7 minute read
The calculated exit
THE CALCULATED
Every CPA I speak with would agree that tax and generally accepted accounting principles (GAAP) compliance have become more difficult to keep up with than ever before. Unfortunately, despite this fact, there’s a lot more we need to worry about than tax returns and financial statements. We need to engage our clients in meaningful discussions about their ultimate exit from their businesses. Without these conversations and proper planning, we just aren’t doing our jobs.
Navigating the mergers and acquisitions (M&A) landscape for your clients
Anyone servicing business clients certainly knows by now that the M&A environment has been very active for the last few years and reached a boiling point during the fourth quarter of 2021. Let’s review how we got here and the key pain points that CPAs are hired to help alleviate — and hopefully eliminate — during the transaction process. First off, how did we get here?
Deal activity
Our transaction advisory team saw a very active 2020 deal climate grow substantially in 2021. We have been active in dozens of 2021 deal closings and have several still in process as we head into 2022. I’m writing this article before 2021 has closed and before tax legislation has been finalized, but as we stand today, substantial momentum in deal activity continues to occur heading into 2022. Many of these deals did not close in 2021 despite any possible changes to tax law. These changes are beginning to look less consequential, but only time will tell.
Valuations
Valuations have generally continued to be strong, with little to no decrease in valuation multiples and buyer appetite in sight. Some sectors have seen an increase in both over the last 18 months, while cash surpluses and public and private sector pressure on investment returns continue to fuel acquisition deal flow, as does the proposed tax legislation.
By David Richards, CPA, MST What do our clients need from us?
Clients need us to engage them in discussions around their ultimate exit from the business. The topic I get involved in most with clients lately circles around the timing of their business exit. It used to be a discussion centered around the age of the owner, personal goals and the readiness of the business to undergo a changing of the guard. Now these conversations focus more on the markets, interest rates and, most certainly, taxes.
I get asked questions along these lines: • What do you think about tax legislation? • Is it the best time to sell? (Notice I didn’t say the
“right” time.) • What would you do if you were me? (Isn’t this always the ultimate question?) These and other questions that are on the minds of many business owners need several counter-questions to be answered before they can be evaluated in a constructive way. These are my questions to clients: • Are you ready to give up control yet still participate in the growth of the business? • Is your team able to thrive in what will likely be a larger, more corporate environment? • Is your business mature and stable enough to withstand a productive change in control? • Are you ready to withstand buyer due diligence and retain your value through negotiations? • Have you dotted all your I’s and crossed all your T’s? • Do you know where the skeletons lie and how to evaluate their impact on the deal?
Are both the client and the business ready?
Taxes and interest rates should be part of this analysis for sure, but more importantly, are the client and business truly ready to be transitioned? If the client is the head cook and chief bottle washer, and all institutional knowledge rests with them, the business isn’t ready. Even if this is the case, it takes more than a day to get the business ready, so a proactive approach is needed to obtain the desired result for our clients.
The importance of financial reporting
Every deal I have ever been involved in centered largely around what the business has historically done financially and what the business forecasts it can do in the future. These are simple concepts; however, they become much less simple when the pains of due diligence set in on an unprepared seller. Your client must have solid numbers, and they can’t get caught ill-equipped to substantiate them. A material adjustment to the reported financial statement earnings can be the kiss of death in a deal. An accountant preparing a tax return is generally not concerned with whether their reported net income will withstand a due diligence audit
or what is called a “quality of earnings” review. Revenue recognition, inventory valuation, missed accrued expenses and many more items can be easily missed during the tax preparation — and even during the financial statement review and audit process at times. These factors could have a material impact on their earnings and, therefore, their valuation.
Determining adjusted earnings before interest, taxes, depreciation and amortization (EBITDA)
EBITDA can be calculated straight from the client’s financial statements. Adjusted EBITDA is a step beyond this, taking into account all expenses of the business that are in excess of what the business actually needs to be successful. There are countless examples, but a few common ones include: • Excessive owner compensation. (Would someone do the job for less?) • Excessive vehicle expenses (or personal cars in some cases). • Excessive travel, meals, entertainment expenses or other personal items. • One-time or extraordinary legitimate business expenses, such as a lawsuit, anniversary party, failed marketing campaign, etc. • Relatives on the payroll who aren’t really working and won’t go with the acquiring company. Have you or your client done an analysis of these types of expenses for the last three or four years and the current year to date? They will need it for the sale of the business efforts when they move forward with the sale process.
The importance of internal controls
Internal controls are procedures and documentation that are put in place for many reasons. They include: • Safeguarding assets, including cash and physical assets such as inventory. • Integrity of the processes and procedures. • Onboarding new personnel and getting them up to speed. • Safeguarding against the sudden loss of a key person who handles key business functions. • Giving the buyer a good look into how you run your business and how secure it is against the risks noted above and many more. Is your client able to segregate duties and document the key financial control functions? This is seen as an enterprise strength to a discerning buyer. While some entities are just too small to truly segregate all the major control functions, you still need to have the conversation and try to instill best practices in your client’s business wherever possible.
Make sure your client is prepared
As they say, proper preparation prevents poor performance. For most business owners, their exit from the business can be the most financially rewarding event of their lives. The question is, why don’t more owners focus on this and help maximize the outcome? Another question is, why don’t the trusted advisors of these owners help them realize where their focus should be?
The longer view
Now is the time to plan and strategically enhance your client’s enterprise value by helping them focus on driving EBITDA, cutting costs and enhancing existing margins. Our team works with M&A clients on both the seller and buyer side. In many cases, it can take years of planning and fine-tuning to properly position a business for a successful exit, and we have found that business owners who plan ahead are overwhelmingly more successful in the end.
David Richards, CPA, MST, is managing partner at CRR LLP. Contact him at david.richards@crrcpa.com.
Reprinted with permission from the Massachusetts Society of CPAs.
