Professor X teaches biology at the University of ND (UND)
Question # 00292752
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Updated on: 05/21/2016 11:40 AM Due on: 06/20/2016
Case 15-10
Who’s in Charge?
Background
Professor X teaches biology at the University of ND (UND). As part of his employment
agreement, UND has the rights to any intellectual property or technology developed by
Professor X while he is employed by UND. During his employment at UND, Professor X
founded several companies that use the technology he developed. This technology
involves the use of non-embryonic (adult) human cells to reprogram genes within adult
human cells into stem cells. Each company founded by Professor X is an affiliate of UND
(for simplicity, UND) and has entered into an agreement whereby the company would
license the technology developed by Professor X from UND in exchange for equity in the
company and ongoing royalty payments to UND.
Phoenix
On June 15, 2XX8, Professor X established Phoenix, a biotechnology company that
specializes in producing stem cells using the latest technology.
Thunderbird
On January 26, 2XX6, Professor X established Thunderbird, a biotechnology company
that specializes in producing stem cells using second-generation technology. Thunderbird
is developing products, but has had no revenue (except minimal grant revenue).
Darwin
On November 9, 2XX4, Professor X established Darwin, a biotechnology company that
specializes in producing stem cells using first-generation technology.
As of mid-2XX8, Darwin has several products and services, contracts with customers,
and minimal revenue.
Darwin and Thunderbird share office and lab space, equipment, and employees. Because
of ethical concerns and the regulatory environment surrounding embryonic stem-cell
research, both Darwin and Thunderbird were unsuccessful in gaining significant market
traction.
The Merger
On July 25, 2XX8, Darwin and Thunderbird merged into Phoenix, the surviving entity.
Phoenix issued its common shares to the shareholders of Darwin and Thunderbird in
exchange for their shares of Darwin and Thunderbird. After the merger, the Darwin and
Thunderbird legal entities ceased to exist. The shareholders of Phoenix, Darwin, and
Thunderbird agreed that the value of each of the respective companies was equal.
Copyright 2014 Deloitte Development LLC
All Rights Reserved.
Case 15-10: Who’s in Charge?
Page 2
The initial financing for each of the three companies was provided by a venture investor,
VC, in exchange for equity in each of the companies. VC is an investment company that
accounts for its investments at fair value in accordance with the specialized accounting
guidance in ASC 946. VC proposed the merger to Professor X, who gave preliminary
support for exploration of the proposal. The proposal was then discussed with the boards
of each of the companies. The reasons for the merger include (1) the opportunity for all
parties to participate in the benefits of Phoenix’s technology and (2) the potential benefits
of shared management, economies of scale, scientific cross-fertilization, and enhanced
fundraising capacity. In addition, Phoenix was able to acquire access to Darwin’s and
Thunderbird’s employees, their stem-cell scientific know-how, equipment, and facilities.
Ownership, Governance, and Significant Financial Information
Before the merger, there was some common ownership among Phoenix, Darwin, and
Thunderbird. Professor X controlled Phoenix, but no one shareholder controlled Darwin
or Thunderbird. In addition, each of the companies had individual investors. The
following table illustrates the shareholder ownership of the entities pre-merger and postmerger:
Pre-Merger
Phoenix
Darwin
Thunderbird
Post-Merger
Prof. X
55.3%
37.8%
36.3%
43.1%
VC
21.9%
27.2%
22.0%
23.7%
UND
14.6%
7.0%
8.4%
10.0%
Mr. C
13.6%
4.5%
Mr. F
14.4%
4.8%
Ms. H
15.6%
5.2%
Ms. S
12.2%
4.1%
5.5%
4.6%
100.0%
100.0%
Mr. P
8.2%
Total
100.0%
100.0%
As noted above, Darwin, Thunderbird, and Phoenix had common investors and thus, had
many common members of their boards of directors and some common members of
senior management. Each director had a single vote, and there was no agreement among
the directors that required board members to vote together. Certain significant decisions
at each company, such as a change in control, merger, or change in capital structure (i.e.,
protective rights), required at least a 75 percent voting share approval. To effect the
merger agreement, 75 percent of Darwin’s voting shareholders, 80 percent of
Thunderbird’s voting shareholders, and 75 percent of Phoenix’s voting shareholders were
required to approve the transaction.
