M&A 101 Should Include SAB 101

Practitioners of due diligence in m&a situations have recently been forced to fine-tune their nit-picking to include guidance gleaned from the Securities and Exchange Commission’s SAB 101. This set of directives about when companies can recognize revenue was issued in December 1999, but due to differences in companies’ reporting cycles, only started affecting nearly every company early this year. “It’s sort of a block and tackling issue, but you can really suffer if you overlook it in some cases,” says Ray Beier, PricewaterhouseCoopers’ national leader of its structuring practice. At first glance, SAB 101 lays out a series of principles about when companies can appropriately book revenue. Although it may not seem like rocket science, experts have said that some parts of the rule making are not as simple as they might seem. And because revenue recognition issues can affect valuation, EBIT-DA, and the quality of earnings, a number of deal professionals are treating it like more than an arcane accounting rule. Some of the basic SAB 101 guidelines stipulate that revenue from a sale is earned and should be booked only when: a sales arrangement exists, delivery has occurred, the price is fixed or determinable, and collection is reasonably assured. But while these standards might not seem radical, they do differ from the common practice in some industries, particularly in the technology sector. “The companies that have been the most affected by 101 are the ones in the new economy space, because they tend to have complicated revenue streams,” Beier says. From a deal maker’s perspective, the smart buyer should understand the importance of the timing of revenue recognition, according to SAB 101 maven Mark Watson, national director of advisory services at Ernst & Young. He recommends paying attention to consignment sales arrangements, contingent income, and the sale of goods that have installation requirements. In addition to looking at these potential SAB 101 flash points, Watson states that tire-kickers should pay close attention to any underlying arrangements about the terms under which a company is shipping its products. It can be important to understand whether a customer has the right to back out of a sales contract, for example. Revenue recognition problems can affect a transaction in more ways than just by making a target’s performance more opaque. Beier says that if a 101 problem surfaces on the potential acquirer’s books, it can weaken the company’s stock price and, in the process, water down its acquisition currency. In private equity deals, an SAB 101 problem in a portfolio company can significantly delay the buyer’s exit strategy, the PricewaterhouseCoopers executive notes. In all, SAB 101 has become another check-off item in the prudent dealmakers to-do list. If ignored it can “throw a monkey wrench into GAPP,” as Beier puts it. But his fellow professional, Watson, notes that if the due diligence process is through, it will nail down revenue recognition procedures at targets. “I’d like to think that no one would overlook 101, but it can be helpful to highlight the significance of these matters and the impact they can have on earnings, to make sure they are considered.”