What Are The 3 Most Common Problems With Sellers’ Financial Records?

As entrepreneurs, we love setting up businesses, making money, and building our empires. But the one thing a lot of us hate with a passion is the paperwork – in particular the financial accounts. I always wait until a month before they are due before doing them.

The inescapable fact is though, when the time comes to sell your business, your accounts need to be as organized as possible. Otherwise a potential buyer may hesitate about buying the business and getting involved with the messy finances. At the very least, the sale will be delayed while you are neck-deep in paper, trying to make sense of it all.

So in my continuing quest to further my education in website brokerage, I turned to the brokers at Quiet Light to milk their fountain of knowledge. I asked them the question “what are the 3 most common problems you see with a seller’s financial records?”.

Here are their responses, very lightly edited for clarity.

Jason Yelowitz – Three Corners You Should Never Cut With Your Finances

When I asked Jason this question, he immediately told me the three ways sellers commonly cut corners, which leads to problems down the road.

“If they keep the books themselves, but don’t have a background in bookkeeping, it can lead to serious challenges during due diligence” said Jason. “I often advise sellers it’s worth it to pay $1,000 – $2,000 to a bookkeeper to get the books in order for the past three years”.

This is sound advice, especially, if the seller does what Jason told me about next.

“If they intermix multiple companies in their financials, it can also lead to challenges” he said, “Buyers will make their own assumptions about the costs of running the business for sale, and buyers’ cost estimates will often be much higher than the actual expenses”.

Sellers might think it is sound business sense to save on their taxes wherever they can, but Jason says even that can cause issues.

“I occasionally see sellers who under-report their revenue in an effort to save on taxes. When I’ve seen this, the business is likely unsellable because buyers simply won’t trust the seller”.

Bryan O’Neil – Incomplete, Unspecific, & Badly Done Accounts

Bryan knew right away what his biggest common headache is when dealing with a seller’s financial records – “incomplete financial statements”.

“A large number of businesses incur expenses that aren’t directly related to the business” clarified Bryan, “such as the owner’s travel expenses, car and insurance payments. While these expenses will not influence the business’s valuation, it’s crucially important not to remove them from the Profit & Loss Statement, as it will always create issues in the due diligence phase”.

Bryan also decided that sellers were not specific enough with their accounts as he told me another thing he commonly sees.

“The lack of proper monthly breakdowns” he said. “Having yearly totals is good and helpful, but for an accurate valuation, your broker will need a full monthly breakdown of the Profit & Loss Statement to be able to determine any trends, month-over-month growth (or decline), and seasonality”.

Then finally there is the pitfall that many probably experience in their quest to save money.

“Many business owners who keep their books themselves, or who use an inexperienced accountant, tend to account for their cost of goods on a cash basis. This means goods purchased show up in the month in which they were purchased, rather than in the month in which they were sold.

“Doing your books in this manner is much easier than the “proper way”, but it can create a lot of issues, as even though the current inventory value can be added back to the P&L, not having an exact overview of what was sold when will make it difficult to determine the business’s true performance, as well as accurate key metrics such as its gross margin”.

One of our other brokers, Joe Valley, chimed in with his opinion on this subject.

“If you have always kept books on a cash basis, no worries” he said. “Keep track of your monthly beginning, ending and inventory purchases, and your broker can accurately flip your cash COG (Cost of Goods Sold) accounting to accrual. The result will likely be a higher (and more accurate) value for your business”.

Joe Valley – Separating The Financials & Highlighting The Revenue Streams

As a solo entrepreneur, I appreciated the need for separate bank accounts from day one, keeping payments totally separate. Yet according to Joe, some clients do not do this.

“When the financials are commingled with other businesses, it makes it challenging for brokers, buyers and potentially SBA lenders to feel 100% confident about the real expenses of the business. In an ideal world the seller has one bank account for the one business and does not mix expenses from any other businesses in it”.

Joe also highlights why you should be very detailed on your Profit & Loss statement as to where all of your revenue is coming from.

