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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


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