The following table illustrates the governance roles of the shareholders in the entities premerger and post-merger:
Copyright 2014 Deloitte Development LLC
All Rights Reserved.
Case 15-10: Who’s in Charge?
Page 3
Pre-Merger
Post-Merger
Phoenix
Darwin
Thunderbird
Prof. X
Director, Chief
Science Officer
(CSO)
Director, CSO
Director, CSO
Director, Chairman
of the BOD, and
CEO
VC Principal 1
Director, Chair
Director, Chair
Director, Chair
Director
VC Principal 2
Director,
President, CEO,
Treasurer
Director,
President, CEO,
Treasurer
Director, President,
CEO, Treasurer
Director, ViceChairman of the
BOD and President
UND
Mr. C
Director, Chief
Technology
Officer
Mr. F
Chief Operating
Officer
Director
Vice President and
Chief Technology
Officer
Chief Operating
Officer
Ms. H
Director
Director
Ms. S
Director
Nonshareholder 1
Director
Nonshareholder 2
Director
Chief Business
Officer (CBO)
CBO
Nonshareholder 3
Director
Director
The following table provides key financial information before the transaction:
Pre-Merger
Phoenix
Darwin
Thunderbird
$6.0 million
$4.4 million
$2.7 million
Cash on hand
0
$484,000
$146,000
Employees
5
22
12
$277,000
$154,000
$175,000
Debt outstanding to VC
Fair value of licensed
technology
At the time of the merger, each company was deemed to be of equal of value, $5.3
million. However, no valuation assessment was performed to independently verify that.
The majority of the value of each of the companies was related to the employees,
scientific know-how, and technology. Phoenix’s technology is estimated to have the
highest fair value of $277,000.
In this case study, assume that VC meets the definition of an investment company under
both U.S. GAAP and IFRSs.
Copyright 2014 Deloitte Development LLC
All Rights Reserved.
Case 15-10: Who’s in Charge?
Page 4
Required:
1. How should Phoenix account for its acquisition of 100 percent of equity interests
in Darwin and Thunderbird: as a merger of entities under common control or as a
business combination?
2. If the merger of Phoenix, Darwin, and Thunderbird is a business combination,
which entity should be identified as the accounting acquirer?
Copyright 2014 Deloitte Development LLC
All Rights Reserved.
Who’s in Charge?
Background
Professor X teaches biology at the University of ND (UND). As part of his employment
agreement, UND has the rights to any intellectual property or technology developed by
Professor X while he is employed by UND. During his employment at UND, Professor X
founded several companies that use the technology he developed. This technology
involves the use of non-embryonic (adult) human cells to reprogram genes within adult
human cells into stem cells. Each company founded by Professor X is an affiliate of UND
(for simplicity, UND) and has entered into an agreement whereby the company would
license the technology developed by Professor X from UND in exchange for equity in the
company and ongoing royalty payments to UND.
Phoenix
On June 15, 2XX8, Professor X established Phoenix, a biotechnology company that
specializes in producing stem cells using the latest technology.
Thunderbird
On January 26, 2XX6, Professor X established Thunderbird, a biotechnology company
that specializes in producing stem cells using second-generation technology. Thunderbird
is developing products, but has had no revenue (except minimal grant revenue).
Darwin
On November 9, 2XX4, Professor X established Darwin, a biotechnology company that
specializes in producing stem cells using first-generation technology.
As of mid-2XX8, Darwin has several products and services, contracts with customers,
and minimal revenue.
Darwin and Thunderbird share office and lab space, equipment, and employees. Because
of ethical concerns and the regulatory environment surrounding embryonic stem-cell
research, both Darwin and Thunderbird were unsuccessful in gaining significant market
traction.
The Merger
On July 25, 2XX8, Darwin and Thunderbird merged into Phoenix, the surviving entity.
Phoenix issued its common shares to the shareholders of Darwin and Thunderbird in
exchange for their shares of Darwin and Thunderbird. After the merger, the Darwin and
Thunderbird legal entities ceased to exist. The shareholders of Phoenix, Darwin, and
Thunderbird agreed that the value of each of the respective companies was equal.
Copyright 2014 Deloitte Development LLC
All Rights Reserved.
Case 15-10: Who’s in Charge?
