beans2I hope all of you enjoyed the recent holiday.  I know I did, even if my waistline did not.  In the interest of Thanksgiving, and the positive spirit in brings out in all of us,  I wanted to hold off on this post, because there is not a lot of good news within.  Long short, further barriers to rightsizing transaction velocity continue to emerge my friends.  I don’t have to continue to wax on about the challenges in the private transaction markets, but after reviewing the proposed changes to accounting and reporting standards in mergers and acquisitions brought to you by the Financial and Accounting Standards Board, I can say we have achieved an even further state of gloom.  The implications, discussed below, are going to create a significant drag for acquirers post January 1, 2009.  I expect these new policies are going to create further frictions to getting deals done at attractive valuations.

Before we get into the captivating nuances of FAS 141(R) and FAS 160, let me make one positive note, albeit it a fleeting one.  At this time, it does not appear the Obama regime is in a rush to change capital gains treatment.  While it remains my belief that the Democratic regime recently elected into office will raise capital gains on households that meet the $250,000 income threshold, Team Obama appears to have recognized that raising taxes on anyone is generally not good policy when trying to steer a large ship out of an economic crisis.  One small victory for tax-kind.

Now on to the rest of our story…

So like all good stories, this on has a protagonist, the Financial Accounting Standards Board, better known as FASB.  FASB is responsible for developing the Generally Accepted Accounting Standards, or GAAP, the basis of public company accounting.   FASB sets the standards for GAAP within public companies and private equity firms then “force” these down upon the private sector.  FASB has two red headed step children, so to speak, FAS 141(R) and FAS 160, which governed GAAP related to business combinations and non controlling interests in consolidated financial statements, respectively.  Until January 1, 2009, the twins were reasonably well behaved, limiting the impact of transactions on near term earnings per share and allowing for structure deals consideration to be amortized.  However, in 2009 the twins are moving towards the concept of “fair value”, in a effort to achieve greater balance sheet transparency.  Good for accounting, bad for acqusitions. Here are some of the key changes that should impact M&A.

>  Valuation of Equity Consideration: Previously equity consideration was valued at the time of announcement.  Subsequent fluctuations did not impact the purchase price for accounting purposes.  However, new for 2009 (I feel like I am narrating a car commercial) the purchase price will be based on the stock price at close.   This change, becomes meaningful when the value of the equity consideration appreciates materially from announcement to close as it will result in additional goodwill being recognized by the acquirer.  Goodwill is bad in the M&A world, in general, and more so in this case.  As a result, expect to see more purchase price caps, which are disadvantageous for sellers, who are bearing a majority of the prurchase price risk fluctuation.

> Transaction and Restructuring Costs:  Under the old regime, transaction costs were recognized as part of the purchase price and amortized like goodwill and restructuring costs were recognized as a liability as of the date of acquisition.  In both cases, they were considered part of the deal price — you inherited these as a cost of M&A.  Warts, but not tumors.  Going forward these items will be unbundled, and recognized separately from the transaction.  This means they will be expensed as incurred.   This will push down earnings in the post transaction period as a result of expensing what had previously been goodwill (double bad).  You should also expect to see more detailed explanations of fees and restructuring expense justifications.  Expect public floggings as a result.  The concept of “immediately accretive’ will be banished from the acquisition vocabulary, which is again bad for sellers.

> Contingent Consideration: Historically earnouts were accounted for at the time of realization.  As a result, you did not have to take the accounting hit, unless you actually had to pay the freight (recognized  as additional goodwill in the deal).  In the brave new accounting world, all contingent consideration must be recognized at fair value as of the date of the acquisition.  This will increase goodwill at the time of close.  This creates several conundrums, not the least of which is how to value earnouts at the time of close.  More importantly, the associated liability for contingent consideration recognized, but not yet paid, will fluctuate as the earnout is, well, earned.  Earnings will be more volatile as a result.  Net net, in a world where earnouts are necessary to bridge gaps in valuation, FASB is slapping the hands for those who utilize them as deal structuring mechanisms.  Bad bad FASB.  Bankers who get their kicks deriving complex consideration structures will be banished, rightfully, to the corner.

> Partial Acquisitions and Non Controlling Interests:  For deals involving partial acquisitions, where the buyer acquires a controlling interest (> 50%), the buyer must record all assets and liabilities at fair value on the date control is obtained.   There is no longer a ratable recognition based on percentage ownership.  In order words there will be full recognition of goodwill and more depreciation and amortization, which will have a greater impact on earnings than previously contemplated.  If asset values are impacted over time, it will also have a more significant impact on underlying earnings per share.   Additionally, an acquisition of a minority interest, where there is no change in control, will be treated like an equity transaction, which will impact the investors equity account based on consideration relative to fair value, which will fluctuate over time.  Net net, getting strategic investors to take a minority interest will be more of a headache due to the consolidation accounting that will come with the financial benefits of ownership.

All in the new accounting standards for mergers and acquisitions will influence deal negotiations and associated structures.  We expect to see valuations negatively impacted and buyers reluctant to let sellers earn in over time due to the fair value implications at close.  Net net, FASB has served the transaction community cold soup at a time where it really needs a warm hot meal.


(p.s. that picture at the top of this post is an unhappy bean counter)