Key Value Drivers:
Financial Statement Quality and Accounting Process Integrity
In a recent blog, we talked about a few key value drivers business owners should be focusing on if they are planning to sell their company in the near-term future. The first, and probably most important, of these value drivers is financial statement quality and accounting process integrity.
In fact, this is the number one area where we see deals fall through. Specifically, we’re talking about owners who haven’t worked with a CPA to prepare quality audited or reviewed financial statements, or when the financial statements are not clear and consistent, organized according to industry norms, or are intertwined with personal interests or other businesses.
Put yourself in the position of a buyer- would you buy a business where you cannot easily determine the financial position or the results of operations? Even if you do by the business, are you willing to pay top dollar?
A Buyer’s Top Priority
The quality and accuracy of financial statements is usually the number one priority for buyers of closely held businesses. If a buyer is going to pay a multiple of EBITDA for a business, he or she needs full assurance that the financial statements upon which the seller’s EBITDA claims are made are complete and accurate in order to ensure the future cash flow stream.
The best way for sellers to make this assurance is to have their statements reviewed or audited by a competent CPA. However, many owners of small and mid-sized businesses have not spent the time and money required for reviewed or audited financial statements. This is understandable: If a business’ lender, bonding company or investors doesn’t require reviewed or audited statements, then why bother with it?
This kind of thinking may be acceptable if the owner isn’t thinking of selling the business anytime soon. But if you are planning to sell in the near-term future, you should work with a professional to determine if the benefits you will get from audited or reviewed financial statements is worth the cost. It often is.
However, if it is determined that an audit or review doesn’t make sense, there are several things that can be done by either your internal accountant or an external CPA that will position your business in the best possible situation for sale. SMAA can work with your accounting and advisory team to position your business for the best possible outcome for a sale.
A Quality of Earnings Study
Absent reviewed or audited financial statements, most buyers will perform a quality of earnings study during the due diligence process. Similar to an audit, this process will scrutinize every aspect of your financial statements. Note that some buyers – in particular, professional buyers like private equity groups – will perform a quality of earnings study even if you have reviewed or audited financial statements.
If a buyer determines during the due diligence process that your financial statements are inaccurate and your EBITDA isn’t what you thought it was, he or she is probably going to step back from the deal. In a best-case scenario, the buyer will renegotiate the price based on revised and accurate financial information and EBITDA. In a worst-case scenario, the buyer will simply walk away.
In this scenario, you as the seller go from a position of strength to a position of weakness. The buyer may think that if your financial statements and EBITDA are inaccurate, what else about the deal is iffy? All of these problems can be avoided by having your financial statements reviewed or audited well in advance of the date you plan to put your business on the market.
What About ROI?
At this point you might be thinking, “Will I recoup my investment in having our financial statements reviewed or audited?” Unfortunately, there is not a definitive “yes” or “no” answer to this question.
However, it’s almost a certainty that there will be more interested and serious potential buyers for your business if you do. The fact is, many buyers simply do not view companies as professionally managed businesses if they don’t make this kind of investment in their financials.
An M&A advisor can help you with the process of having your financial statements reviewed or audited in order to ensure statement quality and accounting process integrity. Please contact us to schedule a meeting where we can discuss your situation in more detail.