This article is excerpted and adapted from chapter 19 of “The Exit Strategy Handbook: The Best Guide for Selling Your Business,” written by Jerry L. Mills, co founder of B2B CFO, a CFO services firm. The book guides owners of closely-held companies through the process of preparing to sell a company.
A seller’s business acumen will be judged severely by a prospective buyer. Having bad internal financial information and error-riddled financial statements is the fastest method you can use to chase away a good prospective buyer. The buyer will expect information to be accurate and in accordance with generally accepted accounting principles (GAAP). The buyer will expect monthly records to be closed on a timely basis, by around the tenth to fifteenth day of the following month. Everything the seller does is either enhanced or made suspect by the timeliness and accuracy of the company’s internal financial information.
The lack of financial integrity is one of the most common hurdles encountered during the sales process.
[For example,] the owner of (the) business tells (the buyer) that the company has been making $5 million per year for the past three years and expects it to make even more in the future. Are you really surprised that the buyer’s first thought is, “Prove it!”? If a seller then produces financial information that proves incorrect, insupportable or incomplete, the buyer will be highly skeptical or, more likely, simply gone. You would never pay millions of dollars without complete confidence in the company’s financial information. Should your buyer?
[Here are some common problems with sellers’ financial information.]
Balance sheet errors. It has been our experience that almost all companies have material errors on their balance sheets. These errors are often compounded if the company owns subsidiary companies. It is critical to fix any potential errors on balance sheets prior to showing them to a prospective buyer. Procedures should then be established to help minimize the future likelihood of such errors being recorded on the new company’s balance sheets. Common errors on balance sheets include such items as:
Revenue recognition. The revenue recognition policy of the company will be looked at very closely. The buyer will look at the matching of revenue and expenses to determine if it feels the financial statements are properly stated.
If you recognize yourself as an owner who has been overly aggressive in shifting income and expenses, (or, more likely, have given the financial controls insufficient attention over the years) it is of fundamental importance to the entire sale process that your past aggressiveness be diligently reviewed and corrected where appropriate.
Projections. One of the most important parts of making projections about future income and expenses is the documentation of the key assumptions used. This is the area where companies usually fail. The buyer will scrutinize the assumptions and ask for a lot of detail about how your staff arrived at the conclusions of the assumptions. They will want to see backup and proof of all key assumptions. Additionally, errors on the balance sheets, described above, will often cause errors on projections about future income and expenses.
Sellers can also be better prepared by having ready the financial information a buyer will want. Here’s a list of must-have information and data.
Historical information. Balance sheets, income statements and statements of cash flow for the past three years.
Current information. Most current balance sheet, income statement and statement of cash flows.
Projections. Projections of income statement and balance sheet for the next three years, including a detail of key assumptions and potential risks to the projections.
Revenue recognition. The revenue recognition policy of the company (e.g., percentage of completion, accrual basis, cash basis, deferred income).
Accounts receivable. The most recent accounts receivable aging. Identify bad debts and describe the company’s policy to determine bad debts.
Notes receivable. Copies of all notes receivables due from customers, employees, etc.
Fixed assets. A detailed list of fixed assets, including location and the depreciation policy. List all obsolete or damaged assets.
Accounts payable. The most recent accounts payable aging. Explain material amounts owed 60-plus days.
Accruals. List of material accruals.
Notes payable and lines of credit debt summary, including debt to related parties. List the terms (e.g., interest rate, balloon payments, number of months owed on the note, guarantees, loans in default, cross-collateralization).
Leases. Copies of all material leases.
Contingent liabilities. List all contingent liabilities of the company (e.g., liabilities that may be incurred by an entity depending on the outcome of a future event such as litigation, regulatory change and negotiations).
Business plan. Copy of any business plan presented to bankers, lenders, investors or third parties during the past three years.
Capital budget. List all material capital expenditures the company needs to make to accomplish future projected growth.
Jerry L. Mills founded B2B CFO in 1987. He is the author of three books, including “The Danger Zone, Lost in the Growth Transition” and “Avoiding The Danger Zone, Business Illusions.” Mills was nominated in 2014 as one of the five Middle-Market Thought Leader of the Year Award finalists by the Alliance of Merger & Acquisition Advisors.
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