Financial Diligence Tips/Tricks on SMB

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by a searcher from Villanova University
in Miami, FL, USA

2yrs ago

Financial Diligence Tips/Tricks on SMB

How do you guys handle financial diligence on a small business that barely has books (perhaps no quickbooks, or completely disorganized). Any tricks or ideas on how to handle and/or reduce risk? I spoke to a searcher that had a very clever idea...he is having a third-party accounting firm do a 2-year re-do on the books, and if they close, buyer pays..if they don't, seller pays. I think it's a good idea because if the seller really has nothing to hide, then they should be willing to engage in this. Any other ideas or tips welcome.

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reply by an intermediary 2yrs ago
from Clemson University in Raleigh, NC, USA

Poor books and records are 100% the responsibility of the seller. I would price out all risk and make an offer with a back-up offer at X times QoE adjusted EBITDA that THEY pay for. Sounds to me like this "seller" shouldn't even be on the market.

reply by a professional 2yrs ago
from West Chester University of Pennsylvania in Cochranville, PA 19330, USA

Engage a Third-Party Accounting Firm: As mentioned, having a third-party accounting firm redo the books for the past two years is an excellent strategy. This not only ensures accuracy but also demonstrates the seller's transparency. Structuring the payment based on whether the deal closes (buyer pays) or not (seller pays) can incentivize honesty and thoroughness.

Conduct a Forensic Audit: If there are significant concerns about the accuracy of the financial records, consider a forensic audit. This involves a detailed examination of financial records to uncover any discrepancies, fraud, or hidden liabilities. Cash Flow Analysis: Focus on analyzing the cash flow statements. Even if the books are disorganized, understanding the cash inflows and outflows can provide a clearer picture of the business’s financial health.
Review Bank Statements: Obtain and review bank statements for the last few years. Bank statements can provide a reliable source of information regarding the business’s revenue and expenses, even if the internal books are messy. Assess Tax Returns: Request and review the business’s tax returns. Tax returns are typically prepared by professionals and are less likely to be manipulated. They can offer valuable insights into the business’s financial performance.
Owner Interviews: Conduct in-depth interviews with the current owner(s). Ask detailed questions about the financial operations, major expenses, revenue streams, and any anomalies. The owner’s responses can provide context to the available financial data.
Customer and Supplier References: Speak with key customers and suppliers to verify the business’s revenue and expense claims. This can provide third-party confirmation of the financial information provided by the seller.
Operational Diligence: Conduct a thorough review of the business’s operations. Visit the business premises, observe the operations, and evaluate the efficiency and productivity of the processes. Operational insights can often corroborate financial data.
Utilize Financial Ratios: Even with limited data, you can use financial ratios to assess the business’s performance. Ratios like gross margin, net margin, return on assets, and inventory turnover can provide valuable insights into the business’s financial health. Structured Seller Financing: Negotiate for a portion of the purchase price to be structured as seller financing. This means the seller receives part of the payment over time based on the business’s future performance, aligning their interests with the buyer’s and reducing the buyer’s risk.
Contingency Clauses in Purchase Agreement: Include contingency clauses in the purchase agreement that protect the buyer if significant financial discrepancies are discovered post-transaction. This can include price adjustments or even termination rights.
Utilize Professional Advisors: Engage experienced professionals such as business brokers, valuation experts, and legal advisors who specialize in SMB transactions. Their expertise can help navigate the complexities of due diligence.