Categories News

GOODWILL IMPAIRMENT WITH UNCERTAINTY OF COVID-19

The World Health Organization (WHO) announced that COVID-19 (also known as coronavirus) officially became a pandemic on March 11, 2020. This outbreak has contributed to market volatility causing substantial declines in market capitalization for public companies and potentially negatively impacting companies’ financial performance through supply chain and production disruptions, workforce restrictions, travel restrictions, reduced consumer spending and sentiment, among other factors. Depending on a company’s unique set of facts and circumstances, these market events will more than likely trigger the need to conduct interim impairment testing.

 

Assessing Potential Impairment

Goodwill impairment testing is conducted annually under the guidance detailed in ASC 350, Intangibles – Goodwill & Other. However, more frequent testing is required when events occur that indicate it is more likely than not that impairment exists. The financial impact from the pandemic could be assessed as a “triggering” event. While short-term disruptions may not indicate an impairment, the effects of a prolonged suspension of activities may cause asset impairments. The table below, while not exhaustive, contains possible triggering events for impairment of goodwill in the current environment.

·         Deterioration in general economic conditions (limitations on accessing capital, other developments in equity and credit markets, etc.)
·         Deterioration in the environment in which the reporting unit operates (decline in market-dependent multiples or metrics, a change in the market for the reporting unit’s products or services, etc.)
·         Increases in raw material costs, labor, or other costs that can negatively affect earnings and cash flows
·         Negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual or projected results of relevant prior periods
·         Changes in entity-specific events, including management, key personnel, strategy or customers, contemplation of bankruptcy, litigation, etc.
·         Changes in the carrying amount of assets at the reporting unit including the expectation of selling or disposing certain assets

It should be noted that these factors apply to both public and private companies, even those private companies that have previously elected to amortize goodwill under ASU 2017-04. While the election to amortize goodwill over time mathematically decreases the likelihood of an impairment, audit teams may request a “Step 1” impairment request during times of economic  downturns; contraction of valuation multiples combined with deteriorating company performance can lead to a drop in the fair value of an asset.

 

Impairment Testing

Long-lived assets to be held and used (including finite-lived intangible assets), indefinite-lived intangible assets, and goodwill may all need to be tested for impairment at the same time.

The order in which a company tests each asset or asset group within a reporting unit for impairment is important because the goodwill impairment model requires a comparison of the fair value of a reporting unit to its carrying amount  to signal impairment. The order in which assets generally need to be tested for impairment is (1) indefinite-lived intangible assets, (2) long-lived assets to be held and used, and (3) goodwill.

The first step of a goodwill impairment test involves estimating the fair value of the reporting unit primarily via the income approach and market approach. The fair value of the reporting unit is then compared to its carrying value to determine if an impairment has occurred.

We note that the current environment introduces complexity regarding financial projections prepared by company management. Management will need to carefully evaluate and update key inputs and assumptions. If management reduces revenue growth and margin assumptions,  there will likely be a significant affect on the determination of the fair value of a reporting unit given recent market conditions. Examples of key inputs that are common in valuation techniques include:

  • Revenue
  • Gross margin
  • Earnings before interest, taxes, depreciation, and amortization
  • Selling, general, and administrative expense
  • Capital expenditures

Further, other valuation assumptions that may need adjustment in the current environment include assessing appropriate discount rates, analyzing and applying multiples from publicly traded comparable companies, and considering applicability of transaction multiples that occurred prior to the current environment. While some industries and companies may be more vulnerable than others, both the effects of the  pandemic and COVID-19 containment measures may affect social and economic behavior, increasing overall uncertainty.

 

Conclusion

Intrinsic can help companies navigate the nuances of impairment triggers and in the event an impairment analysis is required, we can assist with valuations of goodwill, indefinite-lived intangibles, and long-lived assets for impairment testing purposes pursuant to ASC 350, Intangibles – Goodwill & Other, ASC 360 -10, Impairment or Disposal of Long-lived Assets.

For a discussion on the above and how COVID-19 may impact your impairment testing, please reach out to myself or any of our valuation team members.

Categories News

IRC 409A – COVID-19 UPDATE

PRIVATE COMPANIES: IS NOW A GOOD TIME TO ISSUE STOCK OPTIONS?

COVID-19 (also known as coronavirus) officially became a pandemic on March 11, 2020. This outbreak has caused significant market volatility and substantial declines in market capitalization for public companies. The effects have taken a toll on many private businesses as well, potentially causing negative impacts on companies’ financial performance.

