Your financials indicate the health of your business, and as such, play a big part in determining your valuation. If your company performs well, and your financials are easy to understand, you may command a higher asking price. Messy, confusing numbers may do the opposite.
While financials reveal past performance, they also feed into various startup valuation methodologies, such as the multiple methodology. A buyer might apply a multiple related to growth or return on investment, so the quality of your financials can indicate whether your asking price is fair (and worthy of an offer).
If you want to sell your business fast, you must convince buyers your business is a good investment. That means keeping a squeaky clean profit and loss (P&L) statement that allows you to share everything from your EBITDA to your growth rate. Buyers want to predict their return and how long it’ll take to earn it.
Your financials, therefore, tell a story about your business, and buyers will use them to benchmark your business against others.
In other words, your financials set the tone for everything that follows in your acquisition – including due diligence and negotiation. Fail here, and you wave a red flag. Even innocent mistakes are frowned upon. If you want to sell your business fast, learn how to prepare your financials (and financial metrics) to encourage the best offers.
What Financials Do Buyers Want to See?
Buyers want to see clean financials that credibly tell your company story to derisk their investment. Not only do they want to ensure they earn a return, but if they’re borrowing money to Acquire your business, they also need to ensure it generates enough profits to service that debt.
When you list your company for sale on Acquire, it’s a good idea to connect your financial metrics (along with your web traffic and customer metrics) to give buyers real-time, verifiable data. Collecting and presenting the data in a buyer-friendly way manually is time-consuming, and spreadsheets are renowned for containing errors1.
Buyers will want to see your P&L statement first, including your revenue, costs, and expenses. Ideally, you’ll have the past five years’ financials, but at least the last three. If your startup is new, you might only have one or two years, but share it anyway. Your P&L establishes the financial health of your business.
You’ll also need to share your balance sheet (your assets, liabilities, and shareholder equity) and cash flow statement (to show the net flow of cash in and out of your business).
Your P&L is usually split month-by-month. Historic performance helps buyers forecast future performance, so your monthly numbers tell a story from inception to present and how things might go in the future.
Your story might indicate things like seasonality or an investment that didn’t pay off (such as a poorly executed marketing campaign or misfiring product).
When you sell your business, you sell your company’s future as extrapolated from its past. The multiple contains that element of forecasting, so if you want the buyer to believe the story you tell (and your multiple), your numbers must substantiate your claims.
Let’s say your startup has been growing 10 percent yearly but you’re trying to convince the buyer it’ll grow 50 percent next year. How could this story suddenly unfold? Maybe you’re about to launch a new product, win a large customer, or enter a new market. To avoid the buyer balking at your numbers, prove they’re realistic.
Beyond the P&L
Buyers will also want to see financial metrics specific to the type of business you own. For example, if you run a SaaS business, buyers will want to see metrics like churn, recurring revenue, customer acquisition cost, lifetime value of customer, and lots more.
Combined with your P&L, these metrics can strengthen or weaken your case for a specific multiple. For example, you might try to justify a higher multiple on customer growth, but if your churn rate is also increasing, your potential buyer might have to spend more in customer acquisition to maintain or grow revenue, and they’ll argue for a lower multiple.
Your financials and financial metrics only tell half the story, however. The other half is your pro forma, a document that forecasts your performance by extrapolating from history.
Buyers create their version of a pro forma in the financial models they run on your numbers. They’ll project best and worst-case scenarios, tweaking the variables to establish a range of asking prices they’re comfortable paying.
Their models will also determine how they want to structure the deal. They might request components such as a seller’s note, earnout, holdback, or other terms. They might decide they need to get their people in, retrain your employees, or ask you to stay for six months or more to help with the transition. Their offer will take all of this into account.
Your numbers are just as important to you as they are to the buyer. By referring to your financials, you can project whether your business is on track to meet milestones in an earnout, for example, or whether the business can afford to repay a seller’s note post-acquisition.
Cleaning Up Your Financials Before Acquisition
Preparing your financials before acquisition can reveal things about your numbers you might’ve taken for granted. You might find, for example, that you have to adjust the figures because of misreporting or underreporting.
