Earn-outs and NOLs ?
tax question for which I have not been able to find any info on the net. in M&A , the amount of possible NOLs as per IRC 382 is Price*IRS exemption rate. in the case of an earn out where the price may change, what Price is taken into account for this?
Per macabacus (great tax resources):
"Record contingent consideration on the acquisition date, measured at FV on such date, as a liability or equity in accordance with other applicable GAAP."
http://macabacus.com/accounting/accounting-changes
i'm not sure this answers my questions. what you quoted holds for IFRS recognition but what does the IRS think of it?
The quoted Macabacus answer above applies to GAAP accounting not tax. This would be highly subject to the terms of the earnout and there is no "hard and fast" answer. Earnouts are bespoke, highly negotiated arrangements.
If you're just trying to show the illustrative impact for financial model, probably best to use the expected earnout amount in the consideration value. The tax code is more stringent, so my guess is that in reality, you wouldn't be able to apply the earnout to the use of NOLs until the earnout had been paid. An expected amount is not a realized amount. But using the expected amount is probably a good representative approach.
thanks this was clearer. what you suggest is a sort of optimistic case. the way I thought about it initially is that the earnout would be structured like this: Get 40m > transfer ownership ; a sale happened. IRS says this is the price and thus limits annual nol to 40m*rate Drug passes FDA Phase I tests ; Get a subsequent 80m. now why would the IRS allow us to get Nols on this too? thus effectively subsidizing our purchase ? i'm working on a case study comp and have to value a pre-clinical phase pharma venture. i'm still a student and have no real world experience doing this. this is my first real option model. The other issue I have with the optimistic NOL case is that 70+% of the value would come from the NOLs :/
70% of value coming from NOLs does not pass the sniff test. 70% of value should not be coming from NOLs.
I agree with your qualms regarding the optimistic case above. I think it is conservative and safe to limit the value in the first year to the 382 allowance arising from the 40m and then after the earnout apply a higher limitation.
Think for purposes of your case study opt for the conservative approach and footnote that structuring maneuvers could potentially yield a higher 382 limitation in Y1.
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