You Can’t Have it Both Ways
Many business owners I meet point out that they either have expenses that shouldn’t be counted as part of operating the business (owner’s perks) or have a cash component that may be understated, or both. One would expect a small privately held business to do it’s best to minimize reportable earnings and maximize the dollars they keep after taxes. But when it comes time to value the company, these owners (now sellers) want the prospective buyer to recognize these phantom earnings when valuing the business.
You can’t have it both ways. I do work with clients to help them recast their financial statements in a favorable light. We add back into earnings non cash entries such as depreciation and amortization as well as interest payments. We also review each expense item and add back in one time charges that don’t reflect a true ongoing expense. Finally, we add back in any expenses that may be considered an owner’s perk and not necessarily critical to operating the business. Only those items that can be fully documented should be added back into earnings as part of the recasting process. A buyer is only going to accept a recasting of earnings if the seller can prove that each perk actually was expensed to the business and the business really can operate without it.
Don’t expect a buyer to recognize any seller claim of a cash component to earnings. More importantly, a bank will never recognize a claimed cash component when considering the businesses’ debt service capability from historical cash flow. A bank is also unlikely to recognize recast perks when developing cash flow models for a potential acquisition loan. Thus to maximize price, the owner turned seller, has a few options: (1) maximize reportable earnings for three years prior to offering their business for sale, (2) fully document any perks for at least three years prior to selling the business, (3) and in lieu of (1) be prepared to offer significant seller financing so a buyer has an alternative to bank financing.
It is important for owners to meet with a qualified business consultant and intermediary to help plan an exit strategy that maximizes both their current earnings and the potential earnings from the future sale of the business. I recommend to my clients that we meet at least three years prior to a planned sale and then bi-annually to review the status of the business and operation to make sure that the owner and business are staying on track.
Leave a Reply 
Brad Elliott is Principal/Broker at VR Business Brokers in Ewing, NJ. Brad himself has owned, operated, and sold a multitude of small to mid-sized businesses over the last 15 years. Brad received his MBA from MIT’s Sloan School of Management and comes from a family of entrepreneurs.
