Are you considering the sale of your company but are apprehensive about its proper valuation? I like to tell owners that there’s no such thing as an “ugly baby.” What I mean by that is every business – and I mean every business – can be valued and sold. That’s true even if you’ve used what I call “creative accounting practices.”
I hear a variety of reasons why someone says they’re 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 to go. They may feel uncertain about their legacy or have an indistinct feeling that “the time is just not right.”
But one of the most common reasons involves concern about their business’s accounting practices. Following GAAP (generally accepted accounting principles) should always be your go-to, but entrepreneurial minds often lean toward maximizing capital, which requires creativity.
This is a reason cited by some owners about why they’re uncertain about selling, but it’s one I tell owners they generally don’t need to worry about. They might say they want to wait to sell for two or three years in order to clean up their financials. Perhaps there’s a relative (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.
I try to help them see that it’s recommended but not necessary to have squeaky clean books in order to come to a fair value for the business with a buyer. A buyer can come in and do some forensic accounting to adjust – up or down – for any lack of discipline in your accounting practices or short-term blips in your profitability.
Most closely held businesses, for example, look for ways to minimize their tax burden. An experienced buyer or hired broker can review your books and adjust the business’s value accordingly. Maybe you bought a booth or renovated your offices last year, resulting in a major hit to your profit on paper. That can result in an “add-back,” so any such one-time purchases don’t hurt your company’s value.
Alternatively, there can be some “removal” type adjustments made as well. If you sold in the waning months of 2020, for example, a buyer might have disregarded the middle two quarters of that year — when your business was most impacted by the pandemic — when determining the fair value of the business.
Another scenario: Maybe you 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 can’t adjust mishandled cash. It’s unacceptable to say, “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 or tracked.
But otherwise, don’t believe that you need two or three years of financials that maximize your company’s profitability in order to get a fair value for your 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 EBITA does factor into the valuation. So any business, even those with a poor EBITDA or with some “creative accounting” can be fairly valued and sold.