by Jodi Ristrom, CPA
The time has come to entertain the idea of selling your family owned business. You have met with an interested buyer who appears to be a perfect match for your business and have received the letter of intent. The sale appears to be a done deal. The next step, due diligence. This should not be a problem, right, what could go wrong? In the due diligence process, your financial statements, projections, records and internal controls will be thoroughly scrutinized by the buyer. Unless you are prepared, the due diligence phase is where the acquisition often stalls, terminates, or results in a reduction of the purchase price. Here lies the problem: you know your business in and out but the buyer doesn’t, and your financial records may not support your representations.
Problems in the due diligence process are costly, time consuming, and frustrating. The key to assuring that you receive top dollar for your business is to be prepared before your initial talks with a buyer. There are many aspects to the due diligence phase: financial statements, projected sales, customers, vendors, and human resources to name just a few. This article walks you through what is focused on in the areas of financial statements, financial records, and internal controls.
GAAP Financial Statements
Your financial statements need to be maintained on a GAAP basis (generally accepted accounting principles). It is common practice for small businesses to maintain their financial statements on a cash or income tax basis. However, most buyers require financial statements on a GAAP basis. GAAP is a set of accounting standards that make financial statements comparable from year-to-year and with other businesses in your industry. The main feature of GAAP is the matching principal where revenue and related expenses are reported in the same period. Other significant differences between GAAP and income tax basis are the depreciation of fixed assets, recording of estimates for bad debts and liabilities. The conversation from a cash or income tax basis to a GAAP basis will require adjustments to the balance sheet at the beginning of the fiscal year, which will impact the prior year and current year income statements. Most buyers like to receive at least three years of comparable financial data.
Audited Financial Statements
Buyers prefer that the annual financial statements are audited by an independent certified public accountant. Audits should be performed for a minimum of two consecutive years. Please note however, that audits can be expensive and can take months to complete. The audit should be prepared well before deciding to sell your business.
The due diligence team will request detail schedules for each item on the balance sheet. It is important to maintain accurate and complete detail schedules for all balance sheet accounts. From these schedules, the team will request supporting documentation for the transactions. This may consist of invoices, agreements, amortization schedules, and purchase documents, accounts receivable, payable detail and sales registers. It is essential that these schedules are prepared and reviewed before you enter into a sale agreement. This will allow you time to identify errors and deficiencies, which may require that you revise your financial statements.
The buyer will be concerned that procedures and processes (internal controls) are in place to ensure that accounting transactions are captured and accurately recorded. Buyers are more confident that your financial statements are accurate and that fraud is not occurring when companies have sound internal controls in place. Sound accounting processes involve consistent processes, segregation of duties, and management oversight. These processes should be documented so employees know their roles and levels of authorization.
We cannot stress enough the importance of evaluating your financial records and internal controls well before you decide to enter the seller market. Don’t let the due diligence phase kill the deal. Buyers are more likely to pay the asking price if they are confident that your accounting records are complete and accurate.
HMWC performs audits, reviews, evaluations of internal control processes, and due diligence procedures. Please contact us for help as you prepare to sell your business so you receive the best price for your business.