Selling a Business? Invest in a Seller’s QoE Report
I'm the founder of a $25 million revenue business preparing to sell in the next six to nine months. Due to low quality financial statements, bumpy transition of our accounting software from desktop to the cloud, incorrect routing rules, running the business on cash basis vs accrual, gaps in revenue and payroll on a month-to-month basis, and inconsistent bookkeeping entries, our M&A advisor has recommended, prior to confidential marketing of the business, that we make the $60,000+ investment in a seller-prepared QoE report in order to reconcile these discrepancies.
For a company our size, is this worth the additional investment? If so, what weight does the seller’s QoE report provide in the sale process and how should we look at the ROI post-acquisition?
We understand your situation completely. Owning a thriving small business is the American dream. But when it comes time to sell, financial potholes hidden beneath years of "minimizing taxes" can turn that dream into a bumpy ride. This is especially true for businesses under $50 million in revenues, where a lack of dedicated financial resources often leads to inconsistent bookkeeping, confusing tax returns, and ultimately, a lower sale price. Having accurate and clear financial records is crucial for selling a business, and discrepancies like the ones you mentioned can raise serious red flags for buyers, potentially lowering the purchase price significantly. Engaging a third-party accounting firm, distinct from the company's management, staff, or tax accountant, is crucial. This independence ensures an unbiased evaluation, assuring potential buyers that the financial information presented is accurate and reliable. Given this scenario, your M&A advisor's recommendation for a seller's QoE report is absolutely warranted and deserves careful consideration.
Why Small Businesses Often Have Messy Finances
Let's face it, running a small business is a whirlwind. Between juggling operations, marketing, and sales, bookkeeping often gets relegated to the back burner. Consider:
Limited Resources: Hiring a full-time CFO isn't in the budget for most small businesses. Juggling bookkeeping with running the business often leads to gaps, inconsistencies, and reliance on cash-basis accounting, which doesn't paint a clear picture of the company’s financial health.
Tax Optimization Focus: While understandable, overly aggressive tax strategies can create complex structures and deductions that obfuscate true profitability. This raises red flags for buyers and lengthens the due diligence process, potentially dropping the valuation of the company.
Lack of Financial Expertise: Without a dedicated CFO, which most small businesses cannot afford, deciphering complex financial statements and anticipating buyer questions during a sale process can be overwhelming while running your business.
Tax Returns vs. Transparency: Why Due Diligence Becomes a Drag
Financial statements and tax returns optimized for tax minimization don’t tell the whole story. While tax-focused strategies can reduce current tax liabilities, they often result in financial statements that undervalue the business, potentially deterring potential buyers. Buyers need a clear picture of your business's true financial health, and inconsistencies lead to:
Extended Due Diligence: Financial statements and tax returns geared towards tax efficiency may not align with the requirements of potential buyers, necessitating a thorough reconciliation. Buyers will scrutinize every detail, demanding additional documentation and clarification, slowing down the sale and potentially scaring off serious offers.
Discounts and Downward Adjustments: Discrepancies can raise doubt about your profitability, leading to lower valuation and less attractive offers to support your next phase in life.
Post-Sale Risks: Hidden liabilities or inaccuracies can lead to legal challenges and reputational damage down the line.
The QoE: A Strategic Investment Worth Making
Think of a Quality of Earnings (QoE) report as a financial deep clean and a strategic investment for businesses preparing to sell. A well-prepared QoE report, conducted by an independent accounting firm, meticulously reconciles discrepancies, clarifies accounting practices, and presents a transparent picture of your business's true financial performance. Beyond rectifying discrepancies, it enhances the business's valuation, reduces deal uncertainty, and provides a competitive advantage when buyers are actively making acquisitions in your industry.
Financial Quarterback: Beyond the report itself, the accounting firm acts as your financial quarterback, rolling forward data, answering buyer questions, and guiding you through the sale. This frees you to focus on running your business.
Transparency and Accuracy: The report reconciles discrepancies, normalizes accounting practices, and presents a clear picture of your adjusted EBITDA and cash flow, building buyer trust.
