It doesn't matter if you represent an active private equity firm and are an experienced, frequent purchaser of companies or if you are about to purchase a firm for the first time: An understanding of the purchase price allocation process is essential if you are to achieve the maximum tax benefits from your purchase.
There is no legal requirement that you conduct a purchase price allocation on your acquisition. But you will need one if you intend to depreciate any of your assets to improve your new firm’s cash flow or if you plan to make use of potential tax advantages of amortization.
On day one, every buyer of a company is an optimist. They are paying good money for something because they think they can improve upon it, fix it better than the last owner or penetrate new markets with its products. The buyer needs to know how much of what they paid is for assets and how much is for “good will,” the premium you pay beyond its assets for that opportunity to make a company better.
A purchase price allocation uses standard practices to value the tangible and intangible assets of an acquired firm. These include such tangible assets as real estate, leases and inventory and such intangibles as the value of a brand and of customer and vendor relationships. The long-term tax implications of failing to obtain a solid purchase price allocation can be significant.
A growing number of consulting firms can perform a purchase price allocation for you, and large publicly traded firms are likely to perform that function internally. When you choose a firm to perform this service for your new acquisition, it’s important to be able to put your trust in a company that has extensive experience and understanding of the rules that apply to this process.