In uncertain times such as these, strategic planning regarding employee compensation and retention is a topic which has risen to the forefront. For business owners looking to incent management or compensate employees without draining cash reserves, issuing equity-based compensation could be an attractive strategy.

While equity-based compensation can take on many forms, we are focusing on the issuance of stock options to employees of privately held companies. When issuing stock options to employees, companies must be aware of IRC §409A.

WHAT IS 409A?

  • 409A (“409A”) is a tax provision of the Internal Revenue Code. It was added in the code in 2005 due to perceived abuse of deferred compensation arrangements. If the series of rules detailed under 409A are not followed, employees who have been issued stock options could be subject to punitive tax consequences. However, an exclusion to the tax consequences is allowed if an option is issued with an exercise price that is at least equal to the fair market value of the underlying stock on the date of grant.

Further, the regulations under 409A provide a safe harbor that allows a company to rely on a valuation from an independent, third-party firm that specializes in valuations for 409A and follows consistent valuation methodologies. If the current fair market value is challenged, the burden of proof shifts to the IRS to prove that the fair market value at the time of option issuance was ‘unreasonable’.

Therefore, a 409A valuation is used to set the strike price of equity options issued to employees at the current fair market value of the stock.

HOW OFTEN DO YOU NEED TO HAVE A 409A VALUATION PERFORMED?

Generally, a company can rely on a 409A valuation for a 12-month period, as long as there are no events or circumstances during that period that would materially affect the valuation of the company.

Unfortunately, there is no definition of what constitutes a material change. Raising a financing round of new equity or debt, M&A activity by the company, or significant changes to a company’s financial outlook are all events that likely indicate a material effect on valuation.

Do the impacts of Covid-19 count as an event or circumstance that would cause a material effect on valuation? While dependent on the facts and circumstances, it is likely for most companies the current environment has caused a material effect on valuation.

If this is the case and you plan to issue stock options to employees in the near term, you will likely need to have a current 409A valuation performed, even if you had a 409A valuation performed within the past 12 months.

CAN WE RESTATE THE STRIKE PRICE OF PREVIOUSLY ISSUED OPTIONS?

As mentioned above, companies issue stock options to incentivize management or employees and align their interests with those of the shareholders. When values decline sharply and the current fair market value of the stock is below the strike price of previously issued options, the employees’ outstanding stock options become “underwater”. Underwater stock options have several negative consequences, namely a failure to provide their intended incentive, motivational, and retentive benefits. In addition, they likely have caused a company to take accounting charges for equity awards that are not providing value.

Common methods to handle this include repricing the option or an option exchange. Repricing involves lowering the exercise of the previous option to no lower than the new fair market value price. In an option exchange, the company offers to exchange the previous options for new options with a strike price equal to current fair market value or higher. In either scenario, a 409A valuation will need to be performed to determine current fair market value and set the price of the options.

Companies should consult their tax advisors or legal counsel whenever they are considering an option repricing or exchange, as there are many aspects to consider. However, these events do not generally create tax implications to the participant, especially if the options are Non-Qualified Options.

CONCLUSION

Intrinsic can help you navigate the valuation process and provide you with a comprehensive analysis to assist in issuing employee stock options or restricted stock. Providing equity compensation can help you retain employees and conserve cash in these uncertain times. Retaining a qualified and independent valuation firm helps ensure the 409A valuation work is defensible and the safe harbor applies.

For a discussion on the above and how COVID-19 may impact your 409A valuation, please reach out to me or any of our valuation team members.

Brad Smith, CPA, CFA

720.442.7834

brad@intrinsicfirm.com

BRAD SMITH, CPA, CFA

Brad serves as a Managing Director and head of Intrinsic’s Tax and Family Office practice. He leads the firm’s activities regarding tax valuation technical issues and resolution, as well as interactions with professional and industry associations. In addition, Brad fosters relationships with family offices, supporting their various needs from gift and estate, tax, and financial reporting matters to providing expertise in scenario analysis and financial modeling. His areas of expertise include the valuation of business enterprises, debt and equity securities, and options and warrants for purposes of financial and tax reporting, mergers and acquisitions planning, reorganizations and restructurings, employee stock ownership plans, minority-interest buyouts, stockholder litigation, and other matters. Brad has presented testimony as an expert witness on valuation matters for various district courts in Colorado, Wyoming, and Florida. He is experienced in valuing companies at all stages of their life cycle, from very early stage startups to established global companies. Brad is an active member of the Association for Corporate Growth and a Chapter Leader for the Rocky Mountain Chapter of the Alliance of Merger & Acquisition Advisors

Prior to joining Intrinsic, Brad spent over seven years at Karsh Consulting, an accounting and consulting firm, where he concentrated on business valuations for litigation and gift and estate tax purposes. Prior to Karsh, Brad spent time at industry leading firms Arthur Andersen and the Citigroup Private Bank. In these capacities, Brad advised clients on wide ranging matters including valuation, investments, tax, and accounting.

