Tender rights of non-controlling interests (NCI) denotes a group’s obligation to purchase its equity interests (e.g. Shares) from non-controlling interests should the NCI offer these shares (usually a so-called issuer settlement option). In many cases, the NCI's right becomes exercisable at a predetermined future date and expires thereafter. Seen from the perspective of the company that grants this right, the transaction is economically a short position on treasury shares, i.e. a written put option with the treasury share as the underlying. This potential repurchase obligation of the company is often referred to as a "tender right" (or puttable instrument) in the literature on the accounting treatment of the obligated company.

We see such tender rights frequently used in practice in a variety of contractual constellations. The same applies to companies that do not really want to have anything to do with derivatives and, in particular, options. Generally, tender rights are not openly included as individual contracts, but as a contractual passage in other contracts, for example in the context of business combinations (as defined by IFRS 3). At times, however, such contractual passages are also intended to enable market access. In such cases, for instance, a company needs a local business partner with the right contacts, who understands how the business works, or who facilitates the company's business activities in the first place in terms of legal requirements (e.g. abroad). And in these instances, tender rights are typically also included in service contracts or similar. 

NCI tender rights are a "popular" source of errors in financial statements, as several aspects have to be assessed. The resulting errors can occasionally lead to significant misstatements in the IFRS consolidated financial statements and the key figures derived from them. Since equity and financial liabilities are regularly measured or recognized incorrectly as a result of an error, a significant number of typical financial covenants may also be affected (for example, the net debt ratio).

Frequently, tender rights need to be taken into account in the presentation of business combinations under IFRS 3 (for example, as part of the determination of Consideration Transferred) or they are in the scope of IFRS 2 on share-based payments (IFRS 2) (for example, NCI granted to employees). A distinction is also hard to make insofar as companies can also be beneficiaries of share-based payments. 

As share-based payments have already been the subject of various articles in this newsletter series, the following describes tender rights arising from company acquisitions. As at the acquisition date, the Group must (fully) consolidate the subsidiary's assets and liabilities and disclose the shares held by outside shareholders as non-controlling interests (NCI), which it discloses in equity.

Apart from the recognition of the tender right (on the credit side), the offsetting entry (on the debit side) at initial recognition has also caused quite a stir, which is why both topics are briefly discussed below in a simplified manner.

About the approach to the tender right: While the tender right has the payment and valuation profile of an option from a finance mathematics perspective, it is not recognized at this value (IAS 32.18 in conjunction with IAS 32.23). Under IFRS, the obligation arising from the right to tender is generally (compare KPMG Insights into IFRS 19th in conjunction with not a derivative or equity, but a financial liability that needs to be recognized initially at the discounted repayment amount (IAS 32.23). Consequently, for traditional tender rights, a liability is not recognized in the amount of the option's fair value ([market value - exercise price/strike] plus fair value), but in the amount of the present value of the exercise price itself. Where, in accordance with the general principles for the subsequent measurement of financial liabilities, the carrying amount of this particular liability has to be adjusted, in principle there is the elective right, which can be exercised continuously, to recognize the change in the liability's value in profit or loss (P&L) or in the Group's equity with no effect on profit or loss. It goes without saying that the elective right is limited to liabilities arising from the tender rights described here. 

Should, for example, the right exist to sell the shares of a group company to the same group within two years at the then fair value, then the tender right has a mathematical option value of zero, as the following always applies at the time of exercise: 

Market value of the shares = Exercise price 

and such a contract has neither intrinsic nor fair value. In contrast, the amount of the liability for the tender right is set by the expected purchase price (and the specific discounting).

For the offsetting entry of the tender right's initial recognition: As a rule, the NCI can be derecognized or the portion of (consolidated) equity attributable to the parent company can be reduced directly (in the case of business combinations in accordance with IFRS 3, goodwill can also be considered. The case will not be discussed further here)..First of all, the decision must be based on an assessment of whether the NCI have already de facto lost their ownership position ("present access"). This assessment is based on the circumstances of the case as a whole and must be considered on a case-by-case basis. In this regard, it is necessary to take into account participation in positive and negative changes in the share value and access to dividends. For example, the ownership position is not effectively lost if the shares may be sold at maturity at their then existing fair value and the NCIs continue to be eligible for dividends in the meantime In cases where the non-controlling shareholders continue to hold the "ownership position" in economic terms, the company that has granted the tender rights has the elective right to recognize the debit entry either in consolidated equity or in the NCI (but not in the case of business combinations). If "present access" no longer exists, the so-called "anticipated acquisition" method (KPMG Insights into IFRS 19th 2.5.690.30) must be applied, and thus the debit entry must be made against the NCI. If there exists “present access”, the company has the elective right to apply this method. In practice, often the "anticipated acquisition method" is applied. However, only any remaining difference (liability </> NCI) would be recorded against the Group's equity.

On the tender right's exercise date, the right is either exercised (usually against cash and cash equivalents) or it expires. If the right has expired, the liability is derecognized directly in the Group’s equity.

Given the above reasons, drawing up a contract with foresight protects against "unpleasant surprises". At any rate, before a tender right is granted, its accounting implications should be assessed in detail and, if necessary, also simulated so as to avoid any undesirable effects on balance sheet ratios.

The Finance and Treasury Management team would be pleased to answer any questions you may have.

Source: KPMG Corporate Treasury News, Edition 125, September 2022
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Felix Wacker-Kijewski, Senior Manager, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG