IFRS 3 Reverse acquisitions How to? – or reverse mergers present unique accounting and reporting considerations. Depending on the facts and circumstances, these transactions can be asset acquisitions, capital transactions, or business combinations.
A reverse acquisition that is a business combination can occur only if the accounting acquiree meets the definition of a business under IFRS 3. An entity that is a reporting entity, but not a legal entity, could be considered the accounting acquirer in a reverse acquisition. Like other business combinations, reverse acquisitions must be accounted for using the acquisition method.
A reverse acquisition occurs if the entity that issues securities (the legal acquirer) is identified as the acquiree for accounting purposes and the entity whose equity interests are acquired (legal acquiree) is the acquirer for accounting purposes. For example, a private company wishes to go public but wants to avoid the costs and time associated with a public offering. The private company arranges to be legally acquired by a publicly listed company that is a business. In other words, in reverse acquisitions, it is the accounting buyer’s equity interests that are being acquired by the accounting target.
However, after the transaction, the owners of the private company will have obtained control of the public company and would be identified as the accounting acquirer under IFRS 3. In this case, the public company would be the legal acquirer, but the private company would be the accounting acquirer. The evaluation of the accounting acquirer should include a qualitative and quantitative analysis of the factors. See Identifying the acquirer for further information. Here is a diagram of a reverse acquisition.
Diagram of a reverse acquisition
The legal acquirer is the surviving legal entity in a reverse acquisition and continues to issue financial statements. The financial statements are generally in the name of the legal acquiree because the legal acquirer often adopts the name of the legal acquiree. In the absence of a change in name, the financial statements remain labelled as those of the surviving legal entity.
Although the surviving legal entity may continue, the financial reporting will reflect the accounting from the perspective of the accounting acquirer, except for the legal capital, which is retroactively adjusted to reflect the capital of the legal acquirer (accounting acquiree) in accordance with IFRS 3 B21.
Reverse acquisition (merger) involving a non-operating public shell and a private operating entity
The merger of a private operating entity into a nonoperating public shell corporation with nominal net assets typically results in (1) the owners of the private entity gaining control over the combined entity after the transaction, and (2) the shareholders of the former public shell corporation continuing only as passive investors.
This transaction is usually not considered a business combination because the accounting acquiree, the non-operating public shell corporation, does not meet the definition of a business under IFRS 3. Instead, these types of transactions are considered to be capital transactions of the legal acquiree and are equivalent to the issuance of shares by the private entity for the net monetary assets of the public shell corporation accompanied by a recapitalization.
Under IFRS, any difference in the fair value of the shares issued by the private entity over the value of the net monetary assets of the public shell corporation represents a service, and the cost of the service should be recognized as an expense by the acquirer.
Consideration transferred in a reverse acquisition
IFRS 3 B20 In a reverse acquisition, the accounting acquirer usually issues no consideration for the acquiree. Instead, the accounting acquiree usually issues its equity shares to the owners of the accounting acquirer. Accordingly, the acquisition-date fair value of the consideration transferred by the accounting acquirer for its interest in the accounting acquiree is based on the number of equity interests the legal subsidiary would have had to issue to give the owners of the legal parent the same percentage equity interest in the combined entity that results from the reverse acquisition.
In a reverse acquisition involving only the exchange of equity, the fair value of the equity of the accounting acquiree may be used to measure consideration transferred if the value of the accounting acquiree’s equity interests are more reliably measurable than the value of the accounting acquirer’s equity interest. This may occur if a private company acquires a public company with a quoted and reliable market price. If so, the acquirer should determine the amount of goodwill by using the acquisition-date fair value of the accounting acquiree’s equity interests in accordance with IFRS 3 33.
The following example illustrates the measurement of the consideration transferred in a reverse acquisition.
EXAMPLE – Valuing consideration transferred in a reverse acquisition
(adapted from IFRS 3 IE5 – most reliable measure)
Company B, a private company, acquires Company A, a public company, in a reverse acquisition.
