HOUSTON BUSINESS REVIEW

TUTORIAL ON SELLING YOUR BUSINESS "Enhancing Value – Financial Perspective Part V"
By Ralph Fain

Ralph Fain is a principal in the brokerage firm, R/Fain Group. Mr. Fain also has over 20 years of broad business experience with Fortune 500 companies. R/ Fain Group is a professional business brokerage firm which confidentially represents the interests of various sellers and buyers. Each week Mr. Fain will give tips on Business Brokering, and how to sell your business.

In our last article we continued the discussion regarding the need for accurate, reliable and comparable financials and the impact this has on financial presentation and hence, the valuation of your business. That review was from the perspective of comparison to industry norms or standards. We also discussed some basics regarding variance analysis and the resultant “re-casting” of financial statements precipitated by same. As stated previously, the proper “re-casting” of financial statements can better highlight your company’s strengths and ultimately lead to a higher valuation for your company.

Today we will continue that discussion and once again stress the importance of ensuring the proper classification of expenses and the proper recording of accounting/financial transactions. For example, if you are not properly recording the addition/disposition of assets, your actual fixed assets (physical) will not agree to those recorded as per your books and records. This and other misclassifications can lead to material misstatements of the financial results of your company and can cause a lack of credibility in your company’s financial statements – which in turn could lead to a buyer’s lack of confidence in you and your business and to a diminution in the valuation of your business.

Although we all want to legally minimize our tax liabilities, sometimes we inadvertently “shoot ourselves in the proverbial foot” when we become too tax driven. An example would be the aggressive expensing as Repair and Maintenance of expenditures which could be construed to be capital expenditures (i.e., additions to fixed assets). By taking this aggressive stance and expensing these items, you have decreased the profitability of your company and also have decreased the value of its assets as per your books and records. While you have minimized (perhaps) your tax liability, you have also diminished (by some multiple greater than one) the valuation of your business.

Some business owners may minimize taxes by using overly aggressive strategies or by using techniques to disguise their income/earnings but knowledgeable buyers recognize such strategies and will not pay for earnings/income which cannot be clearly documented. As most businesses are valued as a multiple of earnings, investing in taxes not only is the right/legal thing to do but it also makes financial and economic sense to do so.

When accounting recording/classification errors are made and/or when aggressive and complicated tax strategies are enacted, it may become difficult to establish the true profitability of your company. A more prudent approach is to ensure the adoption of clear transparent tax strategies which result in the legal minimization of taxes to you (the business owner) and your company and to ensure proper coding/classification of expenditures. This approach will allow you to prove the profitability of your company through “add-backs” and will enhance the valuation of your business.

We had written earlier about the definitions of cash flow and “add-backs” – gross cash flow as you may recall was defined as Net Income plus “add-backs” and “add-backs” are items/expenses/expenditures that are “added back” to the Net Income figure (on your Income Statement/tax return) in order to gain a true appreciation of the earnings/discretionary cash flow to the owner of the business. This process of “re-casting” the financials is necessary in order to document the true cash flow to the owner of the business and also to maximize the value of the company to the prospective buyer.

“Add-backs” can include the following:

• Non-cash expenditures – i.e., depreciation and amortization expenses
• Interest expense – on debt not to be assumed or incurred by the buyer/new owner
• Owner’s salary/taxes/benefits
• Family members salaries/taxes/benefits – add back only if positions filled by family members are not to be continued/replaced or replaced at lower cost
• Non-recurring/one- time expenses – e.g., moving expenses, remodeling expense, etc.
• Rent adjustments – only if rent is to change with the buyer/new owner
• Other owner benefits/add-backs – e.g., owner’s vehicles and insurance, owner’s travel and entertainment, other owner’s perks, etc – portion, if any, not used !00% for business
• Capital expenditures expensed as repair and maintenance or classified as some other expense
• Other - any current expenses which are not to be incurred in the future under new ownership
As the evidence of your documentation increases, the initial doubt and skepticism of the buyer will turn to confidence. This confidence, once instilled, will develop into enthusiasm (if you follow our suggestions included in our other articles) which, in turn, will translate into a higher price for your company.

See you in this same space for the next article which will continue the discussion regarding improving the financial presentation of your company and will detail a comprehensive example of the “re-casting” of financial statements and its effects on the valuation of a company. As always, should you have any questions or require additional information please feel free to contact the R/ Fain Group at 832-646-0832 or via our web site.