Price adjustment quandry - Cash v. Accrual Accounting
August 20, 2020
by a searcher from Brigham Young University in Kahului, HI, USA
Aloha All,
I have a business purchase in process, with LOI agreement and executed. (Teaser to come soon. Let me know if you have interest...)
I based my purchase price on financial info given as part of the investment memorandum. Once the LOI was signed and I was given full financials, tax returns, banks statements, etc. I found out that they use an accrual basis for their financial reporting, but a cash basis for their tax returns. In the long run, this wouldn't be a large issue. In the short run, it means tax return reported revenue is less than cash collected revenue in a given period. To multiply the issue, they are growing regularly so expenses incurred on the front end of the cash cycle impact the profitability even more on a short term cash basis.
I am a self funded searcher. I will be using the SBA to leverage a large percentage of the purchase in order to retain equity personally. While the issue above doesn't automatically effect the business value, it directly changes how the SBA perceives the income and then subsequently the amount they will loan. The temptation would be to try to re-trade the purchase price based on the way this changes the capital structure. (Equity injection required increases by###-###-#### %) At the same time, the value and potential upside of the business has not changed. .
Would you revisit the purchase price at the risk of messing up an acceptable deal?
from Tufts University in Los Angeles, CA, USA
If they have a broker/banker then I would go to your SBA lender and have them play the "bad guy" and present the issue to the broker/banker and let them figure out how to manage their client. That way you remove yourself from any negative goodwill from the price adjustment, and force the seller's agent to negotiate for you in order to keep the deal (and their commission) alive.
If you're working directly with the seller then I'd be more hesitant to try to reopen the price. Hopefully you got in at a good price on the front end since presumably it was a less competitive process. If you truly cannot get the deal done at the price discussed because it doesn't hit certain SBA guidelines then you have no choice, but I would expect most sellers to have a pretty negative reaction to this situation, even if you're being totally honest and transparent.
I'd love to see a teaser when you have one.
from University of Virginia in Richmond, VA, USA
1) If the accounting method changes the income recognized that much then your multiple sounds like it was high to start.
2) You could keep the purchase price the same but change the working capital. I made my seller leave a certain amount of cash in the business and made sure that the difference of receivables and payables was five times that. This basically adjusts the purchase price without adjusting the purchase price and it's justified because you didn't know about the difference in revenue recognition.
3) If you do adjust the price you may want to consider a stock purchase instead of a asset purchase. This will let you borrow less if you reduce the price and it can allow the seller to walk away with the same cash at sale after tax. The broker won't like this though.