The recent bank collapses have triggered large waves of additional uncertainty throughout our economy, already weakened by increasing inflation and interest rates.
While our firm represents primarily lower middle market, privately held businesses, these unexpected shifts in the banking system have had direct impacts on the sale of businesses regardless of the size. Yet, even before these recent disruptions, buyers have become increasingly more meticulous in scrutinizing financials during the due diligence process.
If you are an owner considering the sale of your business within the next few years, we recommend that you start working with your accountant to actively address the following:
Accurate Tax Returns
While profit/loss, income, and other forms of cash flow statements help to determine the true annual cash flow (SDE or EBITDA) for a business, most buyers and their advisors will want to start with the tax returns. If there is a large disparity between the tax return and financial statements, then addressing this upfront with clear documentation or amending the return may be necessary before exposing the financials to potential buyers.
Due to the increasingly high uncertainty in today’s market, any unexplained discrepancies in the financials can create unnecessary hurdles and create negative perceptions which can quickly erode value. For a business that could sell in a range between 4-6 times EBITDA, just one bad tax return or inconsistent financials may decrease the value upwards of 0.5-1 times EBITDA at the closing table. More than ever, buyers are gravitating to traditionally healthy income and balance sheet statements. It is vital to have a good accounting firm in place who can ensure that the financials are in order to help limit these risks when it is time to sell.
Robust Financial Reporting
Comprehensive, detailed reporting, such as, Quality of Earnings (QoE) have traditionally not been utilized during due diligence for transactions under $5M. This has now changed as buyers on all levels are demanding a deeper understanding of the overall financial health of a business. These types of reports are more expensive than standard appraisals and demand much more time and detail including questions specific to client concentration, monthly cash flows, balance sheet trends, working capital, etc.
For example, in addition to a detailed marketing package or Confidential Information Memorandum (CIM), appraisal companies will typically require 8-10 additional questions while a QoE report will often require 50+ additional questions that can easily take weeks to address. Unfortunately, if the financial reporting for the business is not set up properly, this rigorous process can further expose a lack of management in critical business areas which can often decrease the value at the closing table.
While the 2023 tax season is currently in full swing and accountants are looking forward to a much-needed break, we recommend business owners set an appointment in the coming months with their accountant to start addressing the company’s ability to provide accurate, timely financial reporting. We regularly refer reputable accounting firms so feel free to contact us if you or someone you know is looking for a firm who understands the importance of sound financial reporting in the sale of a business. The majority of our business comes from referrals, as we appreciate your continued trust in our firm.
Robert W. Amerine
President, CBI, M&AMI