Source: Todd Ganos from Forbes
In our first installment of this series on the value of your business, we identified that your company is like an atom. In the arcane science of quantum mechanics, an atom is at multiple positions simultaneously . . . and its observed position will depend on the observer. The value of your company is at multiple positions simultaneously . . . and its observed value will depend on the buyer — a strategic buyer, a financial buyer, a peer/competitor, an employee, or a family member. Same company, same financials, different prices.
In our second installment of this series, we suggested that your company is like a steak. Some beef is USDA Select (no thanks), some beef is USDA Choice (average), and some beef is USDA Prime (great). Roughly 80 percent of companies — which would include the “average” — within a given industry and of a given size are Select or Choice and not in sellable condition. On the other hand, the companies that do sell — and the multiple of earnings you see being paid — are typically purchases of USDA Prime.
Regarding those “average” companies, the financial statements for an “average” company within a given industry and of a given size are available via a particular IRS database. Regarding those companies that sell, the financial statements of these companies are significantly stronger than the average reflected in the IRS database figures.
So, the question for you became this: are your financials more like the average or significantly better? If your firm’s financials are closer to the industry average . . .
Now, let’s turn to a more fundamental question: how are you maintaining your financial records?
In the accounting world, there is something called an accounting framework. While there are a few different frameworks, the one that a USDA Prime buyer — the strategic buyer and the financial buyer — wants to see is U.S. Generally Accepted Accounting Principles (US GAAP). Why? Because in most cases, they are required to report within the GAAP framework. And, because in most cases, their own financials are audited within the context of GAAP.
So, if you want to attract that USDA Prime buyer, you want to have GAAP financial statements. If you don’t, you can expect an offer price for your firm that might be 0.5 to 1 time earnings lower than the USDA Prime deal prices you hear about. (Do the math for your company.) If you don’t, spend the money to convert your books over to GAAP. It might cost you $100,000 — ouch — but it will be worth it. (Again, do the math for your company.)
Next, irrespective of which accounting framework you use, do you have an annual audit performed? This question speaks to a couple items. The first item relates to the most obvious issue: has an independent accounting firm examined your books and attested to them accurately reflecting your financial condition. In short, can WE trust your books?
The second item relates to the concept of “internal control.” If you don’t have your books audited, how do you know that they accurately reflect your financial condition? In short, can YOU trust your books? The image you want to portray is “disciplined.” If you don’t, expect another 0.5 to 1 time earnings lower price. It might cost you $50,000 to go back a few years — depending — but it will be worth it.
Next, even if you don’t have your books audited annually, can they be audited? That is, are your financial records in such a condition that a CPA firm could perform an audit? Are your records in a condition so that your CPA could perform a Quality of Earnings report to assess the sustainability of your earnings after the sale? If not, your best buyers probably have left the room, and if not, your best price certainly has.
So, if you are seeing deals at 5 to 6 times earnings in your industry, the company that can’t be audited will go for less, probably much less. Investing in proper accounting and financial planning systems is one of the fastest ways a company can generate return on investment – when the company is sold, it’ll give the investment banker much more deal leverage to get the best price. That assessment comes from Dick Bransford, an investment banker with Mid-Market Securities.
From all of this, you need to set your expectations. Know where you stand. If you need to be standing in a different spot, do something about it. 1. Get your financials into compliance with GAAP. 2. Get your financials audited. 3. If your numbers point to industry average, do something about it. What that something is will be the subject of our next installment.