2012 TrEAT Award goes to RoseRyan guru Michelle Perez

A year has rolled by and it’s TrEAT time again. TrEAT—an acronym of Trustworthy, Excel, Advocate and Team—is our much-coveted internal award, created to recognize one RoseRyan consultant whose work and approach throughout the year has exemplified our values. TrEAT nominations are accepted from RoseRyan gurus throughout the year. 

Even in a group of colleagues as close-knit as ours, this year’s honoree Michelle Perez stands out for her commitment to the team. Take the time, for example, when a fellow consultant had to leave a client assignment early to go on maternity leave (those darned kids; they never stick to the schedule). Everyone else was busy on other engagements and Michelle herself was about to go on vacation. But when she heard about the client’s predicament, she canceled her vacation and swooped in to save the day.

A founding member of our Values Team, Michelle walks her talk. She is generous with her time and ideas, and boldly tackles projects that are out of her wheelhouse—like giving the inaugural “Tips from the Trenches” presentation to the whole team at a company meeting. Well done, Michelle, and congratulations! Thank you for living RoseRyan values every day.

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RoseRyan volunteers go for the orange at Second Harvest Food Bank

“This was great, it’s amazing the work they do here,” “That was fun, I smelled oranges in my sleep” and “I never thought packing boxes of oranges could feel so rewarding” were just some of the sentiments of the 13 RoseRyan volunteers who packed more than 15,000 pounds (yes, almost 8 tons) of oranges at the Second Harvest Food Bank in San Jose.

On December 12, our job at the Second Harvest Food Bank was to break down 1,250-pound pallets of oranges into 25-pound boxes. There were 12 pallets, and the volunteer leader said we wouldn’t get through them all since we only had two hours. Team RoseRyan was up for that challenge! Joining other volunteers in a team of 30, we constructed the boxes, filled them with good oranges, weighed the boxes to ensure they were exactly 25 pounds (as precise accountants will do), and stacked them, ready to be distributed.

Being not only precise but also overachieving, we set a second goal, to finish before the apple-packing team. Mission accomplished on both fronts: we packed all 15,000 pounds of oranges and we were done before the apple team! Our reward: help the apple packers. We soon found out why they were slower. Apples were harder to box as they are slippery, they needed more quality control to sort the bad from the good, and the fruit bruises easily so you have to be more careful when putting them into the boxes.

Nevertheless, apples or oranges, RoseRyan is committed to fighting local hunger. This is the second year we’ve volunteered at Second Harvest, which is one of the largest food banks in the nation. In 2012, they distributed 45 million pounds of nutritious food to people in need in every ZIP code from Daly City to Gilroy. In addition to providing food, they conduct nutrition classes and work with lawmakers to advocate for policy changes that can help eliminate hunger and its root causes. Throughout the year, volunteers contribute over 300,000 hours of service to the food bank, saving the organization more than $5.9 million in personnel costs.

We’re proud to contribute to this significant community program. And we get something from it, too. As RoseRyan grows, it becomes harder to keep in touch with our colleagues. This event gives us the opportunity to take a break from the world of debits and credits and hang out together.

Read about our inaugural Second Harvest volunteer event.

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RoseRyan nurtures life sciences companies with QB3 Accelerator program

We’re pleased to announce that we are a partner of the brand-new QB3 Accelerator program, created by the California Institute for Quantitative Biosciences (QB3) to help life sciences companies become operationally efficient. We’ll be providing members of the QB3 Accelerator with finance and accounting services that range from getting their accounting functions up to serving as CFO and consulting on finance challenges.

Joining forces with QB3 was a no-brainer: we’ve been working in the life sciences sector since 1996 and understand what companies in this sector need at every stage of growth. QB3, formed in 2000, houses 62 companies in its incubator network and has helped 95 teams start their companies in the last 15 months. The QB3 Accelerator can make a huge impact by giving member companies access to opinion leaders, networking events, operational assistance and services from partners like RoseRyan.

