By Marc Abbey and Jim Leroux, both Principals at First Annapolis Consulting1
On Wednesday, April 21, 1999 the Financial Accounting Standards Board (FASB) voted to eliminate the "pooling of interests" method of accounting for acquisitions by sometime in late 2000, a development that may significantly reduce the prices that buyers are willing to pay for certain merchant businesses. Buyers must account for acquisitions of businesses under either the purchase method or the pooling of interests method. The majority of the acquisitions of non-bank merchant businesses and ISOs occurring since 1995 were accounted for under the pooling of interests method. Nova, PMT, and FDC have all accounted for acquisitions of non-bank merchant businesses using pooling of interests, with PMT being by far the heaviest user of this method. In general, if an acquisition qualifies for pooling of interests, the buyerís and the sellerís balance sheets and income statements are combined as if the two companies had been one company. If an acquisition does not qualify for pooling of interests, the acquisition must be accounted for using the purchase method. Under the purchase method, the amount of the purchase price exceeding the fair value of the net assets acquired is required to be recorded as goodwill and written off after the acquisition. This amortization reduces the GAAP earnings of the buyer after the acquisition.
FASB has stated that it intends to have at least a three to four month comment period prior to adopting a final rule. Many banks and other companies are active opponents of eliminating pooling of interests, however, it is unlikely that FASB will change its position. Once it adopts a final rule, FASB will establish an effective date, most likely late 2000 or early 2001. FASB has indicated that it is unlikely the rule will be retroactive to acquisitions occurring prior to the effective date; however, the closer an acquisition is to the effective date, the more difficulties buyers may have in attempting to use the pooling of interests method.
FASB voted to eliminate the rule for several reasons. First, pooling of interests has the potential to hide the impact of a poor acquisition. With purchase accounting, the buyer must write off goodwill each accounting period making it easier to determine whether the acquisition had a net positive or negative impact on the buyer. Second, many international markets do not allow pooling of interests, therefore eliminating pooling in the U.S. is consistent with a general trend toward consistent international accounting principles. Additionally, FASB believed that having two different approaches (purchase vs. pooling of interests) to account for the same type of event was undesirable from a policy perspective.
The elimination of pooling of interests accounting could have a widespread impact on the purchase prices paid for non-bank merchant businesses and ISOs. Currently, it is a sellerís market and buyers are paying attractive prices for merchant businesses. At these prices, acquisitions using purchase accounting typically require the buyer to record significant goodwill and to reduce future GAAP earnings by writing off such goodwill. On the other hand, acquisitions using pooling of interests permit buyers to pay these high purchase prices without recording goodwill or reducing future GAAP earnings. As a result, buyers that are concerned about future GAAP earnings are often unwilling to pay as high a purchase price for a business if the buyer must use purchase accounting instead of pooling of interests.
After FASB eliminates pooling of interests, buyers will have no choice but to factor goodwill and the corresponding reductions in future GAAP earnings into their purchase prices. This has the potential to significantly reduce the prices that buyers are willing to pay for certain merchant businesses. FASB, however, has given sellers a window of opportunity to complete deals using pooling of interests before the elimination of pooling takes effect. As a result, we anticipate a rush for the doors in certain merchant business (such as non-banks and ISOs), as sellers try to complete transactions while pooling is still permissible. If a sufficient number of sellers try to complete transactions during this window, the current sellerís market in merchant portfolios may turn to a buyerís market.
If you think that you may want to sell your merchant business within the next few years, you should seriously consider the potential impact of the elimination of pooling on the price you would receive for your business. You first need to determine whether your business could currently qualify for pooling of interests treatment in an acquisition. Your business must pass a number of tests to be pool-able. If you do not have a pool-able business, the change in the rule does not specifically impact you except to the extent the change impacts the entire merchant portfolio market (e.g., a flood of sellers in the marketplace driving down prices). However, if you could qualify for pooling of interests in a sale, you have some additional thinking to do.
Timing is everything, and this is essentially a question of timing. You should think through your plans for your merchant business. If your business is pool-able and you think that you may want to sell your business in the next few years, you need to be thinking seriously now about whether to close a sale before pooling of interests is eliminated. It has been our experience that it takes much longer than you think to plan and prepare for a sale. It is not uncommon for companies to take several years from the time they begin to prepare for a sale and the closing of the sale. If you want to take advantage of pooling before it is eliminated and before the potential flood of other sellers in the market, you should begin planning and preparing for a sale now in order to target a closing date comfortably in advance of the elimination of pooling.
1.First Annapolis is a full service management consulting firm that specializes in the financial services industry.