Boosts Confidence: During buyer presentations, a clean QoE shows buyers you're transparent and have nothing to hide, building trust and potentially attracting more qualified offers. It also helps you speak intelligibly about your business and convey to buyer’s your vision for how the company can scale.
Faster & Smoother Due Diligence: With discrepancies addressed upfront, you attract qualified buyers who can focus on the real value of your business, streamlining the process and saving everyone time and money, getting you to closing quicker.
Higher Valuation: Transparent financials breed confidence, and confidence translates to higher bids. A well-prepared QoE report can increase your target enterprise value (aka your sale price) by as much as 5-15% or more, potentially netting you hundreds of thousands of dollars more. In most cases, our clients have seen an increase in their target enterprise value by as much as 25%. Assuming a $60,000+ investment could generate a $500,000 increase in enterprise value, that’s a 733% net gain!
Reduced Post-Sale Risk: A thorough QoE minimizes surprises and mitigates potential legal liabilities post-acquisition.
Successful Execution: Draft the Right Advisory Team
While the QoE report is a crucial investment, it's only part of the playbook. Investing in a seller’s QoE report, alongside engaging an investment banker (also called an M&A advisor) and M&A transaction attorney, might seem like a hefty cost. But consider it an investment in your sale price and most importantly, your peace of mind. Plus, understand that if the buyer is willing to invest $250,000 or more to buy a $5 million business, we highly recommend that our clients be willing to consider a similar upfront cost of doing business. The key members of your team will be your investment banker, M&A attorney, wealth manager, tax advisor, and third-party accountant. When going through the process, it is important to have a team that works well together and represents the culture of your business.
Remember you will be working closely with these professionals for the next 6 to 12 months so it is imperative to find people with whom you can work well with.
M&A Advisor: Develops the strategic game plan and prepares the business for sale, including connecting you with the best transaction attorney, strategic wealth advisor, and third-party accounting firm that suits your needs should you not have access to these resources already. An experienced investment banker will confidentially market your business, navigate the complexities of the sale, negotiate favorable terms, and manage the entire process, freeing you to focus on running your business.
Strategic Wealth Advisor: Empowers you to maximize the after-tax windfall from the sale of your business. Their expertise ensures optimal post-sale investment strategies, minimizes potential tax liabilities, and navigates the financial complexities of wealth creation and preservation, securing your long-term financial well-being.
M&A Attorney: Safeguards your legal interests and maximizes value throughout the sale process. Engage them early, ideally alongside your M&A advisor, to craft watertight contracts and agreements, negotiate complex deal terms, offer protection against potential liabilities, and execute a watertight closing that ensures a secure and legally sound transaction.
QoE Accountant: Scrubs the financial playbook, reconciles discrepancies, and prepares a clear, accurate financial picture. They also answer buyer’s financial due diligence questions, roll forward data, and stay on top of every detail regarding the company’s financials. This is where having an industry specialist is critical.
While it might seem like a lot to juggle, remember that this baseline advisory team – your wealth advisor, QoE provider, investment banker, and transaction attorney – becomes your financial braintrust, ensuring a smooth, successful sale. Investing in a QoE report, along with the right team of advisors, is the key to maximizing valuation and unlocking a profitable sale of your business.
FAQs
Q: Why is a QoE report necessary for a business of this size?
A: A QoE report is essential for all business that don’t have audited financial statements. It rectifies financial discrepancies, providing transparency and accuracy crucial for potential buyers assessing the risks associated with the acquisition.
Q: I have a good tax accountant. Do I still need a QoE report?
A: Not unless they're completely independent of your business. While tax accountants are invaluable, their focus is on minimizing tax liability, not preparing your financials for sale. A QoE report takes a different perspective, ensuring transparency and clarity for potential buyers. Plus, maintaining arms-length objectivity is crucial.
Q: Can't I just clean up my records myself?
A: While you can try, an independent third-party firm adds credibility and objectivity to the process, raising buyer confidence and potentially increasing your sale price.
Q: Will a QoE guarantee a higher sale price?
A: While it significantly increases your chances, other factors like market conditions and industry dynamics also play a key role.
Q: How does the seller investing in a QoE report impact the sale timeline?