“What we love about QB3 Accelerator is that it’s designed to help startups achieve operational efficiency quickly,” says RoseRyan cofounder and CEO Kathy Ryan. “That mission falls right in our wheelhouse. These companies don’t want to worry about accounting and finance—they need to focus on their mission.

“We know how important it is to do things right from the start—mistakes can turn out to be very expensive later on. And we understand how issues change as a company grows. QB3 Accelerator lets us tailor our services—we deliver just what clients need so they can relax and spend their time in the lab.”

QB3 Accelerator business partners have been recommended by life sciences startups. In addition to accounting and finance, the services they provide include IT, lab services, insurance, staffing and payroll and benefits. QB3 Accelerator launches officially Dec. 14. Currently, more than 30 startup companies are members.

For details on RoseRyan’s QB3 service offerings, see the QB3 website.

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Making a list and checking it twice

The holidays are fast approaching, and with them, all the stress of the season. Santa is making his list and checking it twice, and we accountants can follow his lead to keep a little sanity in our 2012 closeout activities.

Here’s my recommended year-end to-do list:

Account reconciliations—Yes, ideally these were performed on a monthly basis, but if other priorities shunted them aside, now is the time to get them done. And it’s a good idea to review all your current reconciliations to see if any items need resolving before you ring in the new year.

Impairment analysis—Have you attempted to identify indicators that might affect your asset valuation? Have you documented your findings in an accounting memo for your records? No? Get on it!

Inventory of non-routine business transactions with accounting or disclosure implications—If you haven’t already, prepare an accounting memo summarizing each of these transactions, and for each, outline the accounting policy and its basis in GAAP. It’s best to prepare these memos close to the time of the transaction, while the information is readily available and the details are fresh in your mind, but if other demands took precedence, catch up—before you close your books and invite your auditors in.

Revenue recognition—Have you been keeping good documentation for large or unusual transactions? If not, now’s the time to tackle this task. Review your revenue transactions and make sure you have a well-written accounting memo documenting the basis in GAAP for your revenue recognition conclusions. Also, make sure you have copies of the relevant contract or other pertinent information. Is VSOE important to your revenue recognition policy? If so, ensure that you have maintained it by updating or testing it.

SOX annual controls—By definition, these controls are performed once a year. Take a look through your SOX documentation and make sure you have a complete list of everything you need to do. It’s easy for something to fall through the cracks. Speaking of which, do you have SOC 1 reports from all your in-scope third-party providers? Have you reviewed and evaluated them for any adverse impact on your internal controls?

Stock-based compensation accounting—Let’s be blunt: this task is a hotbed of opportunity for things to go awry. If you haven’t been through your equity records with a fine-tooth comb in a while, examine them now. Problems we commonly find range from data entry errors to missing or incomplete paperwork, surprise (at least to the accounting department) option modifications, and unsupported Black-Scholes assumptions. Check out our guide, Stock Options: Do You Have a Problem?, to avoid these and related pitfalls.

This list should help you stay on track for a smooth year-end close. Happy holidays!

 

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Headlines from the ‘IPO Bound’ seminar

Taking your company public is a heady thought. But as soon you climb off Cloud 9, you realize there’s a lot to contemplate—including people, process and technology—as you start down that road. Three Silicon Valley experts recently shared their insights on making IPO dreams a reality at a popular RoseRyan-sponsored seminar, IPO Bound? New Strategies, New Ideas and Tips for Success.

Kelley Wall of RoseRyan, Matt Taggart of Ernst & Young, and Dan Winnike of Fenwick & West aimed their advice at high-tech, life sciences and cleantech companies that are beginning to plan for IPOs. Here are the headlines:

Your journey to a successful IPO requires planning for three phases: the one to two years prior to your big event, the actual IPO process and post-IPO operations. Each phase presents legal, audit and accounting issues and requirements. Anticipating the issues and staying up to date on the requirements can minimize risk and accelerate execution of your IPO.

