Clean financials reduce buyer uncertainty, strengthen seller leverage, and make it easier to defend the value of your firm.
There is a frustrating contradiction I see regularly in AEC transactions: An owner wants top dollar for their business but is unwilling to spend a relatively small amount of money to produce financials that allow a buyer to understand what the business is actually worth.
You can't have it both ways.
I've seen firms pursue premium valuations while resisting relatively modest investments in cleaning up their financial reporting. In some cases, converting and recasting the financials on an accrual basis might cost less than $10,000, while the lack of clear financials could ultimately put millions of dollars in potential value at risk.
That’s the kind of disconnect AEC owners need to understand before entering the market.
Buyers pay for what they can understand
Cash-basis accounting isn't inherently wrong. Plenty of firms use cash accounting for tax purposes, and many firms that pay taxes on a cash basis still track their business performance on an accrual basis. The problem comes when cash-basis records are the only reliable financial picture available.
A buyer is trying to understand the economic performance of the business. What revenue did the firm actually earn during a given period? What expenses were required to produce it? What work has been performed but not yet billed? What has been billed but not collected? How consistent are margins from one period to the next?
If invoices or revenue don't even enter the accounting system until cash is received, answering those questions becomes much harder – and uncertainty has a cost.
A buyer faced with clean, understandable financial information can spend its time evaluating the business. A buyer faced with incomplete or difficult-to-interpret financial information has to spend its time reconstructing the business first.
That slows the process, complicates diligence, and gives the buyer more reasons to question what they're seeing.
Every question creates friction
M&A transactions already involve plenty of moving parts. Owners, buyers, attorneys, lenders, and advisors all have their own requests and timelines. Even relatively straightforward transactions can become exercises in coordinating dozens of people around the same set of facts.
The same issue can arise when an internal audit or financial recasting requires a modest five-figure investment. Owners may hesitate over that expense even when the potential difference in transaction value is measured in millions. That’s difficult to reconcile when so much may ultimately be at stake. Owners often view these requests as transaction costs when they should be viewing them as investments in protecting the value of the deal.
The cleaner the information, the easier it is for a buyer to get comfortable with the company. The messier the information, the more opportunity there is for doubt – and buyers rarely pay a premium for doubt.
Preparation should start before the buyer arrives
Many AEC ownership teams are simultaneously considering internal ownership transition, an ESOP, or an external sale. An external sale itself could mean many different things, from strategic acquisition to private equity investment. Owners don't necessarily need to know exactly which route they'll take before they begin preparing. However, they do need financial information capable of supporting the conversation.
In our pre-sale preparation work, the cash-to-accrual issue is often one of the first things we identify. That's because valuation isn't simply about applying a multiple to whatever number appears at the bottom of an income statement. The underlying earnings have to be understood and defensible.
If the financials need to be reconstructed after a buyer is already at the table, the seller has surrendered valuable time and leverage. Questions that could've been resolved months earlier instead become issues during diligence, when the buyer is scrutinizing every weakness and the seller is under pressure to keep the deal moving.
The best time to discover that your accounting practices make the business difficult to value is not after receiving an offer.
Make the business easier to buy
Owners spend decades building AEC firms. They recruit people, develop clients, establish reputations, and take on the risk required to create something valuable. But buyers can't pay for a story they're unable to verify.
If you want a premium valuation, start by making the business easy to understand. Get the right advisors involved. Clean up the financials. Recast what needs to be recast. Make sure the numbers reflect the economic reality of the firm.
A relatively small investment in financial preparation can remove a major obstacle from the transaction. Saving thousands on the front end is a bad trade if it costs you millions at the closing table.
If your firm is preparing for a sale, ownership transition, or other major change, Zweig Group’s Transition consulting team can help you evaluate your options, understand your firm’s value, and prepare for what comes next. Learn more about Zweig Group’s Transition consulting services.
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Will Swearingen is a principal and senior director of Transition consulting at Zweig Group. Contact him at wswearingen@zweiggroup.com. |
