Increased activity from Private Equity (PE) is expected in 2025 as UK PE firms sit on around £119bn of dry powder which they need to deploy.

While the upcoming changes to UK accounting rules may not be effective until the 2026 financial year, we recommend that PE firms acquiring UK portfolio companies in 2025 should act now as these changes could impact the calculation of deferred consideration linked to performance targets (“earn-out” consideration). Let’s take a closer look at what the key changes mean.

What are the upcoming changes to UK GAAP?

From 1 January 2026, UK accounting standards will undergo a major overhaul, aligning closer with IFRS. This update will be beneficial for PE houses who are investing in international businesses as it will create more consistency with financial reporting across their portfolio companies.

The two headline changes are as follows:

• Revenue recognition – a new model based on IFRS 15’s five-step model, with simplifications. The way in which businesses will be impacted will depend on the underlying industry they operate in and the legal form of their contracts with customers; and
• Lease accounting requirements – a new model for lease accounting, based on IFRS 16’s on-balance sheet model, with some simplifications. Many businesses that use operating leases will be impacted.

However, there are a number of less publicised changes that will impact the financial statements of businesses going through a transaction. These include changes to:

• Business combinations – there is new guidance on determining whether earn-out arrangements form part of the cost of the acquisition.
• Share-based payments – there is new guidance on share-based payments that form part of business combinations. These are in addition to scope changes on accounting for share-based payment transactions with a choice of settlement, and treatment of vesting conditions for cash-settled share-based payment transactions.

How will these changes impact deal metrics?

The updated accounting standards will have an impact on key deal metrics without any changes to the underlying commercials of the business:

Revenue multiples

The impact of the updated standards will have no impact on the underlying cashflows but they could impact the timing of revenue recognition in the financial statements. The impact will be dependent on the sector that the underlying portfolio company operates in - industries expected to see a big change include tech or life sciences, and in businesses with contracts that sell multiple goods and services.

EBITDA

PE houses monitoring EBITDA closely will see significant changes as the historic rent expense (within EBITDA) is replaced with a new interest and depreciation expense (outside of EBITDA). As a result, EBITDA will increase despite there being no underlying changes to cash outflows relating to lease costs or the overall performance of the business.

Variable interest margins

As part of a new deal structure, loan notes may be issued which include variable interest margin payments. As a result of this accounting change, interest payments may be impacted in cases where the margin calculation is based on a multiple of EBITDA. This could alter cashflows in relation to interest payments despite there being no underlying change to the performance of the business.

Balance sheet ratios

Bringing leases onto the balance sheet will impact the assets and liabilities of a business without any underlying commercial change in lease arrangements. Any ratios dependent upon the balance sheet will be impacted.

Monthly reporting into the PE house

Although revenue changes can be applied retrospectively, lease changes only apply prospectively. In the year of initial adoption, there will be a lack of comparability in the profit and loss statement and balance sheet, which may lessen the usefulness of management information and analysis of changes in metrics.

Why does this impact deal negotiations in 2025?

In many PE deals, earn-out payments are included relating to the post-deal performance of the business. These bonuses are often linked to the growth in the key deal metrics, such as revenue or EBITDA.

James Wild, Head of M&A at RSM UK comments that “earn-out agreements are typically based on the GAAP in place at the date of the agreement. So, as part of deal negotiations throughout 2025, all parties should discuss whether deal metrics will be based on historic GAAP calculations or new GAAP calculations. Not specifying which GAAP will be used could result in the change of accounting standards impacting earn out payments in a manner which was not intended – rather than the performance of the underlying business.”

Early preparation is the key to successful deal

PE houses should prepare early for these changes in UK GAAP to make sure they are considered during the deal negotiations, rather than considered post deal.

Quantifying the impacts of the new accounting standards on the target portfolio companies can be time consuming.

To prepare for the new changes:

• Management teams will need to identify and analyse lease contracts across the business before calculating the balance sheet values both at the start and end of the year.
• Management teams will also need to assess the impact of the application of the five-step revenue model on their revenue contracts.
• Businesses can choose to decide whether to apply the revenue changes retrospectively, so management should consider if restating comparatives would result in a more useful reflection of the entity’s performance. If so, organisations should put together a robust plan to apply the revised standard to historic revenue contracts.
• Share-based payment arrangements issued during the deal will need to be reviewed and analysed against the new accounting guidance.

How we can help

Across our UK GAAP series, we’re highlighting the specific impact of changes to FRS 102 to businesses across a range of industries. To find out more, explore our Bridging the GAAP insights.

Our team of accounting and financial reporting experts are also on-hand to support and guide you as you navigate the potential impacts on your target portfolio company. Get in touch with us today and find out how we can help you.

Related insights