Among other things, you may be wondering how you’re going to accommodate IPO planning on top of managing and growing your company. And how can you recruit a board of directors that will help take your post-IPO enterprise where you want it to go? Good questions!

For the answers, and more insights on preparing for the big event, check out the seminar presentation slides.

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Year-end heads-up: don’t let equity issues take you by surprise at audit time

December 31 is fast approaching. Can audits be far behind? Every year as we help our clients maneuver through the audit process, it seems that one of the areas that can cause significant difficulties is equity. It’s not so much the basics, like recording the issuance of 5 million shares of Series C preferred at $3 a share, or the exercise of a stock option, but the “little” issues that don’t pop up until the financial statements are actually being prepared and the footnote disclosures drafted. Things like stock option modifications (that’s a modification?!), accounting for nonemployee options (what do we remeasure and when?), common stock valuations (we did a 409A valuation in October; why do we need another?) and warrants (what do you mean, the warrants are liabilities?). Let’s take a closer look at these issues.

Stock option modifications

Everyone recognizes that a stock option repricing is an option modification. But a lot of other transactions are also considered modifications—and as such have accounting consequences—including extending the post-termination exercise period; exchanging stock options for other types of awards, such as restricted stock units; and changing the option holder’s status from consultant to employee (or vice versa). Altering the vesting terms of an option or other award can also trigger accounting ramifications. In some cases, only the timing of the expense may be affected. In other cases, including accelerating vesting at termination or changing performance criteria, the value of the option must be remeasured, and additional expense may result.

Accounting for nonemployee options

In general, the measurement date for a nonemployee option is the vest date, not the grant date. So technically, you should remeasure nonemployee options on each vesting date, which can be a rather daunting task if your options vest monthly. Fortunately, most auditors are okay with quarterly remeasurement. However, if you are calculating all remeasurements at year’s end, you may discover unexpected issues related to common stock valuations (see below). Also keep in mind that not all software is created equal when it comes to managing nonemployee stock options. Testing your system by manually recalculating expense for a sample of nonemployee options is always a good practice.

Another thing to remember: once each option tranche has vested, the vested shares are no longer subject to remeasurement. We occasionally see situations in which a company has continued to remeasure all shares until the option is fully vested. This practice misstates expense, frequently overstating it.

Common stock valuations

How often do you really need to have a common stock valuation, also referred to as a 409A valuation, performed? The answer is one of those very definite “it depends.” If your company is relatively stable, an annual valuation may be sufficient for both tax and accounting purposes. But if your company is dynamic and reaching significant milestones, you will likely need 409A valuations more frequently. Let’s say you closed your Series C round in September and had a 409A valuation performed in conjunction with that event. In December, your company achieved a significant milestone, like introducing a new product or receiving a favorable result on its Phase III trial. The December milestone increased your company’s value and likely requires a new 409A valuation. Performing the valuation contemporaneously and proactively is best. Dealing with it when your auditors request it usually adds significant time to the audit and could add to the cost of the valuation if the valuation firm has to expedite its work to meet your timelines.

Warrants

Warrants could easily be the subject of an entire article, but here are a few things to be aware of for now. Companies frequently issue warrants for preferred or common stock in connection with debt agreements (bridge loans, term loans, lease lines, and so on) or equity offerings. In all cases, the proceeds that the company receives must be allocated between the warrants and the base loan or equity offering. If the warrants are for preferred shares and there’s any possibility your company will redeem the underlying preferred shares for cash, the warrants are considered liability instruments and must be revalued at each balance sheet date with the change in value flowing through the statement of operations. In addition, if the base loan is convertible into equity, as is generally the case with bridge loans, the warrant will usually create a beneficial conversion feature because of the allocation of a portion of the proceeds to the warrant. Addressing these situations can be confusing and time consuming. Best practice is to discuss them with your accounting advisors before actually sealing the deal so that any accounting issues can be addressed up front.

