As Fair Value Simmers

A "huge valuation challenge" awaits M&A parties when FAS 141(R) takes effect December 15. One solution: Get the deal done now.

Martha Stewart Living Omnimedia’s bid to acquire a portion of celebrity chef Emeril Lagasse’s empire may offer a first taste of life under FAS 141(R) — although both parties would no doubt like to avoid that. The new accounting rule, which governs various aspects of M&A transactions, presents a “huge valuation challenge,” according to Jay Hanson, national director of accounting for audit firm McGladrey & Pullen. Here’s why:

Lagasse and other partners will receive $45 million in cash and $5 million in MSLO shares, plus a potentially lucrative earnout that could reach $20 million if they meet specific profit goals by 2012.

If the parties can close the deal before December 15, when FAS 141(R) goes into effect (and they probably will), then they can proceed under FAS 141. The current rule says that contingent considerations — which include earnouts — should be estimated if they are determinable and be recorded on the buyer’s balance sheet only when the payout is made. In addition, the future earnout is added to the buyer’s goodwill at the time of the payout and earnings are adjusted up or down accordingly, depending on whether the addition of the earnout payment shows that the buyer paid too much or too little for the target.

Under FAS 141(R), buyers determine the estimated fair value of the future earnout on the day of the sale and record it in the price. Any difference between the estimated fair value and the actual payout is recorded as an expense or gain.

That’s a “perplexing dilemma,” says Hanson, because it requires accountants and valuation experts to estimate the value of the earnout when the buyer and seller can’t agree. “That’s why the deal is structured with an earnout,” asserts Hanson. “The buyer and the seller are agreeing to share the risk of success. Essentially, the buyer is saying, ‘I will pay if you can deliver.’” Under FAS 141(R), an outsider will determine the odds that the seller can deliver, and what that delivery may be worth.

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