Conducting proper due diligence is an important aspect of mergers and acquisitions (M&A) deals, and performing an audit can greatly improve the standing of both the buyer and seller. Generally, these services increase the reliability of financial information which gives a potential buyer confidence in what they’re acquiring. Furthermore, an audit enhances the value of a business because the buyer is more aware of a seller’s financial standing.
Let’s talk through, more specifically, why an audit is so crucial on both the buyer’s and seller’s side of things.
The importance to the buyer:
The greatest benefit of requiring an audit, and/or the various services associated with audits, is so the buyer can have more trust and overall confidence in the financial well-being of the company they are hoping to acquire. When uncertainties or unknowns exist, the cost of capital will rise because of the potential that the buyer has incomplete financial information.
Audits can help a buyer price a transaction more efficiently in relation to the seller’s economic value. They could also reveal that the company is not as valuable as the buyer originally estimated. For instance, the buyer may find out that the value of the business is less because of various liabilities that are discovered. This would ultimately bring the valuation of the company down, and the buyer’s offer down, as well.
An audit can result in a qualified opinion that reveals issues with accounting policies and/or inconsistencies in the quality of earnings. It can also identify deficiencies in internal controls through a management letter. For example, an audit may show poor collection processes for receivables. These types of red flags can be seen as a signal to the buyer that a business may not be run well.
The importance to the seller:
For the seller, it’s important to not only have an audit performed pre-sale but to engage a CPA firm continuously for annual audits. Many buyers expect to see at least three years of audited financial statements. These annual audits enable the seller to tell its potential buyers that it can be trusted as a business entity and is financially well controlled. It also allows the seller time to refine and optimize its financial reporting processes and internal controls.
On the flip side, if a business is not regularly audited, a potential buyer is more likely to lower their asking price because they now need to engage in more due diligence. If buyers see a solid set of numbers and have confidence in the team in place because of these numbers, they’ll likely place a higher premium on the business due to the assurance they are granted.
The importance of time:
Audits aren’t only important from a valuation and/or spending perspective, but from a time-savings perspective, as well. Why? Because the audit provides a level of legitimacy in the business, it expedites the transaction process.
Think about it: starting from scratch will almost always be more time-consuming than reviewing the financials of a business that has gone through annual audits. Many transactions fail because the timing drags out to the point where the exercise is no longer attractive or has been superseded by external events.
Quite simply, audits provide stakeholders with comfort and confidence in their business transfer dealings. You’ll be glad you took the time to engage in audits when it means your M&A deal is a more timely, efficient and cost-effective one.
Founded in 1962, Weinstein Spira is a highly respected firm of experienced tax, audit, business management and estate planning advisors who proactively serve discerning, privately-held businesses and leaders in the Houston area and beyond. More information about the firm can be found on our website.