Paying a friend cash in hand (or them doing work for free) isn’t a realistic projection of future labor costs, for example. Neither are occasional vacations dressed up as business trips realistic expenses. If you’ve been running a car and eating out on the company dollar, you’ll need to adjust those expenses to clean up your financials.
What do I mean by “clean”? It can mean different things to different people. Your P&L can “look” clean if you’ve consolidated a bunch of loans into one line item, for example. Or if you’ve repaid all your debts so there’s nothing outstanding. But what’s important, and what you should take to mean “clean” here, is that your financials are accurate, representative, and truthful.
Most buyers expect you to be able to explain every item on your P&L but probably won’t ask you to. Just remember that confusion breeds suspicion, and if you’re in doubt about a line item, expect your buyer to be too.
Truth is, you can go hyper-granular with financial data, but it’s seldom what buyers do, especially on the smaller end. They just want to see evidence for the story you tell. If January is always a slow month, explain why. If revenue fell three months in a row, what caused it?
Seasonality, changes in Google algorithms, critical employees leaving, and so on can all influence your financials. Buyers will want to see that you’ve pinpointed the cause of these issues and remedied them in some way or it might influence the terms they attach to their offer.
Missing data, however, is where things get difficult. There should be no missing data. Track business financials with software from a reputable vendor or with the help of a professional accountant – or you might never sell your business.
Filling Gaps in the Story
When your financials don’t tell the whole story of the value in your business, use the data room to support them. Even a pre-revenue business can find a ton of evidence to support its valuation, such as:
- Market surveys demonstrating demand for your product
- Purchase orders
- Evidence of a strong sales pipeline
- A sales and marketing team that’s proven to win business and close deals
- Proven technology
You might also fill gaps in your valuation story by learning about the buyer’s side. Maybe acquiring your company will increase the buyer’s sales – even if it’s just a result of acquiring better salespeople. Maybe the lifetime value of a customer will increase, and if the Acquirer is a public company, it’ll bump its share price.
Ask the buyer why they’re considering an acquisition. What’s their goal? Will they shelve the product after they Acquire it? Are they only interested in your engineers? The story isn’t your appraisal alone but also understanding and telling the story of how it fits into the buyer’s goals.
Similarly, if you’ve grown consistently for the past three to five years but expect growth to accelerate after acquisition, add those key growth drivers to the pro forma. This could be new markets, partnerships, sales channels, or anything else you planned to do to boost growth. Buyers might not take them into account, but include them anyway as they’re legitimate growth levers, and instructions, for growing your business post-acquisition.
Your valuation drivers might simply be the inverse of what you’re doing wrong. For example, maybe you’re great at Google ads but terrible at SEO. If your potential buyer is an SEO specialist, their SEO expertise could become the key growth driver that pushes the needle on growth and hence a higher valuation.
Understand It’s a Negotiation
In acquisitions, it’s your word against the buyer’s. Even with a robust set of financial metrics supporting your story, the buyer also has their story to tell. You’ll need to meet in a place where everyone agrees.
Usually, a buyer will incur additional costs as they transition, whether that’s hiring new people, managing customer relationships, or some other task or expense. They might be an SEO expert, but if they want a turnkey business, they won’t want to spend all their time writing blog posts and would need to hire writers to achieve their expected return on investment.
Buyers might not tell you what valuation drivers they’ve attributed to your business. They’re usually comparing your business with others of the same size, industry, and so on. You’re not party to those comparisons, so what’s gravy to you might be mustard to them.
Also, expect buyers to adjust your numbers to account for any additional expenses they believe they need to make a return on investment. They might apply a multiple to a lower EBITDA in their valuation, which in real terms is a lower multiple in the offer, just to account for what they need to do to catalyze growth, profits, or something else.
Everything in your acquisition is negotiable. Even terms in your financials to some extent. While buyers shouldn’t have to question the validity of past performance, your valuation should reflect a version of the future in which both of you have found common ground.
Source
1https://www.wired.co.uk/article/spreadsheet-excel-errors
The content on this site is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional before entering into any M&A transaction. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any M&A professional.
