A step acquisition (also called piecemeal acquisition) is a business combination in which an investor obtains control over an investee through multiple transactions. When the investor obtains control of the investee, it remeasures any investment previously held to fair value and consolidates the investee going forward.
While most business combination occur when the investor purchases sufficient voting rights at once to establish control over the investee, there are instances when the investor establishes control in steps by purchasing chunks of the investee company at different dates. Such acquisitions are called step acquisitions.
Let’s say Company P held 25% stake in Company S on 1 January 2015 for $50 million, it purchased 20% additional holding in Company S on 31 December 2016 for $30 million and 15% on 31 December 2017 for $32 million. The book value of Company P’s total investment just before acquisition was $85 million and the fair value of net identifiable assets is $200 million as at acquisition date.
As at 1 January 2015, Company P and Company S are associates because Company P has significant influence over Company S but no control. On 31 December 2016, Company P got one step closer to controlling Company S by purchasing an additional 20% holding in Company S, however, the total holding is 45% which is still lower than the 50% threshold required to presume control. Hence, as at 31 December 2016, Company P continues to account for Company S investment using the equity method. On 31 December 2017, through purchase of 15% additional ownership in Company S, Company P’s total holding in Company S rises to 60% (25% + 20% + 15%) and this is the date on which Company P obtains control over Company S. It must start consolidating Company S going forward.
Two questions arise at the time an investor establishes control in a step acquisition: (a) how to calculate goodwill and (b) what to do with the investment stake in the subsidiary before control is achieved.
Goodwill in step acquisition
In a step acquisition, goodwill arising in an acquisition equals the acquisition date (31 December 2017 in the above example) fair value of the (45%) investment already held in Company S plus the fair value of purchase consideration paid to Company S (or its shareholders) as at 31 December 2017 plus the fair value of the 40% non-controlling interest minus the fair value of net identifiable assets of the subsidiary:
|Goodwill in step acquisition||Calculation||USD in million|
|Acquisition date fair value of investment already held||O = PC/0.15 × 0.45||$96|
|Add: fair value of purchase consideration||PC||$32|
|Add: fair value of non-controlling interest||NCI = PC/0.15 × 0.40||$85.33|
|Less: fair value of net identifiable assets||NA||($200)|
|Goodwill on acquisition||O+PC+NCI-NA||$13.33|
Fair value adjustment of investment already held
The fair value adjustment made at the time of acquisition in respect to the investment held before acquisition is recognized as a gain. It is calculated as the difference between the acquisition date book value of the investment already held and the acquisition date fair value of that investment. The purchase consideration paid can be considered a good indication of the fair value of both non-controlling interest and the investment already held.
In the above example, the acquisition date fair value of investment already held is $92 million and its book value just before commencement of control is $85 million resulting in a gain of $7 million which must be recognized on acquisition date:
|Investment in Company S||$7 million|
|Gain on remeasurement||$7 million|