Articles Posted in Business Transactions

Even in the reality-distorted vortex of Silicon Valley, a company’s financial statements are a critical tool in any merger or acquisition. If you are a venture-backed company, or have substantial bank loans requiring annual audits, your company’s financial statements may already be in relatively good shape. If you are an owner-operator, or have otherwise been relying on a tax-oriented approach to your financials, you’ll need to convert your financial statements to the standards commonly used by accountants.

Generally accepted accounting principles, or GAAP, is the method used by the accounting profession to create financial statements. If you are trying to sell your company, you will need to have GAAP financial statements to be able to attract the best buyers, and to be sure you are getting the best value. Because GAAP is so widely used and, in many cases, mandatory, failing to provide a buyer with GAAP financials will increase the perceived risk with respect to buying your company, thereby lowering the price.

An acquirer will likely require that you submit GAAP financials. As part of your agreement with the acquirer, you will represent that your company’s financials are compliant with GAAP. If you are wrong and the buyer is damaged as a result, the agreement will provide that you will have to compensate the buyer, usually through a reduction of the purchase price.

Because converting to GAAP financials is not an easy process, you need to get started as early as possible. In some businesses, such as those technology start-up companies, the conversion to GAAP could take years rather than months. Complications may arise, particularly in the revenue recognition area, and prior year financials may need to be restated. This could be disastrous if, in the middle of negotiations, adherence to GAAP eliminates the year-over-year profit increases you hoped to show.

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Your company, like many companies in Silicon Valley, may suddenly find itself faced with a market window to sell and provide a liquid return for its owners. If you are an entrepreneur or other business owner, you are always on the lookout to reap the value of your business. Before you start planning the next phase of your life, however, you need to plan carefully how you will sell your company.

A company sale is typically a multi-year process, and the sooner you begin the better off you will be when a deal finally arrives. Although exceptions exist, particularly in the roulette world of high technology start-ups, a good rule of thumb is that it will take you between two to four years to sell an operating company. You should plan to begin the process no later than three years before you plan to close. Preferably you should start when you form the company.

Why so early? If you are an owner-operator, you will need to change your focus from maximizing the amount of cash and other compensation you generate from your company, to improving business valuation. A simple mathematical example drives home the point. Many companies are sold on a multiple based on earnings before interest, taxes, depreciation, and amortization (often referred to as “EBITDA”). If your business can be sold for five times EBITDA, that extra dollar in compensation will cost you five dollars in sale price.