Opening balance sheet
M&A / Merger ModelThe combined balance sheet as at completion, built by recognising the acquired assets and liabilities at fair value and eliminating the target's own equity.
Also written: day one balance sheet, pro forma opening balance sheet
The opening balance sheet is the starting point for every forecast in a merger model. Until it exists there is no debt balance to charge interest on, no intangible balance to amortise and no share count to divide by, so a model that skips it is producing pro forma earnings out of the air.
Building it is mechanical. Eliminate the target's equity in full, including any goodwill it carried from its own past deals, since goodwill is not an identifiable asset. Add the write ups and the newly recognised intangibles. Recognise the deferred tax liability on those write ups. Then record how the deal was paid for: new debt drawn, new shares issued, cash spent.
Goodwill is what makes it balance. That is convenient and also dangerous, because an error anywhere in the allocation lands silently in goodwill rather than breaking the model, and a balance sheet that balances is not evidence that the allocation is right.
Two costs are treated differently and both belong here. Under IFRS 3 the advisory and legal fees of the acquisition are expensed as incurred, so they reduce cash and retained earnings rather than adding to the price. The fees of raising the acquisition debt are capitalised against that borrowing and amortised over its life.
Worked example
A buyer pays 1,000 in cash and shares for a target with 250 of book equity, 450 of write ups and a 112.5 deferred tax liability on them.
The target's 250 of equity is eliminated, 450 of assets and 112.5 of deferred tax are added, and goodwill of 412.5 is plugged in to make the entry balance against the 1,000 of consideration.
The 15 of advisory fees paid on the deal appear nowhere in that entry. They are expensed, reducing cash and retained earnings in the period of completion.