Bad Documents To Sell A Privately Held Business

Last month, we discussed the right timing to sell a business within the context of macro-economic cycles and the lifestyle preferences of the business owner, we want to focus this month on the right timing within a calendar year.

“’Quite often, we see the New Year’s resolution put into motion by business owners, “says Achim Neumann, President, A Neumann & Associates LLC, a New Jersey based Mergers & Acquisitions advisory and Business Brokerage firm, “with many such sellers approaching our firm in the first quarter of the year.”

Given that it takes a year to sell a business (even though more recently significant shorter periods were seen), the timing within a calendar year is somewhat irrelevant. Nevertheless, many owners have decided to retire once they hit a certain age, and thus, there is the phone call at the beginning of the year.

The major challenge with this timing is the lack of proper documents combined with the inherent nature of a long-term successful business owner.

Typically, at the beginning of the year, a business owner’s tax documents have not been prepared. Thus, the first step in preparing the business for a sale, namely, executing the business valuation, will be executed on the premise of the Profit & Loss for the previous year in addition to the prior two years of tax returns. Without question, the preferable solution would be to have three years of tax returns.

Here is where the problem arises: the business valuation is based on the definition of the true cash flow of the business, by adding back one-time, unusual expenses, owner’s discretionary expenses, and non-cash expenses. Whereas the tax returns are mostly consistent within this context, the P&L, relative to the tax return, is often not ‘comparable’ (setting aside altogether the issues of accrual vs. cash reporting)

In other words, once the business valuation is completed and the P&L is later ‘transferred’ to the tax CPA and the ‘numbers have been re-worked’  – in the owner’s desire to minimize tax payments – the stated profit is often considerably lower, and thus, they are not supporting the previous valuation anymore.

Outcome? An over-valued, non-sellable business – and a very disappointed owner!

Solution? Until a tax return is completed at the beginning of a year, a seller should always provide two years of Profit & Loss. For example, if the valuation would be executed in the first quarter of 2019, with the tax return 2018 not completed yet, the seller needs to provide the 2018 and the 2017 P&L, in addition to 2017 and 2016 tax return. This will allow the valuation firm to compare the 2017 P&L vs. the 2017 tax return and to determine, somewhat, how the numbers will change from P&L to tax return.

A second part of the solution is to contain ‘seller greediness’.

Naturally, nobody likes to pay taxes, however, ‘driving down the profit’ to a minimum level from a P&L to the tax return, will devalue the business, in essence, making it less attractive to an investor. Quite often, it is considerably more profitable to pay the additional $0.30 to $0.40 of taxes on the additional dollar of income than to forgo three dollars in the business sale process for that extra dollar of profit.

In sum, when valuating a business in preparation for a sale in the early part of a calendar year, a little bit more company documentation is required to establish a truly valid valuation – not doing so will only lead to an unsellable business, long waiting times and a very disappointed business owner!

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About A Neumann & Associates, LLC

A Neumann & Associates, LLC is a professional mergers & acquisitions and business broker firm having assisted business owners and buyers in the business valuation and business transfer process through its affiliations for the past 30 years. With an A+ Better Business Bureau rating, the company has senior trusted professionals with a deep knowledge base in multiple field offices along the East Coast and has performed hundreds of business valuations in its history. The firm’s competitive transaction fees are based on successfully completing transactions.