Thursday, December 04, 2008

Clean Up Your Financials Well in Advance of Your Business Sale

When you sell your business, many factors are important in maximizing your selling price. Rock solid financials are job one before you sell. This post discusses why you should remove all personal expenses from your business financials well in advance and how you will be rewarded in your business selling price.

Buying a business is a risky proposition. The buyer is attempting to examine and access all of the risk factors to determine how much to pay, what deal structure to propose, and even whether or not to even make an offer. What if I lose a key customer, employee, or supplier? What if our technology is surpassed by a new, lower-cost solution? What happens if a big company decides to enter our niche? These are just a few of the concerns that make buyers less generous in their offer price and terms. If your financials are questionable, that may be the deciding factor that diminishes your selling price or even blows up the deal.

Audited financials are the best to put a buyer's mind at ease. For smaller companies, the cost of this is not warranted. The next best are reviewed financials. They show that a CPA has put your accounting process through some review and scrutiny. Compiled statements are OK, but are closer to a book keeper's role than a CPA's approach. Just remember, the buyer's accountant is going to perform due diligence on your financials at a level closer to an audited statements process. If he finds mistakes and inconsistencies, a lack of trust on all other data can develop.
Your business tax returns will be gospel to the buyer because the IRS frowns on companies not reporting a portion of their income and that is what the buyer's bank reviews to determine the financing available for the acquisition.

In the Mergers and Acquisitions business we all rely on "recast" financials to basically remove all of the expenses the owner runs through his business and make the company look more profitable to drive up the selling price. Sophisticated buyers (i.e. acquisition oriented corporations) may not directly confront you on the recasting, but they are not likely to give you full credit in their analysis. They may even develop some reservations about your character and ethics if the amounts are excessive. They may question your ability to fit in as a good corporate citizen as you transition your business to their institutional corporate structure.

If you are planning on selling your company in three years, why not start eliminating the expenses you run through the business that push the boundaries of business versus personal expenses? In the first year eliminate 33% of the country club, entertainment, business trips, conferences and non-contributing relatives on the payroll. The second year, eliminate another 33% of those and in the year preceding the sale, eliminate them completely.

Imagine the style points you would get from a sophisticated buyer when they discovered that your financials are really your financials with no recasting. Not only that, but you will likely receive a high end purchase price multiple and a greater percentage of cash at close. So, for example, if companies in your industry sell for a range of between 5 and 6.25 X EBITDA, then your company would likely sell at a multiple closer to the 6.25 high end than the 5 low end multiple.

If you had run $200,000 of owner expenses through the business and eliminated that practice you would pay approximately $80,000 in additional taxes. Your recast EBITDA would be higher than your reported EBITDA, but the sophisticated investor might only give you $100,000 credit and would adjust your multiple to the low end. Your recast EBITDA, for example, of $3.2 million would be credited by the buyer at $3.1 million with a valuation multiple of 5 X, resulting in a proposed purchase value of $15.5 million.

Compare this to using your real EBITDA of $3 million, but because it is not recast, your buyer pays a risk reduction premium in valuation multiple and moves you up to 6 X, resulting in a proposed purchase value of $18 million. This is a pretty impressive improvement in selling price for increasing your company's taxable income phased in over the three years prior to your business sale.

You may be asking yourself skeptically, how can this be? Remember, buying a business is all about minimizing the buyer's perception of risk. Now your financials are rock solid and do not require a long explanation on why they are really better than reported to the IRS. This is the most powerful risk reduction strategy available to business sellers. You will differentiate your company from every other acquisition target the buyer has reviewed. You increase your credibility on every other piece of information that you have provided during the courting and due diligence process. Their opinion on your business acumen, management ability, judgment, and ethics has been elevated. The buyer feels more confident that this will be a successful acquisition. For that they will pay a premium.

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