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Selling your business:

3 accounting pitfalls to avoid


Selling your business revolves around finances in a multitude of big and little ways. And then there are the big ways that only seem little. Accounting is the best example, where the tiniest details frame the financial information that every buyer depends on. They use your financial information to assess your company—and later to integrate your financial statements into their own books.

Accounting pitfalls begin well before the sale and may continue for years afterward. Many founders who sell their company maintain ties with the acquiring company. Often they stay on as an executive in the short-term and even maintain a financial stake in the company's performance.

Whether or not you sign an employment contract with the acquirer, your accounting issues are their accounting issues. Their accounting issues become your accounting issues. If you don't tackle them in advance, you may see your sale delayed and, in the worst cases, cancelled. By identifying and communicating your accounting information to the buyer, you increase your chances of easing the exit process and maximizing your sale proceeds.

The accounting pitfalls of selling a business fall into three categories. Let's review them.

Ladder in the clouds

If you sell your business to a public company, it needs to comply with securities regulation—both immediately after the sale and indefinitely.

Soon after the sale to a Canadian public company, the buyer must report a significant acquisition as a part of its regulatory disclosure requirements. The buyer must provide audited annual financial statements and the most recent quarterly financial statements from your company, in a business acquisition report. Similar requirements apply in other jurisdictions, including the U.S. If you as a seller consider these reporting requirements ahead of the sale, your potential public company buyers won't need to incur significant cost to meet their filing requirements.

The regulatory requirements don't end there for the buyer. As a public company, it needs to file quarterly financial information. While the public company will have followed that process before buying your company, you may have only reported annually.

You should therefore consider how the buyer's quarterly and annual reporting schedule impacts your company's accounting processes and timing. Because acquisitions happen during a quarter, the acquired company will have less than three months to update its processes to integrate into the buyer's books. By addressing these issues prior to a sale, this will make the post-acquisition financial reporting issues less painful for both the buyer and seller.

Founders seeking an exit must consider their accounting standards—and those of potential buyers—well before the sale.

The accounting standards you choose can impact your valuation and, therefore, the sale price. Many private companies in Canada use Accounting Standards for Private Enterprises (ASPE). On the other hand, many foreign and larger domestic companies use International Financial Reporting Standards (IFRS), and U.S. companies typically report using U.S. generally accepted accounting principles (GAAP).

Tech companies see this valuation issue most often. Valuations are typically based on multiples of revenue. ASPE recognizes revenue one way; IFRS and U.S. GAAP recognize it another way. The difference can create significant differences in the “x” portion of the multiples formula. Tech companies looking to sell should consider using IFRS or U.S. GAAP, as potential buyers typically want to base their valuations on those standards.

It's not only tech companies that experience accounting standard differences, and the impact goes beyond valuations. For example, compare the treatment of leases under ASPE, on the one hand, and IFRS and U.S. GAAP, on the other. Most companies using ASPE don't record leases on their balance sheet; most using IFRS or U.S. GAAP do record leases—as liabilities. As a result, a buyer may purchase your business unaware of the additional liabilities it will add to its balance sheet. This could impact its working capital or relationships with lenders.

For a technical comparison of how leases and revenue are recognized under ASPE and IFRS, see our ASPE-IFRS comparison series.

An earnout provides that the seller ‘earns' part of the sale price after the sale—typically if the business meets revenue or income targets. They typically create a win-win by closing the gap in valuation between the buyer and the seller. But they are conditional and as a result may create confusion if the seller and buyer don't agree beforehand how to calculate the revenue target. Sometimes earnout misunderstandings lead to lawsuits.

The challenges with earnouts often come down to the accounting standards you choose. Revenue under ASPE may look very different from revenue using IFRS or U.S. GAAP. One party may think the earnout target has been reached based on their accounting standard, while the other uses another accounting standard and believes it was not achieved.

Earnouts generate enough conflict that buyer and seller should sometimes maintain a so-called two sets of books—which sounds more sinister than it is. The two sets of records reflect two different accounting standards. In reality, most earnouts are calculated using the standard applied before the sale. If the buyer uses a different standard, it needs to calculate revenue using both standards. The buyer's accounting systems play a key role in juggling the two calculations.

Buyers and sellers often try to avoid earnout disagreements by specifying the relevant accounting standard in their share purchase agreement (SPA). However, the SPA doesn't always help. Even if both parties know which standard to use, they may not fully understand its impact. In addition, the SPA doesn't specify other accounting details beyond the accounting standards.

A final word on accounting systems

If acquiring companies rely on receiving the right information from a seller, the seller relies in turn on their internal systems.

Many companies would like to share this financial and operational information with their buyer—only to struggle locating it in inadequate accounting systems. These sellers therefore need to allocate time and resources reconciling records outside their system. From collections history to accounts receivable to inventory turnover, this information could be easily findable in a more robust accounting system.

Systems and processes don't by themselves improve the exit process. But they do support the larger communication needs of founders to find a buyer, maximize their sale price, and make the sale process as smooth as possible.

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