Page 2
The initial financing for each of the three companies was provided by a venture investor,
VC, in exchange for equity in each of the companies. VC is an investment company that
accounts for its investments at fair value in accordance with the specialized accounting
guidance in ASC 946. VC proposed the merger to Professor X, who gave preliminary
support for exploration of the proposal. The proposal was then discussed with the boards
of each of the companies. The reasons for the merger include (1) the opportunity for all
parties to participate in the benefits of Phoenix’s technology and (2) the potential benefits
of shared management, economies of scale, scientific cross-fertilization, and enhanced
fundraising capacity. In addition, Phoenix was able to acquire access to Darwin’s and
Thunderbird’s employees, their stem-cell scientific know-how, equipment, and facilities.
Ownership, Governance, and Significant Financial Information
Before the merger, there was some common ownership among Phoenix, Darwin, and
Thunderbird. Professor X controlled Phoenix, but no one shareholder controlled Darwin
or Thunderbird. In addition, each of the companies had individual investors. The
following table illustrates the shareholder ownership of the entities pre-merger and postmerger:
Pre-Merger
Phoenix
Darwin
Thunderbird
Post-Merger
Prof. X
55.3%
37.8%
36.3%
43.1%
VC
21.9%
27.2%
22.0%
23.7%
UND
14.6%
7.0%
8.4%
10.0%
Mr. C
13.6%
4.5%
Mr. F
14.4%
4.8%
Ms. H
15.6%
5.2%
Ms. S
12.2%
4.1%
5.5%
4.6%
100.0%
100.0%
Mr. P
8.2%
Total
100.0%
100.0%
As noted above, Darwin, Thunderbird, and Phoenix had common investors and thus, had
many common members of their boards of directors and some common members of
senior management. Each director had a single vote, and there was no agreement among
the directors that required board members to vote together. Certain significant decisions
at each company, such as a change in control, merger, or change in capital structure (i.e.,
protective rights), required at least a 75 percent voting share approval. To effect the
merger agreement, 75 percent of Darwin’s voting shareholders, 80 percent of
Thunderbird’s voting shareholders, and 75 percent of Phoenix’s voting shareholders were
required to approve the transaction.
The following table illustrates the governance roles of the shareholders in the entities premerger and post-merger:
Copyright 2014 Deloitte Development LLC
All Rights Reserved.
Case 15-10: Who’s in Charge?
Page 3
Pre-Merger
Post-Merger
Phoenix
Darwin
Thunderbird
Prof. X
Director, Chief
Science Officer
(CSO)
Director, CSO
Director, CSO
Director, Chairman
of the BOD, and
CEO
VC Principal 1
Director, Chair
Director, Chair
Director, Chair
Director
VC Principal 2
Director,
President, CEO,
Treasurer
Director,
President, CEO,
Treasurer
Director, President,
CEO, Treasurer
Director, ViceChairman of the
BOD and President
UND
Mr. C
Director, Chief
Technology
Officer
Mr. F
Chief Operating
Officer
Director
Vice President and
Chief Technology
Officer
Chief Operating
Officer
Ms. H
Director
Director
Ms. S
Director
Nonshareholder 1
Director
Nonshareholder 2
Director
Chief Business
Officer (CBO)
CBO
Nonshareholder 3
Director
Director
The following table provides key financial information before the transaction:
Pre-Merger
Phoenix
Darwin
Thunderbird
$6.0 million
$4.4 million
$2.7 million
Cash on hand
0
$484,000
$146,000
Employees
5
22
12
$277,000
$154,000
$175,000
Debt outstanding to VC
Fair value of licensed
technology
At the time of the merger, each company was deemed to be of equal of value, $5.3
million. However, no valuation assessment was performed to independently verify that.
The majority of the value of each of the companies was related to the employees,
scientific know-how, and technology. Phoenix’s technology is estimated to have the
highest fair value of $277,000.
In this case study, assume that VC meets the definition of an investment company under
both U.S. GAAP and IFRSs.
Copyright 2014 Deloitte Development LLC
All Rights Reserved.
Case 15-10: Who’s in Charge?
Page 4
Required:
1. How should Phoenix account for its acquisition of 100 percent of equity interests
in Darwin and Thunderbird: as a merger of entities under common control or as a
business combination?
2. If the merger of Phoenix, Darwin, and Thunderbird is a business combination,
which entity should be identified as the accounting acquirer?
Copyright 2014 Deloitte Development LLC
All Rights Reserved.
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Rating:
/5
Solution: Professor X teaches biology at the University of ND (UND)