As we have discussed in the past few articles, getting a premium price for the sale of
your business can depend, in large part, upon your efforts to adopt and implement value
drivers. The last value driver that we are going to discuss in this series of articles is the
existence of reliable financial controls that you can use to manage the business.
Documented financial controls are not only a critical element of business management,
but they also can help safeguard a company's assets. Most importantly, however,
effective financial controls help verify (for the buyer) the financial condition of your
During the sale process, the buyer will likely conduct an extraordinarily detailed
examination of your company’s finances known as financial due diligence. If the buyer's
auditors are not completely comfortable when reviewing your company's past financial
performance, the buyer will probably walk away from the deal (or, at best, give a lowball
Take for instance a scenario in which a business owner tells a potential 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?
One of the best ways to document that the company (1) has effective financial controls
and (2) its historical financial statements are correct is through a certified audit by an
established CPA firm. A certified audit is important because lack of financial integrity
has been observed as one of the most common hurdles encountered during the exit
process. An audit demonstrates to potential buyers that the historical information can be
relied upon when making judgments about buying the company based on historical cash
flows. It can be very important to have your CPA review your current financial
statements and practices so that any financial irregularities or inadequacies are
immediately exposed and corrected.
One common "irregularity" that we often see in companies is the shifting income.
Everyone, buyer included, understands that for the years prior to the sale, owners will
naturally handle the company's finances from a perspective of minimizing tax
consequences. This is good tax planning and is anticipated by the sophisticated buyer—
the kind with whom you are likely to deal.
Unfortunately, some owners go one step too far in an effort to minimize tax
consequences. They shift income from one year to the next and shift expenses fromone year to the next—neither the expense nor income shifts relating to each other, or to
the actual services or manufacturing activities that give rise to the income or expense
item. Other owners may improperly report inventory or lack sufficient inventory controls.
For an example of this financial irregularity, let’s look at the story of fictional owner
Vince Diamond owned a successful plumbing parts company in Detroit, Michigan. For
years, Vince had understated his inventory in an effort to reduce his profits, thus
reducing his tax liability. Vince provided the doctored numbers to his accountant who
year after year, used those numbers to prepare the company’s tax returns.
At Vince’s 60th birthday party, his youngest son (who Vince had always hoped would
take over the business) announced his plans to attend medical school. Vince’s
employees had neither the money nor the will to take over the company so Vince
decided to investigate the option of selling his company.
During Vince’s first meeting with a business broker, the broker questioned Vince’s
stated inventory of $250,000. "How can you possibly support annual sales of $2.5
million with an inventory this small? Vince then admitted how, unbeknownst to his
accountant, he had cleverly "saved hundreds of thousands" in taxes over the years by
understating his inventory.
"Well," his broker began, "now you face a difficult choice. We can correct your inventory
numbers so that your EBITDA will support a $10 million sale price." "Great! Let’s do it!"
Vince replied. "If we do," the broker cautioned, "the IRS can, and probably will, charge
you with tax fraud."
Vince then asked, "What happens if we let the numbers stand?" The broker replied, "In
that case, I have good news and bad news. The good news is: you don’t go to jail."
Taken aback, Vince asked, "Then what is the bad news?" The broker replied, "The bad
news is that without correcting the numbers, your company’s EBITDA is too low to
support a $10 million price. In fact, no buyer will want to risk buying a company with
Dejected, Vince left the broker’s office. He ran the company for eight more years until
he had enough money in the bank to support himself in his retirement. At the end of
those eight years, Vince liquidated what he could and closed the doors.
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.
Making sure that you have effective and documented financial controls within your
business can be the value driver that makes or breaks the sale of your company.
As we have discussed in this series of Exit Planning Navigator® value driver articles,
concentrating on developing and enhancing your company’s value drivers can position
you to get a premium price for your business.