Company A issues 150 shares in exchange for Company B’s 60 shares
The shareholders of Company B own 60% (150/250) of the new combined entity
The shareholders of Company A own 40% (100/250) of the new combined entity
Market price of a share of Company A is CU16
Estimated fair value of a share of Company B is CU40
Analysis
The fair value of the consideration effectively transferred should be measured based on the most reliable measure. Because Company B is a private company, the fair value of Company A’s shares is likely more reliably measurable. The consideration effectively transferred of CU1600 is measured using the market price of Company A’s shares (100 shares times CU16).
Otherwise, the fair value of the consideration effectively transferred would be calculated using the amount of Company B’s shares that would have been issued to the owners of Company A on the acquisition date to give Company A an equivalent ownership interest in Company B as it has in the combined company. Company B would have had to issue 40 shares¹ to Company A shareholders, increasing Company B’s outstanding shares to 100 shares. Consideration effectively transferred would be CU1,600 (40 shares times the fair value of Company B’s shares of CU40).
1 The number of shares to be issued that will give owners of accounting acquiree a percentage ownership interest equal to their ownership interest in the combined entity: (60 shares / 60%) × 40%.
EXAMPLE – Measuring the consideration transferred in a reverse acquisition
Legal Acquirer (accounting acquiree) is a public company with 100 shares outstanding and a fair value of $1,000 per share (total fair value of $100,000). Accounting Acquirer (legal acquiree) is a public company with 500 shares outstanding and a fair value of $800 per share (total fair value of $400,000). Legal Acquirer (accounting acquiree) issues 400 shares of common stock to acquire all of the outstanding common shares of Accounting Acquirer (legal acquiree). After the consummation of the transaction, former Accounting Acquirer (legal acquiree) shareholders will own 80% of the combined entity (400 shares issued/500 shares outstanding) and the shareholders of Legal Acquirer will own 20% of the combined entity.
Analysis
As both entities are public, there is a market value for the stock of both entities. At the acquisition date, the fair value of the consideration transferred is determined based on the number of shares the Accounting Acquirer would have had to issue to the shareholders of the Legal Acquirer for the ownership ratio in the combined entity to be the same.
If Accounting Acquirer issued 125 shares to the Legal Acquirer, the shareholders of the Legal Acquirer would own 125 shares out of a total of 625 shares (20%), which is the same ratio the shareholders of Legal Acquirer own after the reverse acquisition. As such, the fair value of the consideration transferred is $100,000 (125 shares x $800 per share).
If Accounting Acquirer were a private company, the fair value of Legal Acquirer (100 shares x $1,000 per share) would be used to determine the consideration transferred as it is likely this amount would be the most reliably determinable fair value.
Share-based payments in a reverse acquisition
In a business combination the acquirer often exchanges its share-based payment awards for awards held by employees of the target entity. Reverse acquisitions are no different, except that the accounting for such exchanges might appear illogical because of the legal form of the transaction.
From a legal perspective, the form of an outstanding share-based payment award held by the employees of the legal acquirer has not changed; however, from an accounting perspective, the award has been exchanged for a share-based payment award of the accounting acquirer.
As such, all or a portion of the acquisition-date fair value of the legal acquirer’s (accounting acquiree’s) share-based payment awards are included as part of the consideration transferred by the accounting acquirer (IFRS 3 51 – 52, IFRS 3 B56 – 62B).
However, in situations in which acquiree awards would expire as a consequence of a business combination and if the acquirer replaces those awards when it is not obliged to do so, all of the market-based measure of the replacement awards shall be recognised as remuneration cost in the post-combination financial statements in accordance with IFRS 2.
The acquirer is obliged to replace the acquiree awards if the acquiree or its employees have the ability to enforce replacement. As a result this requires an allocation of the fair-value-based measure of the share-based payment to pre- and post combination service, with the value attributable to precombination service included in the consideration transferred and the value attributable to post combination service recognized as compensation cost by the acquirer. [IFRS 3 B56-B62B]
The situation at hand can be illustrated as follows:
An important topic in this respect is how to determine which portion of the fair value of the share-based payment awards is included in consideration transferred and which portion, if any, should be considered compensation cost recognized in the financial statements of the accounting acquirer.
