All who are aware of the current Financial Accounting Standards Board (FASB) proposal on business combinations undoubtedly know of the alarm it has generated within the venture capital industry and much of the high-tech community.
The FASB’s attempt to eliminate pooling of interests accounting for mergers and acquisitions without addressing the significant short-comings of its alternative, purchase accounting, would, in the words of a senior executive at Cisco Systems, “derail the engine that is driving the strong economy of this country.”
A large majority of the industry believes that the FASB’s proposal would harm New Economy companies whose acquisition values are driven by intangible assets such as intellectual property. The application of purchase accounting to acquisitions of knowledge intensive companies would distort reported earnings by requiring amortization of different categories of goodwill. The net result would be to impede mergers and acquisitions of New Economy companies and possibly deal a blow to Nasdaq stock market values.
According to the National Venture Capital Association’s 2000 Yearbook, prepared by Venture Economics, both the dollars raised through initial public offerings of venture-backed companies and the proceeds from the M&A sale of venture-backed companies were at record levels. Despite the high visibility of IPOs, the dollars raised through the acquisition of venture-backed companies since 1997 has exceeded the proceeds from IPOs. Even when the public markets were volatile, M&A activity has continued to provide, since 1993, very strong year-on-year growth. The cooled-down Nasdaq and the current limited IPO market will likely reinforce this trend in 2000. Further industry consolidation and the dotcom shakeout will also increase business combinations.
The bottom line is this: mergers and acquisitions are more important than ever to our industry and to the success of the New Economy.
This illustrates the importance of educating the FASB and other policy makers in Washington on the role business combinations play in building companies, industries and, by extension, our economy. Although M&A has always been an important exit strategy, the remarkable numbers coming out of the VC industry indicate that enhancing the conditions under which the industry’s M&A activity takes place should be a public policy priority. The NVCA has been doing just that, leading the charge against the FASB proposal.
To date, the FASB has thus far shown no public indication of backing off its intention to eliminate pooling by early next year. They have, however, begun to consider limited ways in which to improve purchase accounting.
One idea is to apply an impairment test to the goodwill that is generated by a business combination. This test would attempt to identify whether or not the goodwill is actually depreciating and thus should be amortized.
While this ultimately may fall far short of an adequate solution to the current impasse, it may represent an important acknowledgment by the FASB that the old accounting models do not provide accurate information when applied to companies of the New Economy.
Until an acceptable solution is found, the NVCA and its industry allies will remain steadfast in their pursuit of effecting the delay or withdrawal of the FASB’s business combinations proposal. The increasing importance of M&A to our industry demands this vigilance.
Thomas C. McConnell is a General Partner with New Enterprise Associates in Menlo Park, Calif., and is Chairman-Elect of the National Venture Capital Association.