To Audit…or not to Audit…That is the Question
By Brian E. Christian, Partner
Not too long ago, I was having lunch with an extremely skilled, experienced and knowledgeable business transaction attorney. We were having a discussion about the recent merger and acquisition (M&A) climate- including topical things like recent deal flow, his backlog and recent trends he has seen regarding “multiples” of earnings before interest, taxes and depreciation (EBITDA) and some of the industries his deals have been in.
Then he said something that shocked me: He said rhetorically…“you know…over my career, I have probably worked on the sell side of hundreds of deals. Do you know how many times, the buyer…at the nth hour of the letter of intent (LOI) stage, while doing their due diligence, suddenly says ‘you know…given what we have seen in the way of the seller’s documentation…We’d like to have our audit firm come in and give us an opinion as to how representative the financial statements are of the financial condition of the company’. I wish someone would counsel a prospective seller to get an audit BEFORE they decide to sell…in my estimation, they could ultimately save a lot of time, some attorneys’ fees and make the transaction a lot smoother, if not prevent the collapse of a deal…if they could simply make a copy of the CPA’s opinion available to the buyer within a data room”.
I had to concur with my friend…in fact, in our book “The Exit Strategy Handbook” we devote an entire chapter (#21 titled “External Financial Statements Checklist”) as part of our Advanced Due Diligence ProcessTM. Selling a business for the highest price with the most advantageous terms is about establishing credibility…and removing the perceived risk to the buyer as to what they are buying. The credibility of the company’s financial results is best gained if an independent third party (a Certified Public Accounting firm) renders an opinion that the financial statements, as presented by management, fairly represent the financial condition of the company.
It is common for selling business owners to opt not to have an audit performed prior to sale, some of the reasons are as follows:
• For cost reasons- which could be in the five figure to six figure range, depending on the size and complexity of the company.
• The time consuming nature of an audit, which could take months, depending on the size, complexity and completeness of the company records.
• The distraction to managers and employees of conducting the audit.
The seller usually rationalizes the consideration of an audit away reasoning that “if I need one, I’ll cross that bridge when I get there”. If a seller waits until the sale process is underway and the buyer insists on an audit to move forward, the buyer may offer to hire and pay for the cost of the audit. I encourage you to read The Exit Strategy Handbook for all of the advantages and disadvantages of the buyer hiring the audit firm and paying for the audit. Below are a few of the disadvantages:
o If not properly prepared for, audits they can add months to the sale process.
o Audit findings (which the seller is not privy to) can provide a host of reasons for the buyer to lower the price- at the very least to re-coup the cost of the audit.
o The buyer’s CPA firm will likely be chosen without input from the seller. A CPA firm auditing the seller is supposed to be independent and one would hope they would not be involved in audit work of the buyer’s company or its subsidiaries.
o The seller will not have adequate time to address or fix errors or irregularities until the document/record requests are made- in fact, the seller may not have time to provide proof that things are actually different than the assumptions made by the audit firm.
As my attorney friend indicated, the need for an audit should not be unforeseen. Having one done annually, at least for the 3 years prior to a sale, can prevent a lot of problems from arising during a sale…and likely prevent the collapse of the transaction.
The above is a small sample of the knowledge, experience and wisdom contained on the pages of “The Exit Strategy Handbook”. If you would like to learn more on this topic or gain incredible insight into the business transition process, please contact me via email at firstname.lastname@example.org for a complimentary copy of “The Exit Strategy Handbook”.