A: Think of it as a strategic investment in your future. The upfront investment accelerates the due diligence process, potentially shortening the time to close the deal and positioning your business as an attractive and well-prepared investment. Ancillary benefits could include higher valuation and reduced post-sale risks which often far outweigh the upfront cost.
Q: Can't potential buyers conduct their due diligence without my providing a QoE report?
A: While potential buyers can, and will, conduct their own due diligence regardless of a pre-existing Quality of Earnings (QoE) report, it's important to understand the benefits a seller-provided report offers. Yes, buyers will ultimately form their own conclusions, but your proactive action in presenting a transparent, independent assessment of your financials can significantly influence the process. Think of it like this: would you rather have a buyer delve into your financials with a flashlight or a floodlight?
Although it’s not a magic bullet, a seller prepared QoE report acts as a powerful floodlight, illuminating your financial landscape upfront. This proactive transparency offers several advantages and begs repeating:
Starting Point vs. Blank Slate: A QoE report provides buyers with a well-organized, reconciled foundation to build their due diligence upon. This saves them time and resources, allowing them to focus on deeper dives and specific areas of interest. It's important to acknowledge that buyer initiated QoE reports can take two to three months or more to complete, significantly slowing down the sale process. Without the report, they're starting from scratch, potentially delaying the entire process by months while they reconstruct the financial picture. This can be costly in terms of lost opportunities and increased uncertainty.
Confidence and Transparency: A well-prepared QoE report, conducted by a reputable third-party accounting firm, signals transparency, and builds trust with potential buyers. It demonstrates your commitment to open communication and a willingness to address any discrepancies proactively. This can significantly improve the overall tone of the due diligence process, leading to smoother and more collaborative negotiations.
Valuation and Time to Close: While buyers will ultimately determine the final valuation, a clear and accurate QoE report can positively influence their initial offer and potentially lead to a higher sale price. Additionally, the streamlined due diligence process facilitated by the report can significantly shorten the time to close, saving everyone involved valuable time and money… “time is money and time kills all deals.”
Competitive Edge: In a competitive market, a seller provided QoE report can give you an edge over other businesses vying for the same buyers. It showcases your professionalism and preparedness, making your business a more attractive and less risky proposition. Remember, transparency and integrity rarely hurt in business.
It's important to remember that not all buyers will rely solely on your QoE report. Some will prefer to conduct their own comprehensive due diligence regardless. However, the report serves as a shared starting point, fostering trust, saving time, and potentially increasing your compnay’s enterprise value in the eyes of potential buyers. In today's competitive landscape, that's an advantage you can't afford to miss.
Q: What if my business is larger than $5 million?
A: A seller prepared QoE report is valuable for any business size, but we’ve found the impact on valuation and ROI can be even greater for small to mid-size businesses generating average annual revenues of $250 million and under who don’t have audited financial statements (P&L, Balance Sheet, and Cash Flow).
Q: Where do I find a qualified accounting firm for a QoE report?
A: Ask your M&A advisor for recommendations or seek out firms with experience in your industry and transaction size.
Q: How do I get started?
A: When selling your life’s work, don't settle for a "good enough" exit. Empower yourself depending on your specific circumstances, risk tolerance, and desired sale outcome. Take our assessment and book a discovery session with one of our senior bankers to help you weigh the pros and cons and determine the best approach for your situation.
Disclaimer: The information, opinions and views presented in this writing are being provided for general informational and educational purposes only. They should not be considered as legal, tax, financial, or other professional of any kind. All such information, opinions and views are of a general nature and have not been tailored to and do not address the specific circumstances of any particular individual or entity, and do not constitute a comprehensive or complete statement of the matters discussed herein.
Readers should consult with their own legal, tax, financial, or other professional advisors regarding the applicability of this information to their own circumstances. It is important to remember that historical performance is no guarantee of future returns and that investing inherently carries risks. No representation is made that any specific investment or investment strategy directly or indirectly made reference to in this writing will be profitable or otherwise prove successful.
This writing is not and should not be construed as an offering of advisory services, or as a solicitation to buy, an offer to sell, or a recommendation of any securities or other financial instruments.