Oil and gas acquisitions are complex, and the magnitude of complexity escalates with the size of the deal. Complex transactions in this industry can trigger accounting and reporting issues that may result in SEC letters, restatements and challenging conversations with investors.
Below, I'll delve into the complexities that arise before closing an acquisition, and how to address them.
Adequate preparation
In the realm of business transactions, a lack of preparation, due diligence or understanding can introduce complexities that may jeopardize the smooth execution of a deal.
Engage all relevant groups: Engage multiple groups in the transaction process, including the deal team, legal, and various accounting departments such as operations accounting, financial reporting, and tax. Each of these entities plays a vital role in ensuring that the transaction proceeds efficiently and complies with regulatory standards.
Clearly define deals: Deals within the industry can often evolve rapidly, with multiple changes and shifting dynamics. As such, companies should clearly define key aspects of the deal, such as whether assets or an entire business are being acquired and what form of consideration is involved, whether it's stock, cash or contingent arrangements.
Robust preparation: Thorough preparation serves as the linchpin for a successful transaction. Neglecting to involve all the pertinent team members, particularly those in the accounting and tax department, can lead to post-deal complications. Data acquired should align seamlessly with subsequent processes like joint interest billing and revenue processing, and the tax implications and reporting requirements of the deals should be carefully, proactively considered.
Confidentiality: Many argue that involving too many individuals before the deal closes could be risky. But this should be measured by trust in one's employees. While not every employee needs to be privy to confidential information, I recommend including department heads such as revenue, tax and financial reporting directors to facilitate a smoother transaction process.
Timing of the close
Determining the closing date of a deal often goes overlooked but can significantly impact the efficiency of your back-office operations.
Middle-month closes: Closing in the middle of the month, even if you aim for a perfect split like the 15th, can present substantial challenges for your back office and the divesting company. In the context of exploration and production companies, their systems are typically not designed to process mid-month revenue, leading to the necessity of manual calculations to ensure accurate recognition and reporting of profit and loss. This, in turn, results in an increased number of manual adjustments required to correctly book the Day One opening balance sheet for the acquired business.
Closing at end of reporting period: Closing a deal at the end of a reporting period, whether it's the end of a quarter or the fiscal year, imposes a tight turnaround time on your reporting team for fulfilling reporting requirements. While there may be instances where such timing is unavoidable, it's best to avoid closing at the end of a reporting period when possible.
Closing within a reporting period: Opting for a close within a reporting period provides your team with the valuable resources of time and flexibility to address any known or unforeseen issues that may arise during the accounting process for the acquisition. This approach can help streamline the transition and enhance the overall efficiency of your back-office operations.
Reporting requirements
Although reporting requirements are typically addressed after a deal has closed, companies should consider them as a pre-closing issue, particularly public businesses or those affiliated with a public parent company. Even smaller reporting companies are subject to specific disclosures mandated by S-X 4-10 and must adhere to the auditor reporting and independence requirements outlined in S-X Article 2. When dealing with working interests, they are regarded as businesses for reporting purposes according to X-A 11-01(d).
For businesses that meet significance tests, pre-acquisition financial statements become a necessity. These significance tests typically involve a 10% threshold related to assets, income, or investment. Notably, the Securities and Exchange Commission has established specific guidance tailored to the unique requirements of oil and gas companies. Thus, businesses should anticipate and address these reporting requirements before closing for ensuring compliance and a seamless transition, particularly for entities within the oil and gas industry operating under SEC regulations.
Significance test (all at 10% threshold): The Significance Test Guidance, as outlined in S-X 3-05, comprises three key tests to determine the significance of a business acquisition:
- The Asset Test, which evaluates the book value of the assets acquired in relation to the total assets of the registrant;
- The Income Test, which assesses the acquired business's income from continuing operations before taxes in comparison to the registrant's income from continuing operations before taxes; and
- The Investment Test, which involves the calculation of the GAAP purchase price (consideration transferred) for the acquired business relative to the registrant's consolidated total assets.
Abbreviated reporting requirements: Abbreviated reporting requirements come into play when considering the filing of financial statements in lieu of carve-out financials, but specific conditions must be met. These conditions include the property acquired being less than substantially all of the seller's key operating assets and meeting the following criteria:
- The interest in the acquired oil or natural gas property constitutes only a portion of the seller's assets and is not a distinct segment or division of an entity, nor contained in a separate legal entity.
- The acquired business has not previously had separate financial statements prepared, and the seller has not maintained distinct and separate accounts necessary for presenting full financial statements or full carve-out financial statements for the property.
- It is deemed impracticable to prepare the full financial statements as required by Regulation S-X. Under these circumstances, abbreviated financial statements may be utilized as an alternative approach.
Successfully navigating a transaction
Navigating oil and gas acquisitions is a complex endeavor, with the level of intricacy increasing alongside deal size. These complexities can give rise to accounting, reporting and operational challenges that may have far-reaching consequences, including SEC scrutiny, restatements and intricate investor discussions.
Third parties can assist by helping companies address complexities proactively, engage all relevant stakeholders and adhere to regulatory guidelines, to better position companies for success.