Generally, the portion of the award that is part of the consideration transferred is determined by multiplying the fair value of the award by the portion of the requisite service period that elapsed prior to the business combination divided by the total service period.
The portion of the replacement award that is attributable to precombination service, and therefore included in the consideration transferred, is calculated as follows:
Acquisition date market value based measure of the acquiree original award
X
Precombination vesting period
=
Amount attributable to precombination vesting included in consideration transferred
The greater of
1. total vesting period, or
2. the original vesting period
The portion of the fair-value-based measure of the replacement award attributable to post combination service, and therefore included in post combination compensation cost, is calculated as follows:
Acquisition date fair value based measure of the acquirer’s replacement awards
–
Amount attributable to precombination service (as calculated above)
=
Postcombination compensation cost
The following example illustrates this concept:
EXAMPLE – Allocation between pre- and postcombination services of acquiree share-based payment exchanged in a business combination
Assume that an award was granted two years before the acquisition date with a four-year vesting period. The acquiree award was 50% vested on the acquisition date. Assume the fair-value-based measure of the acquiree award and the replacement award each is $100 on the acquisition date. Also assume the replacement award is fully vested on the acquisition date. The amount attributable to precombination service and included in consideration transferred would be $50. [$100 acquisition-date fair-value-based measure of acquiree’s replaced award x (2 years precombination service / 4 years original service period)].
The original service period is used in the attribution calculation because it is greater than the total service period (the total service period is two years because the replacement award is fully vested on the acquisition date). The amount attributable to postcombination service and recorded as postcombination compensation cost by the acquirer would be $50 ($100 acquisition date fair-value-based measure of acquirer’s replacement award — $50 attributable to precombination service). Because the replacement award is fully vested, the postcombination compensation cost would be recognized fully on the acquisition date by the acquirer.
If the acquiree’s employee is required to render service under the terms of a replacement award, the attribution method will result in a portion of the acquisition-date fair-value-based measure of the replacement award being allocated to postcombination compensation cost, even if the employee’s acquiree award was fully vested as of the acquisition date.
Presentation of consolidated financial statements
The presentation of the financial statements represents the continuation of the legal acquiree, except for the legal capital structure in a reverse acquisition. Historical shareholders’ equity of the accounting acquirer (legal acquiree) prior to the reverse acquisition is retrospectively adjusted (a recapitalization) for the equivalent number of shares received by the accounting acquirer after giving effect to any difference in par value of the issuer’s and acquirer’s stock with any such difference recognized in equity.
Retained earnings (deficiency) of the accounting acquirer are carried forward after the acquisition. Operations prior to the merger are those of the accounting acquirer. Earnings per share for periods prior to the merger are retrospectively adjusted to reflect the number of equivalent shares received by the acquiring company.
IFRS 3 provides the following financial statement presentation guidance for revers acquisitions:
Because the consolidated financial statements represent the continuation of the financial statements of the legal subsidiary except for its capital structure, the consolidated financial statements reflect all of the following:
The assets and liabilities of the legal subsidiary (the accounting acquirer) recognized and measured at their precombination carrying amounts.
The assets and liabilities of the legal parent (the accounting acquiree) recognized and measured in accordance with the guidance in this Topic applicable to business combinations.
The retained earnings and other equity balances of the legal subsidiary (accounting acquirer) before the business combination.
The amount recognized as issued equity interests in the consolidated financial statements determined by adding the issued equity interest of the legal subsidiary (the accounting acquirer) outstanding immediately before the business combination to the fair value of the legal parent (accounting acquiree) determined in accordance with the guidance in this Topic applicable to business combinations [IFRS]. However, the equity structure (that is, [ie] the number and type of equity interests issued) reflects the equity structure of the legal parent (the accounting acquiree), including the equity interests the legal parent issued to effect the combination. Accordingly, the equity structure of the legal subsidiary (the accounting acquirer) is restated using the exchange ratio established in the acquisition agreement to reflect the number of shares of the legal parent (the accounting acquiree) issued in the reverse acquisition.
The non controlling interest’s proportionate share of the legal subsidiary’s (accounting acquirer’s) precombination carrying amounts of retained earnings and other equity interests as discussed in IFRS 3 B23 and B24.
