No Ugly Babies
Are you considering the sale of your company, but apprehensive about its proper valuation? Your business can realize a fair value, despite ‘creative accounting’.
When it comes to the sale of your business, you should know that there is no such thing as an “ugly baby,” meaning that every business can be appropriately valued and sold. That is true even if you have used “creative accounting practices.” Following GAAP (Generally Accepted Accounting Principles) should always be your go to practice, but most times entrepreneurial minds lean towards maximizing capital, which requires creativity.
There are a variety of reasons why owners say they are not interested in selling their business. They may feel uncertain about the future of the economy or tax policy, or about where interest rates are going. They may feel uncertain about their “legacy,” or have an indistinct feeling that “the time is just not right.” One of the most common reasons involves concern about their business’ accounting practices, and that is the one that business owners generally do not need to worry about. One might say they want to wait to sell for two or three years to clean up their financials. Perhaps there is a nephew (or any non-productive type employee) on the payroll who doesn’t actually work in the business, for example, or they might be worried that the downturn in revenue during the pandemic is going to depress their company’s value.
It is recommended, but not necessary to have squeaky clean books to come to a fair value of their business. A buyer can come in and do some forensic accounting to adjust – up or down – for any lack of discipline in their accounting practices, or short-term blips in profitability. Most closely held businesses look for ways to minimize their tax burden. An experienced buyer or hired broker can review their books and adjust the business’ value accordingly. Perhaps the company purchased a paint booth or renovated their offices last year, resulting in a major hit to their profit on paper. That can result in an ‘add-back,’ so any such one-time purchases will not impact the company’s value.
Alternatively, there can be some “removal” type adjustments made as well. If a business owner sold in the waning months of 2020, for example, a buyer might have disregarded the middle two quarters of that year, when their business was most impacted by the pandemic, when determining the fair value of the business. Another scenario: Maybe they have some family members receiving health care coverage despite minimal involvement with the business. Again, forensic accounting can adjust for that.
It’s important to understand that a private equity firm or other buyers are not the IRS or other agents of the government. They’re not looking for improprieties to report. They just want to ensure things of that nature are considered to establish a fair value. Typically, buyers will rely on the sellers to handle their own tax ramifications. There is one caveat: A buyer cannot adjust mishandled cash. It’s unacceptable to state, “I took out x amount of unreported cash sales,” or say, “I paid some overtime using cash,” and expect that to lead to an upward shift in the value of your business. Improper cash management cannot be verified and/or tracked. Otherwise, don’t let a false belief that a business owner needs two or three years of financials to maximize their company’s profitability in order to get a fair value for their business. Values these days are largely expressed as a percentage of gross revenues rather than a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), although EBITDA does factor in the valuation. So, any business, even those with a poor EBITDA or with some “creative accounting,” can be fairly valued and sold.