There is no one way to prepare accounts, which means that it’s unlikely you’d want to put forward your standard internal financial reports to a potential buyer. Our fourth and final blog on consultancy financials will look at how to present your accounts when involved in a sale process.
While there are many ways to prepare accounting statements incorrectly, you might be surprised to learn that there are also many ways in which they can be prepared and still be accurate. Given the choices that have to be made when calculating financial results, it’s important to think carefully about how to present these to a potential buyer. It’s important to note, this is not a question of right versus wrong, or accurate versus inaccurate. What we are talking about in this blog is making sure that your financial statements accurately reflect your business performance in the eyes of the buyer. Furthermore, the accounting methods and policies you use to manage your business might be very different from the methods a buyer would use if running your business as a part of their company. The result is that a buyer might look at your internal accounts through the lens of their accounting policies and fundamentally misunderstand your business.
The lesson for the business owner is to always take a fresh look at the accounts and make adjustments for items that could cause a buyer to misunderstand the business. These items could be adjustments to gross margin as discussed in a previous blog, or removal of “owner expenses” that wouldn’t be incurred by the business after a sale to a new owner
One critical category of expenses that might need to be positioned in a sale context refers to growth investments. Put simply, these are expenses that you incur as the owner of a business (and that reduce profitability), but that benefit the buyer because they result in improved performance after the sale. For example, let’s say you hire a new revenue producer in March, and sell the business in December. Since it takes a new producer six months to build a pipeline of client engagements, she hasn’t delivered significant revenue by the time the transaction closes in December. However, her entire monthly draw, which might even be above normal as a transition salary, reduces EBITDA in the period right up to the sale. In our engagements, we would make sure the financial data clearly articulated her draw as a growth investment, and calculated both the real profitability as well as what the profitability would have been had she not been hired.
Another key strategy when positioning financial results to a potential buyer – or buyers – can be called “proving a trend”. This relates to a situation where the financial story of a firm has changed recently and there is significant, justified confidence that it will persist into the future. For example, a business that generated $10m of revenue in the last calendar year, and hired several new producers in that year which reduced profitability, is on track through March of the current year to generate $15m in revenue. Typically, a buyer will view the most recent full year as the scale of the business ($10m) and base a valuation on that number. However, in this situation, we want a buyer to use $15m as the base scale of the business, and to do that we need to prove that the uptrend is real and sustainable through:
- Detailed pipeline analytics
- Demonstration of booked engagements supporting the $15m number
- Monthly or weekly run rate and capacity analysis to prove we are not being unduly optimistic
Financial information is of course hugely important when talking to a potential buyer. Presenting them with your standard internal accounts makes it likely that they will not gain the correct understanding of the business. This could result in you missing out on maximizing your sale price, or missing out on a sale all together. Because of this, external advice should always be sought on how best to present your financials so that the buyer can see what benefits they would obtain through purchasing your business.
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