So, you’ve built a successful business over the years, but you’ve added those years to your age as well. Now it’s time, you decide, to sell the business and retire to your south pacific island – or perhaps just your back-yard garden. You’ve managed your customer relationships well, revenues and profits have held up or grown, even during the pandemic. You’ve produced financial reports each month, and you’ve found an investment banker that you want to work with. You’re ready now. What could go wrong?
Well, let’s suppose your accounting over the years was a bit less than accurate in some subjective areas, like inventory valuation. You kept your book values conservative, i.e., smaller profits reported. You know there’s value there that isn’t reflected on your balance sheet, so that’s a good selling point, right? Maybe not.
One of the impacts of your “conservative” reporting was that you paid less income taxes. Without commenting on whether or not that was a goal of your reporting practices, there is a potential tax liability that is likely going to surface during any due diligence review by potential buyers. How much is that potential liability, plus penalties and interest? You don’t know, your prospective buyer doesn’t know, but they do know it’s a red flag. What else might there be? Other unrecorded assets? Unrecorded liabilities? What are they really buying? Suddenly your buyer cools off, doesn’t respond promptly to emails. And then they’re gone.
What happened? Didn’t they realize there’s hidden value here? Yes, but. It’s the “hidden” part that they are likely worried about. Hidden value offset by hidden costs? Since the best comprehensive statement of the value of your business is your financial records, and if those can’t be relied upon to a reasonable degree, how do they really get a handle on what they’re buying? Given the number of businesses that are coming to market as the current wave of baby boomer retirements builds, there are a lot of options for them to pursue that don’t involve a black box.
This is not to say you must have audited financial statements to affect a sale of the business. Most small and mid-sized businesses, even those with bank loans on their books, operate – and sell – without audits by CPAs. But that also means there is a greater need for reasonably accurate accounting that doesn’t have material misstatements over the years. And if it has in the past, one of the key tasks before you go to market the company is to develop a pattern of recent reporting that corrects those misstatements and properly reflects profits by period. That means fix the books and keep them fixed for a long enough period that you can stand behind your financial reports, knowing there is no hidden liability for taxes or other unrecorded risks. If you’re not sure how to do that, but it’s getting to be time to sell, give us a call.
We are your CFO for Rent.