Wrap up

Before you say good-bye to 2012, do two things. First, review your equity transactions, stock option records, board minutes and other relevant documents to determine whether any of the transactions or situations I’ve described occurred during the year. Then discuss your findings with your accounting advisors, equity service providers or both to ensure that the proper accounting treatment has been applied. You will certainly be better prepared for your audit, and you may save yourself from some significant headaches and maybe even some audit fees.

 

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Evaluating an acquisition target: pay attention to the gray areas

What’s more shocking: HP’s $8.8 billion (yes, billion!) impairment charge recorded in its recently completed fourth quarter, or the fact that it blames the charge on the “accounting improprieties and disclosure failures” of Autonomy, a UK-based company it acquired just last year? Clearly, investors were not pleased, as evinced by the immediate drop in stock price after the announcement was made. What lingers, though, is an aching question that haunts companies contemplating an acquisition: if HP, with its significant M&A experience and multiple Big Four audit teams, failed to see through Autonomy’s misrepresentations, then what hope is there for the rest of us?

Investigations by the Securities and Exchange Commission’s Division of Enforcement and the UK’s Serious Fraud Office are under way to determine whether evidence of fraud exists. I think it’s safe to say that detecting fraud at a target company is not typically engrained in the pre-acquisition due diligence process. However, consider this: what if the “improprieties” weren’t fraud per se, but instead liberal interpretations of principles-based international financial reporting standards?

Drawing focus to areas requiring extensive judgment and assumptions should be an integral part of the due diligence process. Even where the financial statements have already been audited by a reputable firm, focusing on the gray can be exceptionally beneficial: it can highlight areas of financial risk; it can provide greater insights in vetting forecasted financial results; and it can identify areas where the target’s accounting policies differ from your own.

More often than not, the financial due diligence process is focused on quantifying the net assets of the business (aka “scrubbing the balance sheet”) and understanding the assumptions underlying the company’s financial projections. However, attention should also be given to those accounting policies for which judgment and/or material estimates are required. SEC registrants often refer to such policies as “critical accounting estimates” and include required disclosures in the Management Discussion & Analysis section of their periodic filings. Private companies are not required to provide such disclosures, and they may only touch on general accounting policies in the footnotes.

Critical accounting estimates often include areas such as rev rec, asset impairment analysis, contingent liabilities, income taxes and reserve accounting, including warranty provisions, bad debt allowance and reserves for excess and obsolete inventory. Understanding your target’s policies with regard to these areas is critical, not only to assess the judgments applied, but also because certain accounting rules (especially those that are principles based) can provide leniency in interpretation, and different companies arguably have different risk profiles.

So the moral of the story is, no deal is ever black and white. The more time you spend understanding the gray, the better your chances are for understanding and valuing what you’re buying.

For an M&A due diligence checklist, see our report, M&A: Get What You Bargained For.

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Time for a heart-to-heart with your audit firm?

In my pre–Sarbanes-Oxley days, I worked with companies where it was tough to get audit committee members to attend meetings, and many of those meetings were check-the-box exercises without real value. The Sarbanes-Oxley Act changed the landscape significantly. Among other things, SOX clearly laid the responsibility for overseeing external audits on the shoulders of the audit committee—and now we are seeing increased focus on how the audit committee manages the external auditor.

Two documents recently issued by the SOX-created Public Company Accounting Oversight Board, which oversees the audits of public companies, focus on one aspect of that management: communication. The first, AS 16, Communications with Audit Committees, is aimed at increasing the relevance and quality of communication between audit committees and external audit firms. The second, Release No. 2012-003, Information for Audit Committees about the PCAOB Inspection Process, provides guidance on conversations that audit committees may wish to have with their external auditors.

A little background may be helpful. Each year, the PCAOB conducts inspections of audit firms. These inspections ascertain how the firms under review conducted their audits—in essence, whether their audit opinions were sufficiently supported by the facts. They also determine how committed the firms are to quality control—basically, whether they meet professional standards.