The following two examples illustrate the presentation of shareholders’ equity following a reverse acquisition.
EXAMPLE – Presentation of shareholders’ equity immediately following a reverse acquisition (adapted from IFRS 3 IE7)
Company B, a private company, acquires Company A, a public company, in a reverse acquisition. Shareholders’ equity immediately before the acquisition date:
Company A
(accounting acquiree)
Company B
(accounting acquirer)
Shareholders’ equity
Retained earnings
CU 800
CU 1,400
– Issued equity
100 common shares
300
60 common shares
600
Total shareholders’ equity
CU 1,100
CU 2,000
On the acquisition date: IFRS 3 Reverse acquisitions How to
Company A issues 150 shares in exchange for Company B’s 60 shares IFRS 3 Reverse acquisitions How to
Fair value of consideration transferred is CU1,600 IFRS 3 Reverse acquisitions How to
The shareholders of Company B own 60% (150/250) of the new combined entity IFRS 3 Reverse acquisitions How to
How should the statement of shareholders’ equity be presented following the reverse acquisition?
Analysis IFRS 3 Reverse acquisitions How to
The presentation of shareholders’ equity of the combined company on the acquisition date is:
IFRS 3 Reverse acquisitions How to
Combined company
Notes:
Retained earnings is based on the retained earnings of Company B, the accounting acquirer.
The amount recognized for issued equity (i.e., common shares outstanding) is the sum of the value recognized for issued equity interests of Company B immediately before the acquisition, plus the value of the consideration transferred: CU600 + CU1,600.
Shareholders’ equity IFRS 3 Reverse acquisitions How to
Retained earnings¹ IFRS 3 Reverse acquisitions How to
CU 1,400
– Issued equity IFRS 3 Reverse acquisitions How to
250 common shares² IFRS 3 Reverse acquisitions How to
2,200
Total shareholders’ equity
CU 3,600
EXAMPLE – Restated presentation of shareholders’ equity following a reverse acquisition
Company B, a private company, acquires Company A, a public company, in a reverse acquisition. The transaction was consummated on 4/1/X2.
Immediately before the acquisition date:
Company A has 100 shares outstanding (CU1 par)
Company A has total shareholders’ equity of CU125
Company B has 100 shares outstanding (CU2 par)
Company B has total shareholders’ equity of CU1,850
On the acquisition date:
Company A issues 400 shares in exchange for 100% of Company B
After the acquisition date:
The recapitalized entity has net income of CU300 for the period 4/1/X2 to 12/31/X2
How should the statement of shareholders’ equity be restated in a reverse acquisition?
Analysis
Shareholders’ equity (Company B) immediately before the acquisition date:
Shares at par (CU2)
Additional paid-in Capital
Retained earnings
Total shareholders’ equity
1/1/X1 IFRS 3 Reverse acquisitions How to
120
600
300
1,020
Shares issued 7/1/X1 IFRS 3 Reverse acquisitions How to
40
110
150
Net income IFRS 3 Reverse acquisitions How to
250
250
12/31/X1
160
710
550
1,420
Shares issued 2/1/X2 IFRS 3 Reverse acquisitions How to
40
190
230
Net income IFRS 3 Reverse acquisitions How to
200
200
3/31/X2
200
900
750
1,850
Restated shareholders’ at 12/31/X2: IFRS 3 Reverse acquisitions How to
IFRS 3 Reverse acquisitions How to
Shares at par (CU1)
Additional paid-in Capital
Retained earnings
Total shareholders’ equity
1/1/X1 IFRS 3 Reverse acquisitions How to
240
480
300
1,020
Shares issued 7/1/X1 IFRS 3 Reverse acquisitions How to
80
70
150
Net income IFRS 3 Reverse acquisitions How to
250
250
12/31/X1
320
550
550
1,420
Shares issued 2/1/X2 IFRS 3 Reverse acquisitions How to
80
150
230
Net income IFRS 3 Reverse acquisitions How to
200
200
3/31/X2
400
700
750
1,850
Recapitalization 4/1/X2 IFRS 3 Reverse acquisitions How to
100
25
125
Net income IFRS 3 Reverse acquisitions How to
300
300
12/31/X2
500
725
1,050
2,275
Non controlling interest in a reverse acquisition
Some shareholders of the legal acquiree (accounting acquirer) may not participate in the exchange transaction in a reverse acquisition. These shareholders will continue to hold shares in the legal acquiree and will not exchange their shares for shares in the legal acquirer (accounting acquiree). Because these shareholders hold an interest only in the legal acquiree, they participate in the earnings [profit or loss] of only the legal acquiree and not the earnings [profit or loss] of the combined entity.
