NORWALK, Conn. – The Financial Accounting Standards Board (FASB) made several decisions this summer, two that will please venture capitalists and one that will not (VCJ, June, page 5).
The FASB in early September issued a draft proposal to do away with pooling, a method of accounting often used during mergers and acquisitions, leaving purchase accounting as the only acceptable form of accounting when buying a company. The private regulatory organization will take public comment on the matter until December 7 and hold public hearings regarding this issue next year in New York and San Francisco before taking a final vote.
Pooling, a form of accounting in which two companies simply merge their financial statements, is considered by VCs and other investors as preferable to purchase accounting, which forces the buyer to put the acquired company’s goodwill (some forms of intangible assets) on the buyer’s books and amortize it over time. Purchase accounting makes it easier for observers, including investors, to determine how much was paid for a company and to track the performance of the purchase, and it is more consistent with the accounting rules used by other countries, the FASB said.
Companies that buy venture-backed businesses or young companies that merge often prefer pooling, arguing it is a more accurate reflection of what takes place when two small entities join together. Pooling keeps the buyer from having to account for its purchase and the value of its goodwill against earnings for several years, something that could dampen the buyer’s performance on paper. Under the FASB’s proposal, goodwill could be charged to earnings for as many as 20 years, or half the current limit.
Mark Heesen, director of legislative, regulatory and entreprennarial affairs for the National Venture Capital Association was not surprised by the FASB’s decision on pooling but if the practice ultimately is eliminated, he would like to see the FASB reform purchase accounting rules, which were designed for brick-and-mortar businesses and not information-based businesses. The problem largely stems from purchase accounting’s basis in company’s valuation, which is easier to determine for businesses with real estate, equipment and inventory rather than high-tech and biotech companies whose value lies in research and information-based products. Heesen wants the FASB to address this issue before doing away with pooling.
Research and Development Changes
Earlier this summer, the FASB dropped plans to eliminate one time accounting charges for in-process research and development (IPR&D), or research taking place at companies when they are acquired. Buyers generally prefer taking one big hit against earnings rather than dragging it out over time. If the research qualifies as IPR&D, the buyer must take the one-time write-off, FASB Project Manager Kim Petrone said. If the research does not, it is treated as goodwill.
The FASB board in late July voted to drop the matter once it realized in-process research and development should be studied as part of a larger effort to review all R&D write-offs. The board could resurrect the issue with a more general approach and is likely to decide whether to pursue R&D by the end of the year, Petrone said.
“I thought it was the absolutely correct move. It was done very quickly and that was more of a surprise to me,” Heesen said.
Venture capitalists were concerned that doing away with the one time charge would discourage potential buyers of portfolio companies from purchasing young companies or at least encourage buyers to seek lower prices for their purchases to reduce the several years’ hit to earnings.
The FASB also opted in August to forgo plans that would have made companies expense their earnings statements the stock options given to outside directors, including venture capitalists.