Release No. 2012-003 suggests some questions for an audit committee to ask its external auditor, including the following:

  • Has my audit been selected for a PCAOB review?
  • Have other companies similar to my business been selected for review?
  • What issues did these reviews raise?
  • What were the review findings?
  • If deficiencies were uncovered, how is the audit firm remediating them, and how will those efforts affect our company?

Be skeptical if your external auditor suggests that an issue identified was a documentation problem or a matter of professional judgment. You may find it difficult to imagine that your auditor did not gather sufficient evidence to form an opinion when your management team feels like it’s being audited to death—but perhaps this is an opportunity for some candid discussion. A benefit of talking with your auditor about the PCAOB inspection results is to gain more insight about issues the PCAOB is seeing across the profession, and to learn how you might be impacted by those issues and ways to get a leg up on proactively addressing them.

Audit committees are becoming more proactive in managing relationships with external auditors and in evaluating auditor performance—think quality of services and adequacy of resources. Ensuring the audit firm’s independence, objectivity and professional skepticism hinges on good communication.

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New report: sober up your equity compensation accounting

Stock options in Silicon Valley are like free drinks in Las Vegas—and accounting for equity-based compensation often gets treated with the breezy inattention of a gambler ordering another round. But eventually some kind of tab will come due. Think company money and time, restatements and increased auditors’ scrutiny.

Our new report, Stock Options: Do You Have a Problem? by Kelley Wall of RoseRyan’s Technical Accounting Group walks you through the issues we see regularly and tells you how to get clean.

Don’t think this applies to you? Equity-related restatements most often stem from honest mistakes—and they’re more common than you might think. Why? Some companies aren’t fully aware of accounting requirements. Others have incomplete or broken internal processes. And some rely on equity systems with parameters and limitations they don’t really understand.

Let’s take one example. Stock-based awards to employees and nonemployees are accounted for differently. No big deal—but the problem we’ve observed is that companies fail to identify nonemployee recipients as nonemployees. Perhaps the stock administrator assumes all the grantees on a list of option grants are employees. Or the equity administrator doesn’t set up the system to identify both the individual and the grant as nonemployee. Or the accounting department doesn’t realize there are nonemployee awards, so it doesn’t ask for nonemployee stock-based compensation expense reports. In each case, the result is an understatement of expense.

You can avoid this and many other costly accounting mistakes by adopting our recommended best practices in the areas of communication, valuation, modifications/special arrangements and forfeiture rate estimation.

Don’t become yet another sobering example of a painful accounting breakdown. Check out our report to ensure that your equity compensation practices are up to snuff.

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New report: scoring a high valuation in any economy

Let’s face it: whatever the climate for M&As and IPOs, positioning your business for a high valuation can be tricky. What if you could assemble a brain trust to give you the insider perspective on ensuring a big payday?

RoseRyan hears you. We pulled together a roundtable of Silicon Valley’s sharpest minds in accounting, investment analysis, business strategy and the law to answer exactly the questions you’d like to ask. We share the highlights in our new report, Boost Your Business’s Value: What to Do—and What Not to Do—When You Want to Be Worth a Fortune.

Our experts—RoseRyan’s Jim Goldhawk, Adrian Bray of Assay, Jim Chapman of Foley & Lardner and Tony Yeh of SVB Analytics—got deep into a conversation that reveals how complex valuation can be. Financial metrics are only part of the story. Qualitative factors—inflows of top talent and even the background of the founding group—can be predictors of competitiveness. But workforce won’t count as much after the close of deal. That’s when what the workforce has created drives value.

The good news is that even in skeptical times, entrepreneurs can bank against uncertainty to boost valuation. Culture, product positioning, customer mix, business infrastructure—all are within a company’s control. Moving away from commoditization, investing in due diligence, and pursuing what one of our thought leaders calls “organic growth” are a few strategies for preparing to pounce when the time is right.

Our last question: if there was one thing you could say to CEOs who are interested in or worried about their valuation, whether or not they have an exit strategy on the horizon, what would you tell them?

Check out our report to find out how our experts responded!

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