As mentioned in the previous section, the legal acquiree’s assets and liabilities are recognized at their precombination carrying values (i.e., not recognized at fair value) on the acquisition date. These shareholders that will now become non controlling interest holders were not owners of the accounting acquiree and do not participate in earnings [profit or loss] generated in the accounting acquiree. IFRS 3 Reverse acquisitions How to
Therefore, in a reverse acquisition, the value of the non controlling interest is recognized at its proportionate interest in the precombination carrying amounts of the accounting acquirer in accordance with IFRS 3 B24. IFRS 3 Reverse acquisitions How to
The following example illustrates the measurement of a non controlling interest in a reverse acquisition. IFRS 3 Reverse acquisitions How to
EXAMPLE – Measurement of non controlling interest (IFRS 3 IE12)
Company B, a private company, acquires Company A, a public company, in a reverse acquisition. IFRS 3 Reverse acquisitions How to
Immediately before the acquisition date:
Company A has 100 shares outstanding. IFRS 3 Reverse acquisitions How to
Company B has 60 shares outstanding. IFRS 3 Reverse acquisitions How to
Company B’s recognized net assets are CU2,000 IFRS 3 Reverse acquisitions How to
On the acquisition date: IFRS 3 Reverse acquisitions How to
Company A issues 140 shares in exchange for 56 shares of Company B. IFRS 3 Reverse acquisitions How to
The shareholders of Company B own 58.3% (140/240) of the new combined entity. IFRS 3 Reverse acquisitions How to
Four shares of Company B remain outstanding. IFRS 3 Reverse acquisitions How to
How should the combined entity recognize the non controlling interest?
Analysis IFRS 3 Reverse acquisitions How to
The combined entity would recognize a non controlling interest related to the four remaining outstanding shares of Company B. The value of the non controlling interest should reflect the non controlling interest’s proportionate share in the precombination carrying amounts of the net assets of Company B, or CU134. This is based on a 6.7% ownership (4 shares / 60 issued shares) in Company B and Company B’s net assets of CU2,000. IFRS 3 Reverse acquisitions How to
Computation of earnings per share in a reverse acquisition
In a reverse acquisition, the financial statements of the combined entity reflect the capital structure (i.e., share capital, share premium and treasury capital) of the legal acquirer (accounting acquiree), including the equity interests issued in connection with the reverse acquisition. Consistent with this financial statement presentation, the computation of EPS is also based on the capital structure of the legal acquirer. IFRS 3 Reverse acquisitions How to
IFRS 3 provides the following guidance on EPS: IFRS 3 Reverse acquisitions How to
In calculating the weighted-average number of common [ordinary] shares outstanding (the denominator of the earnings-per-share calculation) during the period in which the reverse acquisition occurs:
The number of common [ordinary] shares outstanding from the beginning of that period to the acquisition date shall be computed on the basis of the weighted-average number of common [ordinary] shares of the legal acquiree (accounting acquirer) outstanding during the period multiplied by the exchange ratio established in the merger agreement.
The number of common [ordinary] shares outstanding from the acquisition date to the end of that period shall be the actual number of common [ordinary] shares of the legal acquirer (the accounting acquiree) outstanding during that period.
The basic earnings per share for each comparative period before the acquisition date presented in the consolidated financial statements following a reverse acquisition shall be calculated by dividing (a) by (b):
The income [profit or loss] of the legal acquiree attributable to common [ordinary] shareholders in each of those periods
The legal acquiree’s historical weighted average number of common [ordinary] shares outstanding multiplied by the exchange ratio established in the acquisition agreement
The following example illustrates the computation of EPS in a reverse acquisition.
