Has your company ever finalized an M&A deal, signed a new lease, or completed another complex transaction and then struggled with the accounting for the transaction because the accountants did not understand the legal documents? Has your company ever signed a good deal and then been disappointed when the accounting for the deal looked a bit less glamorous than the deal team had hoped?
It is simply not reasonable (or fair) for the Legal Department to drop hundreds of pages of deal documents on the Accounting Department and assume the accountants will fully understand the transaction and nail the accounting. By the same token, it is unreasonable (and unfair) for the Accounting Department to assume that the Legal Department will structure every facet of a transaction to achieve the optimal GAAP and tax outcomes.
The attorneys and the accountants should be in communication early and often during complex transactions to make sure each group understands the implications of a potential deal before it is struck. The right tone is one of partnership, where each department is generously supporting the other to ensure the best outcome for the organization. Unfortunately, the posture in many companies is one of disdain by the attorneys and resentment by the accountants. Even when the culture is strong and the tone is healthy, each group may miss technical nuances in the other’s terminology, which can lead to a suboptimal result.
For this reason, large organizations are wise to appoint an Accounting-Legal Liaison to facilitate communications between the two functions and guard against misunderstanding at all stages of a deal. The ideal Accounting-Legal Liaison is a leader with both accounting and legal experience and enough stature in the organization to compel the Accounting and Legal Departments to work together.
The Liaison should facilitate multiple meetings between the Legal team and the Accounting team throughout the negotiations, especially at the outset. The accountants will eventually have to account for whatever the deal turns out to be, but the opportunity for the deal team to benefit from the accountants’ insights and suggestions is primarily at the outset of the negotiations. No negotiator likes going back to the other side deep in the negotiation and asking for a new term to help optimize the accounting – those late-stage requests usually cost you something, even if they are neutral for the other party. The best practice is for the deal team (often the attorneys) to explain the nature of the proposed transaction to the Accounting team before the negotiations begin in earnest, allow for robust Q&A, and then give the accountants some period of time to come back with additional questions and, ultimately, their recommendation for how to structure the deal for GAAP and tax purposes. Multiple meetings are usually necessary because the accounting team needs time to consider the nature of the transaction, mock-up the journal entries, identify risks to avoid and opportunities to pursue, and, most importantly, identify parts of the deal that the accountants do not fully understand. The second Liaison meeting is often where the most value is unlocked because the accountants are able to come back and ask better questions. In companies with the right culture, the attorneys understand the benefit of the follow-up meeting(s) and welcome the more informed discourse in hopes of revealing all the relevant issues.
Finally, once the transaction documents have been signed, the Liaison should produce a “Deal Companion Memo” that translates and simplifies the myriad deal documents into a single document the accountants can reasonably be expected to digest and follow. For example, if the company issues secured bonds, the terms of the debt can be spread out over a Loan Agreement, Trust Indenture, Continuing Disclosure Agreement, Deposit Account Control Agreement, Deeds of Trust, and/or other documents. The Liaison can add great value by distilling the deal documents into a single guide, so the accounting team is not forced to navigate the full suite of deal documents each time a question arises.
The Deal Companion Memo may be 10-15% of the size of the deal documents but can be organized in a way where the most important (or highest risk) subject matter is covered up front rather than necessarily follow the order of the underlying deal documents. A “Term Sheet” style summary of the key deal points at the very beginning of the Deal Companion Memo can give the Memo even more utility.
The Liaison should work through the deal documents with the Legal Department and, ideally, have the Legal Department review the Deal Companion Memo to ensure that it comes to the right conclusions and covers the salient points before it goes to the accounting team. Under all circumstances, the Deal Companion Memo should be produced as quickly as possible, while the details of the deal are fresh and so the accounting team can work in the right direction from the start.
An Accounting-Legal Liaison may seem like a luxury, but failure to consider this role may lead to deals with subpar GAAP and tax outcomes and/or frustration and wasted effort in the accounting function.