"VALUATION
OF INTANGIBLE ASSETS"
By James L. Watts, Pacific Summit Capital
If there is one thing I learned from
practicing law in Washington, DC, it is that well meaning technocrats
can create an enormous amount of confusion in their efforts to level
the playing field for corporate America. This indeed seems to be
the case with the new FAS 141 and 142 rules recently published by
the Financial Accounting Standards Board. FAS 141 deals with business
combinations while FAS 142 specifically affects treatment of goodwill
and other intangible assets.
And these are not just technical and
arcane rules, but major changes in the way we will have to account
for goodwill both at the time a merger takes place and on an annual
basis thereafter (the annual valuation requirement also applies
to companies that have goodwill on the books from prior acquisitions).
That could have an effect on the public stocks you own, on the amount
you ultimately may be able to negotiate when you sell your business,
or on the value of the company you currently work for (and consequently
on the value of your stock options or your ESOP).
The genesis of these rules came from
the M&A boom of the 90s and the high prices that were paid for
many acquisitions. Since the values paid in many cases dramatically
exceeded the book value of the acquired companies, large amounts
of goodwill had to be dealt with. And, depending upon the treatment,
goodwill can have a dramatic impact on published earnings for the
company booking the goodwill.
What Should I Do
Depending upon your situation,
you should do any of a number of things. If you are an investor
in public stocks, you should look to EBITDA (earnings before interest,
taxes, depreciation and amortization) as well as to the balance
sheet. You, or your financial advisor, should be wary of companies
with large amounts of goodwill on the books that also have deteriorating
economics (i.e. EBITDA). Under the new rules, companies that experience
deterioration in their valuations can encounter a new phenomenon
known as "goodwill impairment." In certain cases, companies
will then have to take a charge to earnings as a result of the goodwill
impairment. That obviously could affect the price of the stock.
If you own a company that you ultimately
hope to sell, be sure to engage a competent investment banker (not
just a business broker) when the time for sale comes. The treatment
of goodwill, and the valuation of intangible assets, will become
important negotiating items in the ultimate enterprise valuation,
i.e. the price for which your company ultimately sells.
If you own or manage a company that
has a significant amount of goodwill on the books from prior acquisitions,
make sure you hire accountants and valuation experts with the expertise
to deal with these complex issues.
And finally, if you own or manage a
company that plans to acquire other companies in the future, be
sure to hire investment banking professionals with the sophistication
to understand these complex rules and to use them to you advantage.
The issue of potential goodwill impairment will probably be a good
negotiating lever for lowering the purchase price (or at least in
keeping it from escalating too high).
These new rules are complex, sometimes
vague and often confusing. To the expert negotiator, they may become
a valuable tool. To the unsophisticated, they may certainly give
a whole new meaning to the phrase "figures lie and liars figure."
Pacific Summit Securities is an
investment banking firm specializing in transactional and advisory
engagements with emerging growth and middle market companies in
the U.S. and abroad. On the transactional side, the Firm focuses
on financings (both debt and equity) and on mergers and acquisitions.
Advisory engagements include valuations, fairness opinions, litigation
support and expert witness testimony. Headquartered in Irvine, the
Firm is a member of both the NASD and SIPC. James Watts, Managing
Director of Pacific Summit Capital can be contacted at (949)
261-0800 or jwatts@pacificsummit.com.
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