If you are contemplating selling your business, consider having a quality of earnings (Q of E) report completed as part of the process before you start entertaining prospective buyers. A typical Q of E report provides many benefits to a buyer, including the following:
- Clearly defines the company’s goals and direction. Your entire management team should be aware of this message so potential buyers hear consistent answers regarding company goals and plans.
- Outlines potential sales alternatives. Will potential buyers purchase stock or the company’s assets? What are the tax implications of each? Will all of the company be sold, or just a portion?
- Calculates and provides supporting data for EBITDA adjustments (both good and bad).
- Validates compliance with GAAP (i.e., accounting standards).
- Clearly defines the current ownership’s goals. Do the owners want to stay involved in the company after the sale? Is there a management team in place that would allow the owners to leave at the conclusion of the deal (which presents less of a risk for a buyer)? Or, would the buyer need the owners to stay on to assist in transitioning accounts (which involves more risk for buyer)?
- Identifies potential opportunities and risks for the buyer. Is there a concentration of customers? Are there new products and/or services that could enhance sales? Are margins on existing accounts getting better or worse? How much of the existing business is annuity business versus one-time sales? If the building is owned by the seller, is it included in the sale or will the seller retain the building?
- Provides a bridge from historical financial statements to projections.
- Can support the investment bankers on what to include in the prospectus.
A Q of E report should significantly reduce the amount of time a buyer needs for due diligence and reduce the risk of “buyer fatigue” in a transaction. The less time a buyer needs for due diligence, the greater chance the deal closes timely and with the maximum value to the seller.
The advantage of a Q of E report is clear. The more a potential buyer knows about your business prior to submitting a bid, the less risk they will perceive. Thus, the lower a buyer’s risk, the higher the multiple they should be willing to pay for the projected cash flow. A buyer will bring up every negative they can find in an attempt to lower their offer price, and they rarely mention the positives. By doing your homework ahead of time and making those positives readily apparent in a Q of E report, you put yourself in a better negotiating position with potential buyers.
David E. Shaffer
is a director with Kreischer Miller and a specialist for the Center for Private Company Excellence. Contact him at Email.
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