Prospects Rise For LLC Deals

A new accounting interpretation may pave the way for wider use of limited liability companies (LLCs) in mergers and acquisitions on both the buy and sell sides. The guidance issued by the accounting profession’s Emerging Issues Task Force (EITF) deals with how to account for “profits interests” – or the LLC version of stock awards or options given to executives of standard corporations as performance-based compensation. Jeff Kotowitz, a partner in the transaction services group at PricewaterhouseCoopers, says that according to the opinion, the LLC should perform an analysis to determine which standardized corporate equity grant the profits interests most closely resembles. Possible matches include restricted stock, stock options, stock appreciation rights, or profit-sharing arrangements. Subsequently, the LLC should determine whether the profits interests qualify for “fixed-plan accounting treatment,” which is considered more desirable than variable accounting. With fixed accounting, the value of the equity award is set on the date it is granted and carried as a fixed expense until the manager gets the “bonus.” Under variable accounting, the value must be adjusted for each reporting period until the grant is exercised. LLCs are considered desirable business vehicles because they are pass-through entities that incur only one level of tax. Similar to limited partnerships, their profits usually escape taxes and are distributed to shareholders, who pay capital gains taxes. In a recent issue of his firm’s Deal Flash, Kotowitz comments, “Now that the rules on accounting for profits interests have been clarified to some degree, we expect LLC structures to become more popular in acquisitions. As buyers and sellers become more comfortable with LLCs and profits interests, we expect that management at some target companies will push these structures so they can reap the attendant tax benefits.” However, Kotowitz warns dealmakers to keep the profits interests as simple as possible. Adding features like repurchase agreements, special capital allocations, or conversion features could blow fixed accounting and require variable accounting.