What is a Step Acquisition?

Step Acquisition

A step acquisition, also known as a piecemeal acquisition, refers to a situation where an investor acquires a stake in a target company in multiple stages or “steps” over time, rather than obtaining control in a single transaction. During this process, the investor’s ownership percentage in the target company gradually increases until it reaches a point where the investor gains control of the company (usually when ownership surpasses 50%).

The key features of a step acquisition include:

• Initial Non-controlling Interest: The investor starts by acquiring a non-controlling stake in the target company. This stake is usually less than 50%, meaning the investor cannot exert full control over the company’s operations or decision-making processes.
• Subsequent Acquisitions: Over time, the investor purchases additional shares or interests in the target company, increasing its stake.
• Achieving Control : At some point, with subsequent purchases, the investor’s cumulative stake in the target company surpasses the 50% threshold, granting the investor control over the target company.
• Accounting Implications: Step acquisitions have specific accounting implications. When the investor gains control, the investment transitions from being accounted for using the equity method (for significant influence but not control) to full consolidation. At the point of gaining control, the investor must also remeasure its previously held equity interest at its fair value and recognize any gain or loss in profit or loss.

Step acquisitions can offer several advantages:

• Flexibility: The investor can spread out the financial burden over time rather than committing significant capital in one go.
• Risk Management: By acquiring the target gradually, the investor can assess the performance and potential of the target company with each step, mitigating some risks associated with acquisitions.
• Strategic Positioning: The initial non-controlling stake can serve as a foothold, allowing the investor to influence or understand the target company’s operations before taking full control.

On the flip side, step acquisitions can also carry risks:

• Price Fluctuations: The cost of acquiring additional stakes might rise if the target company performs exceptionally well after the initial investment.
• Potential Resistance: The target company’s other shareholders or its management might resist the investor’s attempts to acquire additional shares or exert more influence.

Real-world examples of step acquisitions include many instances where companies initially invest in a strategic partner or potential target, and over time, as the relationship develops or circumstances change, decide to increase their stake until they achieve control.

Example of a Step Acquisition

Let’s illustrate the concept of a step acquisition with a hypothetical example:

Scenario:

TechNova Corp., a tech giant, identifies an innovative startup called NanoSoft Ltd. that specializes in advanced AI algorithms. TechNova sees potential synergies but opts for a gradual investment strategy.

Steps of the Step Acquisition:

1. Initial Investment: In 2020, TechNova purchases a 20% stake in NanoSoft for $20 million. This does not give TechNova control over NanoSoft, but it allows TechNova to have significant influence, so they account for this investment using the equity method.
2. Performance Assessment: Over the next year, TechNova collaborates with NanoSoft on a few projects and is impressed with NanoSoft’s technology and team. During this period, NanoSoft’s market value also appreciates due to some breakthrough developments.
3. Second Investment: In 2022, seeing the potential for deeper integration and synergies, TechNova acquires an additional 35% stake in NanoSoft for $50 million. Now, TechNova’s total ownership is 55%.
4. Achieving Control: With the 55% stake, TechNova now has control over NanoSoft. From an accounting perspective, TechNova will transition from the equity method to full consolidation of NanoSoft’s financial statements. Additionally, TechNova would have to remeasure its initially held 20% stake at its current fair value and recognize any gains or losses in its income statement.
5. Full Acquisition (Optional): By 2024, NanoSoft’s integration into TechNova’s ecosystem is so deep that TechNova decides to acquire the remaining 45% of NanoSoft for $70 million, making it a wholly-owned subsidiary.

Outcome:

Through a step acquisition, TechNova was able to spread out its investment in NanoSoft over multiple years, allowing it to assess the potential of the startup at each stage. This gradual approach provided TechNova with insights into NanoSoft’s operations and strategic fit before making significant financial commitments.

In the real world, step acquisitions can be more complex and might be influenced by various factors such as market conditions, regulatory environment, competitive landscape, and strategic priorities of the acquiring company.