Categories News

ESTATE TAX PLANNING VALUATION – COVID-19 UPDATE

OPPORTUNITIES TO MAKE GIFTS FOR ESTATE TAX PLANNING

While Covid-19 has created a scary and detrimental environment in terms of our health and safety, it has also created an opportunity for estate planning and gifting. For taxpayers looking to maximize the use of their lifetime gift and estate tax exemption, now is an opportune time.

The Covid-19 outbreak has caused a myriad of challenges and obstacles for business, including government-imposed temporary closures for many. Even for businesses that are allowed to continue operations, challenges have included supply chain disruptions, workforce restrictions, travel restrictions, and a reduction in consumer spending from social distancing and stay-at-home orders, among other impacts.

WHAT IS THE IMPACT ON A POTENTIAL GIFT’S VALUE?

One of the earliest provisions governing valuations for estate and gift tax purposes was IRS Revenue Ruling 59-60 (“Rev Rul 59-60”). Rev Rul 59-60 defines the Fair Market Value of a business as “the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.”

While sellers may only be “willing” to sell if they are able to command a value similar to their expectations a few months ago, many buyers, with knowledge of the current, relevant facts, will likely only be “willing” to transact if values come down. Supply and demand will ultimately determine whether business value declines or not, but in the meantime, the following are just a few reasons values are likely lower for Fair Market Value purposes.

  • With many businesses ordered to be closed or customers staying at home to social distance, financial projections of revenue, net income, and free cash flow are likely to be much lower as compared to the forecasts from the beginning of 2020. This would likely lead to a reduced value from a cash flow approach.
  • A common approach to valuing a privately held business is to compare the prices of stock from similar publicly traded companies to the private business. The value of these comparable company stocks has likely fallen anywhere from 10 – 40% since late February.
  • For family partnerships or other entities that own real estate, there is reason to anticipate a fall in real estate prices as tenant’s ability to continue to pay rent, in both the residential and commercial markets, is questioned.

Further, as many know, if the gift or transferred asset is a minority interest, it may be appropriate to apply discounts for lack of control and lack of marketability. It is possible these discounts will be higher to compensate for the additional risks associated not being to control the course of the business during these turbulent times or dealing with the lack potential buyers, as mentioned above.

FURTHER CONSIDERATIONS

Finally, the Tax Cuts and Job Act of 2017 (“TCJA”) raised the lifetime gift and estate exemption base from $5 million to $11 million, subject to inflation adjustment thereafter. After being indexed for inflation, the exemption for 2020 is $11.58 million. The increased exemption is set to expire at the end of 2025; however, there are many estate planners that believe this increased exemption will be rolled back sooner if there is a change in the federal administration this November. Some speculate the reduction could be to the pre-2018 level of approximately $5.5 million or even 2009 levels of $3.5 million. The IRS has provided guidance to taxpayers that any gifts made which are non-taxable by utilizing the current exemption amount will not be clawed back if the exemption is lowered in the future. With this in mind, it may be the right time to pursue making gifts for estate tax planning while the current exemption remains in place.

CONCLUSION

With a potential reduction in the values of privately held businesses and relatively favorable lifetime gift and estate exemptions, it may be an advantageous environment to make a gift for estate tax planning. Intrinsic can help you navigate the valuation process, in order to ensure that your gift is compliant with Fair Market Value and tax standards.

For a discussion on the above and how COVID-19 may impact your 409A valuation, please reach out to me or any of our valuation team members.

