Part 1- Sell-Side Quality of Earnings
What is a sell-side quality of earnings?
Let’s face it, there are many seasoned buyers out there who are very sophisticated negotiators and are ready to take advantage of an unprepared seller. Therefore, like any negotiated transaction, the better prepared a seller is, the more likely they will be able to maximize the sales price. No matter the transaction size, there are basic steps needed to prepare for the sale, which, although primarily intuitive, are often not followed. These steps include developing a clear and concise articulation of the company’s value targeted to attract the right buyers. Many sellers seem to drift into a transaction for several reasons, but once “in play,” things tend to go wrong.
A seller preparing for a transaction should do their diligence, which, like staging a home for sale, means spending a little time and money staging the deal. While there are many facets to the diligence required to get the deal staged, one of the most valuable has become what is known as the sell-side quality of earnings (QoE). The sell-side QoE is designed to protect the seller’s interests by identifying areas of risk that a buyer may unearth during their financial diligence, thus enabling the seller to be prepared with clear, concise answers. The result is that the seller maintains control of the negotiations rather than allowing the buyer to negotiate from strength.
Can the sell-side QoE provide actionable intelligence?
The sell-side QoE is a snapshot of your company and focuses on providing a high-resolution financial overview covering the structure of the company, quality of the company earnings, balance sheet considerations, net working capital and related deal considerations. Deal considerations could include items such as the impact of integration costs, synergies and indebtedness. However, in most cases the primary focus is the quality and consistency of the EBITDA generated by the company. By quality, we mean free of any unusual or non-recurring transactions which either positively or negatively impact EBITDA and are not expected to recur once the business is sold. This is important because a multiple of EBITDA is often used to determine the base purchase price. Experienced buyers generally see EBITDA as a more accurate indicator of business value than net income because it measures the ability of a company to generate free cash flow.
A well-prepared sell-side QoE will provide insight to the seller regarding how a buyer will analyze earnings, assets and liabilities. Taking the first step with a sell-side QoE helps you position the company through the sale process. You do not want to leave the analysis of your business to the buyer’s discretion.
How does seller use the sell-side QoE report?
Having a well-prepared sell-side QoE can convince a buyer to pay a premium for your company, particularly private equity firms and strategic competitors. The sell-side QoE adds credibility to the seller as it not only indicates that you are a serious seller who has invested in an objective third-party assessment, but allows the buyer to leverage the report to determine if the company meets their core objectives. This saves buyers time and effort by establishing a basis for evaluating whether the risk of acquisition is acceptable and manageable.
There are other advantages generated by the production of the sell-side QoE, as a good advisor will not only ensure that basic accounting principles are being applied to record transactions but also help analyze the company by identifying key performance indicators that provide insights that could improve profitability and cash flow. During the preparation of the report, your advisor will also ask questions that prepare you as the seller to discuss your business strategy and its strengths and weaknesses. Whether a deal is ever reached, the exercise undertaken to prepare a sell-side QoE can benefit the seller by identifying positive or negative recommendations to improve the business and its related profitability.
What to expect once you make the decision?
Starting a sell-side QoE sets a comprehensive process in motion:
Information Gathering:
- Company onsite visit to:
o Interview senior management
o Interview the accounting team, IT team and the operations team
o Tour facility
o Meet other professionals – Tax, Audit - Open a data room
- Request documentation
Compile Databook
- Compile information in Excel® Databook structure – includes an income statement and balance sheet
- Identify potential adjustments
- Detailed review of results with management and accounting team
- Make all necessary adjustments/reclassification
- Summarize results to clearly show impact on EBITDA and NWC
Draft Report to include
- Executive summary
- Analyses of key findings
- Appendix
As noted, this is more than a deep dive into the numbers – it is a systematic effort to understand the seller’s reason for selling and what would potentially make the sale successful. Is it just the best price, or does it include the best price plus a continuing involvement? Once this is understood, the sell-side QoE becomes a comprehensive study that allows the reader to assess the sustainability and accuracy of earnings and the working capital requirements. Other areas that could be included as part of the assessment include income, sales, and franchise taxes, information technology infrastructure, personnel organization structure and human resource policies and procedures.
How to choose your advisors?
Sell-side QoE preparation requires advisors who know your industry, potential buyers’ concerns and how to present value. These advisors should have extensive experience with both buy-side and sell-side reporting. Their recommendations should help sellers position their business to mitigate risk and command a premium price while assisting the seller to maximize the capture of all available tax benefits.
Whether you built it from scratch or bought it as an investment, selling a business can be a complex, lengthy process. Once the process is complete, you will want to know that you have maximized your return. This means avoiding the regrets and recriminations that follow missed opportunities.
If you plan to sell your company, Windham Brannon can help. We have provided advisory services to clients in a wide range of industries, and our experience and insights make us well-equipped to advocate for your best interests for the most favorable outcome possible.
To discuss the way forward, contact Laura Berry at Windham Brannon.
