Selling a business may be a natural progression for your company as discussed in Parts I and II of this series by Senior Tax Manager, Naila Sharifova. As Naila explained, there are tax considerations for your company and shareholders which impact the amount of income generated by the sale. But whether you are selling a startup with intellectual property or you are selling your company as part of your retirement plans, the acquirer will want to review your company’s financial statements to determine what they are willing to pay for your company.
Shareholders and management often focus on issues other than financial reporting as they prepare for selling their company. Addressing the financial reporting will minimize a possible holdback required by the acquirer as well as anticipate many of the due diligence requests.
Being proactive regarding the following issues will assist you as you move toward selling your business:
1. Don’t wait until you receive an offer to get the company’s financial statements in order. Deals move quickly. If audited financial statements have not been prepared, acquirers may require an audit to be performed in a very tight timeframe. Accounting staff already consumed with due diligence requests will be required to prepare additional schedules and support for the audit.
2. Prepare internal financial reporting using the most desirable basis of accounting. Most US companies anticipating a liquation event should prepare the financial reporting using US generally accepted accounting principles (GAAP). Using this basis of accounting will allow prospective acquirers to assess the financial results of the company with an understanding of the accounting policies the company is using. Acquirers or investors are not typically familiar with special purpose frameworks for reporting other than US GAAP, so I would not recommend using the income tax or modified cash basis. Some acquirers may request financial statements prepared using International Financial Reporting Standards (IFRS), and in most cases, adjusting from US GAAP to IFRS is not a deal breaker.
3. Financial reporting under US GAAP can be significantly impacted by the accounting estimates made by management. By their very nature, estimates are subject to change. Acquirers may anticipate some changes but may also require a holdback to the purchase price until the estimates have been settled. Examples of financial reporting estimates that can lead to holdback are:
a. Uncollectible A/R
b. Inventory reserves and obsolescence
c. Impairment of intangible assets or long-lived assets
d. Reserves for warranties or sales returns
e. Income or sales tax contingencies
Management should use historical data to minimize the acquirer’s concerns regarding these accounting estimates.
4. Use outside specialists as necessary to support the financial reporting. Business valuation experts assist with proper valuing of stock options and other equity compensation instruments. Complicated revenue recognition approaches can be reviewed by revenue recognition experts to validate the company’s revenue recognition policy. Additional assurance by outside experts can only help to reduce acquirer’s concerns about the financial status of the company.