Contingent consideration to vendors: Acquisition consideration or post-combination services?

The consideration transferred by a vendor in business combinations may include cash, equity instruments and other vendor assets. A substantial part of the consideration is usually transferred upfront, with some deferred over time, and some contingent on further conditions being met.

What is contingent consideration?

Contingent consideration for a business combination is defined as follows:

The acquirer and acquiree in a business combination often agree to include certain amounts of contingent consideration as part of the acquisition agreement in order to share some of the risks associated with the future performance of the business that is being acquired.

Contingent consideration is often tied to factors such as achieving set profit targets, revenue targets or cash flows over a specified period post combination, the granting of a licence or patent, or a vendor employee remaining as an employee of the acquired group for a set period.

How to account for contingent consideration?

The purchaser in a business combination measures the fair value of contingent consideration at the acquisition date. Contingent consideration generally forms part of the total consideration for the business combination, which is allocated to the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values (this is referred to as the purchase price allocation). Any excess consideration over the acquisition-date fair value of the net assets acquired is recognised as goodwill. In practice, contingent consideration often results in additional goodwill.

Contingent payments to employees or selling shareholders

Contingent consideration may be tied to performance measures of the vendors who will remain as employees of the acquiree, or to other employees. In such cases, the purchaser must determine whether the contingent consideration represents:

• A payment to the vendor employee in their capacity as a shareholder (which will be accounted for as part of the purchase consideration), or
• A payment to the vendor employee in their capacity as an employee (which is accounted for as an employee benefit expense in profit or loss when the amount is payable or paid). 

Consideration or post-combination employee services?

Preparers need to understand the nature of each contingent payment arrangement with employees/vendors in order to determine whether it forms part of the consideration or is for post-combination services. This includes understanding:

• The reasons why the acquisition agreement includes a provision for contingent payments
• Who initiated the arrangement, and
• When the parties entered into the arrangement.

Employee services if automatically forfeited

Paragraph B55(a) of IFRS 3 Business Combinations says that a contingent consideration arrangement in which the payments are automatically forfeited if employment terminates is remuneration for post-combination services (recognised in profit or loss).

Arrangements in which the contingent payments are not affected by employment termination may indicate that the contingent payments comprise additional consideration rather than remuneration. However, this is just one indicator of many to be considered (discussed further below).

Indicators where contingent payments are not automatically forfeited

Where contingent payments are not automatically forfeited if employment terminates, the purchaser should consider the following indicators when deciding whether the employee or vendor contingent payment forms part of the overall purchase consideration for the business combination, or whether it is for post-combination employee services:

Continuing employment	Duration of any continuing employment	Level of remuneration	Incremental payments to employees
Number of shares owned	Linkage to valuation	Formula for determining consideration	Other agreements and issues

IFRS 3.B55 indicators

The following table illustrates, for each indicator, how facts and circumstances could lead to a conclusion that a contingent payment arrangement is either remuneration for employee services, or additional consideration (noting that no one indicator is determinative, and judgement should be applied):

Indicator	Conclusion (may indicate)
Continuing employment – no automatic forfeiture	Additional consideration
Duration of continuing employment	If the required employment period coincides with or is longer than the contingent payment period – remuneration. If the required employment period is shorter than the contingent payment period - additional consideration.
Level of remuneration	Employee remuneration (other than the contingent payments) is at a reasonable level in comparison with that of other key employees in the combined entity - additional consideration.
Incremental payments to employees	If selling shareholders who don’t become employees receive lower contingent payments on a per-share basis than the selling shareholders who become employees - remuneration. If selling shareholders who don’t become employees receive similar contingent payments on a per-share basis to selling shareholders who become employees - additional consideration.
Number of shares owned	If the selling shareholders owned substantially all of the shares in the acquiree and continued as key employees, this may indicate a profit-sharing arrangement (remuneration). If selling shareholders who continue as key employees owned only a small number of shares of the acquiree and all selling shareholders receive the same amount of contingent consideration on a per-share basis, this may indicate that the contingent payments are additional consideration.
Linkage to valuation	If the initial consideration transferred at the acquisition date is based on the low end of a valuation range and the contingent formula relates to that valuation approach, this may suggest that the contingent payments are additional consideration. If the contingent payment formula is consistent with prior profit-sharing arrangements, that fact may suggest that the substance of the arrangement is to provide remuneration.
Formula for determining consideration	If a contingent payment is determined on the basis of a multiple of earnings, it may suggest that the obligation is contingent consideration because the formula is intended to establish or verify the fair value of the acquiree. If a contingent payment is a specified percentage of earnings, it may suggest that the obligation is a profit-sharing arrangement to provide remuneration.
Other agreements and issues	Terms of other arrangements with selling shareholders (such as agreements not to compete, executory contracts, consulting contracts, and property lease agreements) and the income tax treatment of contingent payments may indicate that contingent payments not consideration for the acquiree. For example, if the acquirer enters into a property lease arrangement with the selling shareholders, and the terms of lease payments specified in the lease agreement are: Consistent with market terms – the contingent payments may be additional consideration for the business combination Significantly below-market - some or all of the contingent payments may be for the use of the leased property and expensed in the post-combination financial statements.

Need help?

Purchasers should not assume that all contingent consideration is part of the acquisition price. Depending on facts and circumstances, amounts paid to vendors who continue working for the combined group may be remuneration for post-combination services, which will affect group profitability in future. Significant judgement is involved. Please contact BDO’s IFRS & Corporate Reporting team to assist with your business combination accounting, including contingent vendor payments.