Seller’s Mistakes: Valuation Adjustments

What is one of the biggest mistakes a seller can make in selling a business?  We see this time and again – the buyer (understandably) requests financials from the seller.  After executing an NDA the seller then sends along the most recent statements.  A few days later the buyer sends back what is considered a “low ball offer” and the deal falls apart.  Dreams of sailing in the Caribbean are put back on hold.

What’s Wrong With This Picture?

Typically the most important step in understanding and assessing a company’s value is interpreting both past financial performance as well its future prospects.  The company’s financial statements are the key source of such data.  The income statement (aka P&L) offers insights on performance over a period of time, and the balance sheet provides a snapshot of the companies position at a single point in time.

At issue, however, is that financial statements are often misleading:

  • Statements contain non-recurring income/ expenses
  • Outdated asset values
  • Many other factors that distort the company’s performance and condition
  • Perhaps most importantly, many business owners actively try to manage their tax bill down by showing the least amount of profit possible

 

By sending the buyer financial statements that have not been properly prepared, reviewed, adjusted, and footnoted, the seller is giving the buyer an incomplete and inaccurate view on the company’s performance and condition.  No wonder they received a low-ball offer.

What is the Impact of Valuation Adjustments?

By not properly working through adjustments a seller is potentially leaving significant money on the table.  Depending on the nature of the unadjusted financial statements the impact could be two time or more in purchase price.

Consider this example:

Impact of Adjustments (Example)
Reported
Adjusted
Operating Income
1500
1500
Depreciation
200
200
Taxes
600
600
EBITDA as Reported
2300
2300
Adjustments
Owners Excess Compensation
300
Non-working Family Member
100
Travel Expenses (Personal)
15
One Time Repairs
75
Legal – Lawsuit Expense
25
Legal – Lawsuit Recovery
(75)
Adjusted EBITDA
2300
2740
Valuation Multiple
5
5
Indicated Value
10350
12330
Value Attributable to Adjustments
1980

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By working with a professional to identify, understand, and detail these adjustments the seller puts themselves in a position to significantly increase the purchase price.

Working With a Professional to Adjust Financial Statements

When you retain a business valuation professional, one of the first steps they will take is to work with you to identify, detail, and document all of the required adjustments to both your profit and loss statement and balance sheet.  These might include:

  • Excess Compensation
  • Non-working compensation
  • Unusual or one time expenses
  • Expenses that might be better adjusted to industry norms
  • Excess working capital / working capital deficits

An experienced professional can quickly identify the proper adjustments to make and help the seller substantiate a more accurate valuation for their company.

 

 

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