“When multiple revenue lines are lumped together, it is not necessarily a problem, more of a lost opportunity. If a seller has revenue from their website, daily deal sites, Amazon, eBay and B2B revenue, why not present it this way in the P&L? Buyers will see each source of income and see some areas that may be growing, presenting areas of opportunity”.

“Presenting it like this will also show the diverse revenue streams, which shows lower risk to buyers. Lower risk means a higher multiple and overall value for your business. Details really do matter”.

What also matters is the presentation of the financials. Scraps of paper and an abacus is going to get you nowhere in the confidence stakes. You need to use professional software. Joe told me a story from his experience that perfectly illustrates this.

“I had a listing in 2015 and the owner was very likeable and honest. The problem? He had no financials. He used a Visa card and a bank account, nothing else. No Quickbooks, no P&L, nothing”.

“The good news it was a separate bank account and Visa, only for the business. He had to build a P&L from scratch going back three years, then we listed the business for sale three times and it fell apart each time because buyers lacked confidence in the financials”.

“After the 3rd time he took my advice, spent $1,500 on a bookkeeper and entered all of the details (from Visa & bank statements) into Quickbooks. The P&L was exactly the same as the one he built from scratch, except exported from Quickbooks.

“We flipped it by reaching out to the backup buyer list. Three of the backup buyers made stronger offers than the previous three LOIs. One was chosen and it closed within two weeks – for $750,000 cash. His $1,500 bookkeeper investment got him a $750,000 return”.

So the moral of that story is you may think you have a unique and quirky accounting system that “works for you”. But when you want a buyer to be confident in handing over a serious amount of money, they will want to see more than a pile of receipts.

Mark Daoust – Not Doing The Necessary Work Can Significantly Lower The Eventual Offer

Mark is the CEO of Quiet Light, and he is also dealing with a client very similar to Joe’s example. Except the stress of getting the records together made her health go sideways.

“She lost her original offer because her books were a mess” said Mark, “the first time, we managed to find a buyer who was very patient through due diligence. After months of trying to recreate the financial records with inventory counts (the stress of which caused my client to become sick), he made a very friendly offer which accounted for the fact that he couldn’t verify financials. I believe the original offer was around $150,000. Based on not being able to verify anything, he lowered his offer to $120,000”.

Mark’s client decided not to sell but eventually she changed her mind and wanted to try selling again. But the books were still a mess and Mark had her do them properly with Bench.co. They made sure she finally had a nice clean bank statement.

But the problem now? She doesn’t want to do an inventory count.

“For her business, she had roughly $210,000 in revenue, but $105,000 in cost of goods sold. However, she thinks that roughly $30,000 of that cost of goods sold is still sitting in inventory” said Mark. “The difference in valuation for her is probably in the neighborhood of $60,000. But she doesn’t want to do an inventory count”.

Mark estimates the business could be sold today in its current state for $140,000. But here’s the kicker – if she got that detailed inventory report done, Mark is convinced the sale price will rocket to as much as $220,000.

Conclusion

So having thoroughly grilled the brokers, here are the main problems boiled down into a nutshell.

• Not getting a bookkeeper and doing the books yourself. Instead, you should invest in training to learn professional accounting software, such as Xero or Quickbooks.
• Inventing an accounting system only you can understand. Or thinking an Excel spreadsheet is all you need.
• Mixing multiple companies into the one bank account, and expecting buyers not to mind the utter confusion that reigns after that.
• Under-reporting on revenue to save on taxes. What else might you be under-reporting?
• Removing non-business expenses from the P&L statement. This is something best left to the broker, as they know what they are doing, and you don’t want to give the impression you are hiding anything.
• Unintentionally mis-recording the Cost of Goods details in the accounts.
• Not specifying where the various revenue streams are coming from.
• And finally, not doing what is required to get the best possible price for your business.

What problems have YOU seen in a seller’s financial records, from the perspective of being the prospective buyer of their business? If you are a seller either now or in the past, are you guilty as charged of any of the above?