy to do 3 valuations. This approach is similar to valuing 3 independent subsidiaries of a parent. I would even question if one should value this business based on consolidation.
M&A: From M&A perspective, buyer may have to buy each entity separately. Seller may also need to know value of each entity for tax purposes. Also, reps and warranties for each entity will be different. I doubt consolidation will significantly enhances value or the type of buyer you can attract for business of this size. Most large buyers are sophisticated enough to look at unaudited numbers and have systems and policies in place for post-acquisition financial reporting.

McGavock Dickinson Bransford
Title: Managing Director
Company: Mid-Market Securities, LLC
(Managing Director, Mid-Market Securities, LLC) |

Again, as discussed we privately, thank you, Nathan for such an in-depth, considered reply.

Topic Expert
Marc Schwartz
Title: Partner
Company: Schwartz International
(Partner, Schwartz International) |

Any potential acquirer will likely focus not only on the financial statements, but also on the local country, U.S. and global tax position and any related contingencies. It sounds like there may be concern about operations in 3 countries with potentially 3+ service providers. I highly recommend you ensure the seller has performed its own global tax due diligence so it identifies any potential weak issues before the potential acquirer does. It is important you have a global tax advisor that can understand and integrate the advice from these different sources.

Often local country service providers will focus simply on local country issues and not on the "big" picture: the integration of the global tax issues.

The broad areas I would examine:
1. Local country taxation (income, payroll, VAT/Sales, etc.).
2. Repatriation of earnings/other cash flows such as interest. Are there F/X registration requirements? Was there proper withholding?
3. Transfer pricing.
4. U.S. tax issues (such as the anti-deferral rules, foreign tax credit, etc.)

I hope this is useful.

McGavock Dickinson Bransford
Title: Managing Director
Company: Mid-Market Securities, LLC
(Managing Director, Mid-Market Securities, LLC) |

Thanks for the great input! Much appreciated.

McGavock Dickinson Bransford
Title: Managing Director
Company: Mid-Market Securities, LLC
(Managing Director, Mid-Market Securities, LLC) |

A few follow-on comments to the last post:
Since you are unidentified as the poster, I am wondering whether I know you. The comments you make seem so. However, you cannot "know the valuation tool I am using," as you suggest, and I assure you that the valuation work I do for clients is not simply the use of a software tool. While I do license BVX software, that's a supplemental tool. This valuation was a Uniform Standards of Appraisal Practices (USPAP) compliant Letter Form report, that I subcontracted to a firm that does nothing but valuation work for M&A and litigation.

The appraisal firm suggested consolidating the financial statements. Since the subs only provide a labor input to the finished product sold by the parent, and do not operate independently, it seemed like a reasonable request. The subs themselves would have almost no stand-alone value (just some fixed assets and a bunch of engineers sitting on them).

Thank you for posing an alternate way to look at this situation. I will take this under advisement as we move ahead.

Mike Adhikari
Title: Owner
Company:
(Owner, ) |

Hi Dick Bransford

That was my first time replying on Proformative. I presumed my name would be automatically displayed with my reply.

I understand the USPAP point. If the subs are not a profit center, consolidation may not add to value. So consolidation should be considered only if USPAP requires it, though it brings up interesting question on "how" as you are asking. Have a good day.

Mike Adhikari
Illinois Corporate Investments, Inc. (M&A)
Business ValueXpress (Valuation and Deal Structure Software)
847-438-1657

3546 views
Topics

Get Free Membership

By signing up, you will receive emails from Proformative regarding Proformative programs, events, community news and activity. You can withdraw your consent at any time. Contact Us.

Business Exchange

Browse the Business Exchange to find information, resources and peer reviews to help you select the right solution for your business.

Learn more

Contribute to Community

If you’re interested in learning more about contributing to your Proformative community, we have many ways for you to get involved. Please email content@proformative.com to learn more about becoming a speaker or contributing to the blogs/Q&A Forum.