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What is Fair Value Block?

The most difficult accounting task in a leveraged buyout is to determine the total value available for assignment to the company’s assets and liabilities. The total value is the sum of the value assigned to outstanding shares of common stock. Where there may be three blocks of stock, the three blocks are the fair value block, the equity-adjusted cost block, and the book value block. The number of shares included in Fair Value Block is determined as follows.

Fair Value Block
This block includes the shares owned by shareholders of the new control group who were not owners of the shares of the prior company. This block also may include the shares of some shareholders who owned shares of the prior company. In order to include a former shareholder’s shares in the fair value block, one of two conditions must be met:

1. The shareholder’s new residual ownership interest must be greater than the residual ownershipinterest in the prior company. The shareholder’s new residual ownership interest cannot, however, exceed 5%. The residual ownership interest includes all outstanding common and preferred shares except those shares that have liquidation or redemption features. This is different from the definition of ownership interest that includes only common shares.

2. If the former shareholder’s residual interest percentage decreased, all the following requirements must be met to record the shares at fair value.
a. The shareholder’s voting interest in common stock must be under 20%.
b. The individual must have supplied less than 20% of the new company’s total capital including debt.2
c. The shareholder’s new residual ownership interest must be less than 5%, and all former owners whose residual ownership interest decreased must have a new residual interest of less than 20%.

There is a limitation on the number of shares included in the fair value block; it is based on the amount of monetary consideration given to owners of the former company. Monetary consideration includes cash, debt, and debt-type securities such as mandatory redeemable preferred stock. If at least 80% of the consideration given to all shareholders (including continuing shareholders) is monetary, there is no limitation on the fair value block. If monetary consideration is under 80% of the total, the fair value block is limited to the monetary consideration percentage times the total common shares outstanding. Thus, for example, if the percentage of shares that would otherwise qualify was 90%, but monetary consideration given for common shares was 70%, the fair value block would be limited to 70% of the outstanding shares. The nonqualifying 20% interest would be assigned book value.