Brad Smith, CPA, CFA

720.442.7834

brad@intrinsicfirm.com

BRAD SMITH, CPA, CFA

Brad serves as a Managing Director and head of Intrinsic’s Tax and Family Office practice. He leads the firm’s activities regarding tax valuation technical issues and resolution, as well as interactions with professional and industry associations. In addition, Brad fosters relationships with family offices, supporting their various needs from gift and estate, tax, and financial reporting matters to providing expertise in scenario analysis and financial modeling. His areas of expertise include the valuation of business enterprises, debt and equity securities, and options and warrants for purposes of financial and tax reporting, mergers and acquisitions planning, reorganizations and restructurings, employee stock ownership plans, minority-interest buyouts, stockholder litigation, and other matters. Brad has presented testimony as an expert witness on valuation matters for various district courts in Colorado, Wyoming, and Florida. He is experienced in valuing companies at all stages of their life cycle, from very early stage startups to established global companies. Brad is an active member of the Association for Corporate Growth and a Chapter Leader for the Rocky Mountain Chapter of the Alliance of Merger & Acquisition Advisors

Prior to joining Intrinsic, Brad spent over seven years at Karsh Consulting, an accounting and consulting firm, where he concentrated on business valuations for litigation and gift and estate tax purposes. Prior to Karsh, Brad spent time at industry leading firms Arthur Andersen and the Citigroup Private Bank. In these capacities, Brad advised clients on wide ranging matters including valuation, investments, tax, and accounting.

Categories News

PAYCHECK PROTECTION PROGRAM

The Coronavirus Aid, Relief, and Economic Security (CARES) Act allocated $349 billion to the Paycheck Protection Program to keep workers employed during the pandemic and economic downturn. The initiative provides 100% federally guaranteed loans to small businesses that may be forgiven if borrowers maintain their payrolls during the Covid19 crisis.

 

WHO IS ELIGIBLE?

  • Businesses in operation as of February 15, 2020 with 500 or fewer employees. Includes non-profits, veterans organizations, tribal business concerns, sole proprietorships, independent contractors, and eligible self-employed and independent contractors.
  • Affiliation rules may preclude some businesses from being considered “small.” Click here for additional information.
  • Affiliation rules are waived for business concerns that employ 500 employees or less per physical location and is assigned a NAICS code beginning with 72.

 

WHAT ARE THE LOAN TERMS?

Maximum Loan Amount Average monthly payroll costs x  2.5, limited to $10 million
Interest Rate 0.50% Fixed rate
Loan Term Two years
Payment Deferral Six Months
Collateral Requirement? No
Personal Guarantee? No

 

WHAT EXPENSES COUNT AS PAYROLL COSTS?

Included Payroll Costs Salary, wages, commissions or similar compensation; payment of cash tip or equivalent; vacation, parental, family, medical, or sick leave; allowance for dismissal or separation; group health benefits; retirement benefits; and State of local taxes assessed on employee compensation.

 

Excluded Payroll Costs Compensation for any employee over $100.0 thousand, prorated for the covered period; excluded payroll taxes, railroad retirement taxes, and income taxes; compensation for employees whose principal residence is outside of the US; and qualified sick and family leave for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act.

 

 

OVER WHAT PERIOD IS AVERAGE MONTHLY PAYROLL CALCULATED?

Businesses in Operation February 15, 2019 – June 30, 2019 April 1, 2019 – March 31, 2020
Businesses not in Operation February 15, 2019 – June 30, 2019 January 1, 2020 – February 29, 2020
Seasonal Businesses February 15, 2019 – June 30, 2019 or March 1, 2019 – June 30, 2019 (selected by borrower)

 

WHAT CAN THE LOAN PROCEEDS BE USED FOR?

Payroll costs, including benefits; interest on mortgage obligations that were incurred before February 15, 2020; rent expense on lease agreements in force before February 15, 2020; and utilities that were in service before February 15, 2020.

 

HOW MUCH OF THE LOAN IS FORGIVABLE?

  • Borrowers will be eligible for loan forgiveness on amounts spent on payroll costs, mortgage interest, rent, and utilities during the 8-week period following loan origination
  • The amount of loan forgiveness will be reduced if you reduce full-time employee count or if you decrease salaries and wages by more than 25% for any employee that makes less than $100,000, prorated for the covered period. Note that businesses can include employee compensation up to the $100,000 cap.
  • Treasury has also noted that due to likely high demand for the program, at least 75% of the forgiven loan amount must be used for payroll in order to receive the maximum forgiveness.

 

WHEN CAN YOU APPLY?

April 3, 2020 (April 10, 2020 for Self-Employed and Independent Contractors).

 

WHERE CAN YOU APPLY?

Any existing SBA approved lender. It is recommended to start with your current bank.

 

WHERE CAN I FIND THE LOAN APPLICATION?

Here.