A change in the Generally Accepted Accounting Principles (GAAP) could lighten the paperwork burden for private companies that use leaseback arrangements.
As you probably know, leasebacks are a popular strategy for many small businesses. A company’s owner will buy a building for the company and then hold that property in an LLC or a similar entity. The LLC then leases the building back to the company. There are real tax and equity-building advantages to leasebacks.
But they can come with an increased burden, too.
If that private company is putting together financial statements to show its banks, insurers or investors, the company is—
under GAAP—supposed to consider whether the LLC’s finances need to be included or “consolidated” with the company’s financial statements. It’s called a variable interest entity (VIE) review.
This review process can be time-consuming, complex and, according to many lenders, not particularly useful. In fact, several lenders prefer not to have a company’s financials consolidated with the LLC’s (or whatever legal form the property-owning entity takes). Banks are more concerned with the stand-alone company’s cash flow and other metrics.
A New Alternative
Recently, the Financial Accounting Standards Board announced a new alternative for privately held businesses in these situations. They can avoid the VIE review if the following conditions are met:
» They are not a public company, not-for-profit organization or employee benefit plan.
» They have a leasing relationship with a company under common ownership.
» Substantially all of the activity between the two entities is related to the leasing activities. Be aware of other activities that may not be construed as leasing activities. These include such items as the performance of additional services or the guarantee of debt on a building that is only partially occupied by the related party.
» If the private company explicitly guarantees or provides collateral for any obligation of the leasing company, the principal amount of the obligation at inception of the guarantee cannot exceed the value of the asset leased. The focus of this qualification must be on value and not merely cost.
What to Do Next
If this alternative rule sounds like an option for your business, first get approval from any interested parties—that is, your bank, your insurance company and your investors. Then work with your accountant and internal financial team to correctly apply the new standard to your financial statements.
Thanks to this new option, private companies can still put together financial disclosures that are useful to its partners. Plus, the paperwork won’t be as expensive because your accountants won’t have to spend time on VIE analysis.
More information about the new standard can be found at bit.ly/1xVvurW.