EXAMPLE – Computation of EPS
(adapted from IFRS 3 IE9) IFRS 3 Reverse acquisitions How to
Company B, a private company, acquires Company A, a public company, in a reverse acquisition on September 30, 20X6.
Immediately before the acquisition date: IFRS 3 Reverse acquisitions How to
Company A has 100 shares outstanding IFRS 3 Reverse acquisitions How to
Company B has 60 shares outstanding IFRS 3 Reverse acquisitions How to
Company B’s outstanding shares (i.e., 60 shares) remained unchanged from January 1, 20X6 through the acquisition date
On September 30, 20X6, the acquisition date: IFRS 3 Reverse acquisitions How to
Company A issues 150 shares in exchange for Company B’s 60 shares. This is an exchange ratio of 2.5 shares of Company A for 1 share of Company B
Earnings [profit] for the consolidated entity for the year ended December 31, 20X6 are CU800
How should earnings per share be computed?
Analysis IFRS 3 Reverse acquisitions How to
EPS for the year ended December 31, 20X6 is computed as follows: IFRS 3 Reverse acquisitions How to
Earnings [profit] for the year ended December 31, 20X6
CU 800
Number of common shares outstanding of Company B
60
Exchange ratio IFRS 3 Reverse acquisitions How to
2.5
Number of shares outstanding from January 1, 20X6 through September 30, 20X6
150
Number of shares outstanding from acquisition date through December 31, 20X6
250
Weighted-average number of shares outstanding (150 shares × 9 / 12) + (250 shares × 3 / 12)
175
Earnings per share for year ended December 31, 20X6 (CU800 / 175 shares) IFRS 3 Reverse acquisitions How to
CU 4.57
New parent company – No business combination
It is not uncommon for a new parent company to be added to an existing group by setting up a new shell company that issues equity shares to the existing shareholders in exchange for the transfer of shares in the existing group, such that there is no change in the substance of the reporting entity.
This may be done for a variety of reasons including taxation and profit distributions. A new parent company added to an existing group is not an acquirer in a business combination. The transaction could be characterized as a reverse acquisition of the new company by the existing group if it was a business combination as defined by IFRS 3. However, IFRS 3 B19 contains guidance on reverse acquisitions that states that “the accounting acquiree must meet the definition of a business for the transaction to be accounted for as a reverse acquisition.” Therefore, the situation in which a new parent company is added to an existing group is not a business combination.
Reverse merger Dell VMware 2018
Michael Dell’s privately owned company Dell Technologies became VMware’s largest shareholder in 2018. Dell was considering merging with VMware, essentially selling itself to the smaller company. Because VMware is already a publicly-traded company, it would mean Dell would basically go public without the need for an IPO. Here are some of the news publications and the most important listings at the SEC on the way to the reverse merger (as they called the reverse acquisition) in December 2018. In chronological order:
02 February 2018 – The first announcement of Dell to look into the evaluation of three business opportunities:
IFRS 3 Reverse acquisitions How to
02 July 2018 – 24/7 Wall Street website news article on the filing of the first Agreement and Plan of Merger:
IFRS 3 Reverse acquisitions How to
02 July 2018 – The filing of the first Agreement and Plan of Merger at the SEC EDGAR Filing Agent:
IFRS 3 Reverse acquisitions How to
19 October 2018 – The filing of the Class V Transaction Proposal at the SEC EDGAR Filing Agent:
IFRS 3 Reverse acquisitions How to
14 November 2018 – The filing of the Amendment to the Merger agreement at the SEC EDGAR Filing Agent:
IFRS 3 Reverse acquisitions How to
09 December 2018 – Financial Times News article Reverse merger:
IFRS 3 Reverse acquisitions How to
25 December 2018 – The filing of the Definitive agreement at the EDGAR Filing Agent:
IFRS 3 Reverse acquisitions How to
29 March 2019 – The filing of the first Form 10-K of Dell Technologies Inc after the reverse merger:
IFRS 3 Reverse acquisitions How to
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