October 23, 2018
Quality of Earnings Due Diligence Before You Sell Your Business
When preparing to sell your house, everyone knows you need to make repairs, declutter, and make it simple for the new owner to imagine themselves in your home. That preparatory work will help you get your best price for the home. It is the same with the sale of your business. Here are those simple (and not so simple) steps to getting the most value for your business, including performing preemptive quality of earnings due diligence.
First, do the things that have been on your to-do list but simply have not gotten done. For example, sell that unused equipment, shut down that unprofitable division, fire that unprofitable customer. These are difficult but undisputed “low hanging fruit” activities.
Second, consider where the true value of your business lies. If it lies with key employees, promote them, reward them, and do what is necessary to keep them in place during the coming upheaval impacting business during the sale.
The Importance of Quality of Earnings Due Diligence
The third and most important step is investing in preemptive quality of earnings due diligence. Most transactions are priced on a multiple of normalized EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Normalized EBITDA is actual historic EBITDA, adjusted for things that better reflect the go forward business, hopefully in a positive direction. As a seller, you are in the best position to identify those addbacks which improve the purchase price. This is where Inglewood can come in, performing that preemptive quality of earnings due diligence, assisting you in identifying and quantifying gems of value.
Following are selected examples of addbacks we have quantified for sellers:
- Addbacks based on strategic decisions made in the last 2-3 years, such as shutting down unprofitable divisions, upgrading equipment to improve efficiencies, or the expansion/contraction of lines of business.
- Impact of new startup offices/branches using historic profitability patterns you experienced in past startup offices and identify the likely profit improvement to come from newer operations.
- Profitability impact from sales trends, new customers, lost customers, and their respective margins. For example, in automotive cases, we evaluate price downs (reductions in pricing baked into the contract) and normal efficiency improvement by part and by model to evaluate the vehicle model sales trends and model turnover.
- Impact of one-time events that increased expenses in the past but are not likely to happen again, such as an unusual lawsuit settlement, change in tax or licensing (such as new tax incentives that were not in place before), and one-time bonus programs.
- Determining expenses that will go away with the new owner, including payments to the owner/family/friends that are outside normal compensation for the market or industry.
- Calculating the effect of changes in accounting methodology, such as a historic change in revenue recognition, inventory valuation methodology, reserves for bad debts, or obsolete inventory.
- Addbacks from calculated reserves, accruals, deferrals, and prepaids, including the impact of changes to rebate programs and related volumes.
- Determining the market pricing impact on inventory, including changes in metal markets during periods of volatility.
- Evaluate external impacts such as market supply/demand factors, tariffs, or labor shortages that are outside the control of the business, and propose proven strategies to mitigate those concerns, if possible, for the buyer.
If you are considering selling your business, give Inglewood a call. We can help identify those gems of value for your pre-sale actions and due diligence presentation to buyers. It will mean dollars in your pockets that far exceed the cost of consulting services.