Private companies despair over SFAS 150.

A recent accounting change involving shareholders' interest has raised the hackles of private companies and threatens to put them at a competitive disadvantage with their public rivals--though the immediate threat of the change has been removed.

The issue surfaced in May, when the Financial Accounting Standards Board (FASB) issued Standard 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." Among other things, it requires companies to classify "mandatorily redeemable" financial instruments as liabilities on their financial statements. A financial instrument is "mandatorily redeemable" if it requires the issuer to redeem it by transferring its assets at a specified or determinable date upon an event that is certain to occur, including the death or termination of employment of the shareholder.

SFAS 150 also requires the issuer to recognize a loss at the time of the redemption of the "mandatorily redeemable" financial instrument at fair market value--potentially creating a negative equity situation.

Means to Realize Value

A vast number of non-public entities, including many employee-owned and small businesses, have for years had "mandatorily redeemable" agreements with their shareholders obliging the company to redeem a shareholder's interest in the company when that shareholder dies, retires or resigns. Often, these agreements represent the only means for owners of a business to realize its value for their shares other that through an outright sale.

The effect of SFAS 150 could be to wipe out the net worth of companies that are parties to agreements with their owners obligating the company to redeem shares when their owners die or terminate their employment.

In July, FEI's Committee on Private Companies (CPC) wrote a letter (http://www.fei.org/advocacy/download/f asb_7_17_03.pdf) to FASB Chairman Robert Herz arguing that SFAS 150 would force many non-public companies to reclassify their equity and would put them at a competitive disadvantage vis-a-vis their public company competitors. CPC argued that SFAS 150 would force non-public companies to choose between having a balance sheet that shows a "net worth" comparable to that of a public company, or to severely restrict the use of private stock between itself and its employees.

CPC also argued that SFAS 150, when applied to a non-public company, would present an overly pessimistic picture of the entity's financial position, and could disqualify the company from bidding on government contracts or prevent it from obtaining bank financing.

The problems encountered by private companies in the application of SFAS 150 are unique to them; shareholders of publicly traded companies have access to public capital markets any time they wish to sell their shares. For this reason, only in very unusual circumstances would a publicly held company be party to arrangements that would render its shares "mandatorily redeemable."

Furthermore, the application of SFAS 150 to publicly held companies is logical, as it seeks to stem the abusive accounting practices that some companies had adopted when dealing with their own shares.

In its letter, CPC asked the FASB to either reconsider SFAS 150's application to non-public companies or to delay its implementation so that companies would have additional time to weigh their options with regards to their equity plans. Fortunately, the Board did listen, and on August 27, a divided Board voted to delay for one year the application of SFAS 150 to non-public companies.

The Board has added a FASB Staff Position (FSP) to its Web site (www.fasb.org) that makes the delay of SFAS 150 official and calls for an additional 30-day comment period on the text of the standard. CPC will provide FASB with additional comment regarding the standard and was expecting to hear from Halsey Bullen, the FASB staff member assigned to the SFAS 150 project, at its meeting on Oct. 2-3 in St. Louis, Mo.

For additional information about CPC or its upcoming meetings, please check out the committee's Web page, www.fei.org/committees/CPC/, or contact [e-mail].

Bob Shepler ([e-mail]) is Director of Federal Affairs and is based in FEI's Washington, D.C., office.