In part one and two of this article series, I explained the changes you should expect upon closing a deal with a private equity firm, including changes associated in an asset versus a stock sale, forming a C Corporation from an S Corporation, banking relationships, contracts, and the addition of a board of directors. Part three of this series provides additional insight into what to expect after closing a private equity deal.
Changes in Financial Reporting
All of our companies produce monthly financial statements, including an income statement, a balance sheet, a statement of cash flows with the comparison to the performance of the prior year's month, and performance compared to the budget. Many of the companies that we acquire are producing financial statements on a regular, if not monthly, basis, either internally or using a third party accounting firm; so, typically, this is not a significant change. The one change that may take a little bit of effort is that all of our companies are audited and they produce their financial statements according to generally accepted accounting principles (GAAP). Many of the small companies that we acquire are not producing financial statements according to GAAP and, in every case, there has never been a financial audit of the business. All of our businesses are audited and the standards for an audit tend to be higher than just producing GAAP financial statements. This is an area where we work with our companies so they are prepared for an audit. This is not typically something that is difficult for our companies to achieve, but it’s a change and it is also something that requires an additional expense - around $30,000 for an audit.
In most cases, the companies that we acquire have a dedicated controller and maybe one or two accounting clerks. If we identify in the course of our due diligence that there are financial reporting weaknesses, we work with the companies during the due diligence period to identify solutions to areas of weakness. By the time we close, our goal is to be where we need to be from an accounting and reporting perspective.
Changes in Budgeting
Most of the companies that we acquire do not have budgets. They may perform an annual forecast. In other words, "Last year, we were $14 million in revenue. This year, we’d like to be $15 million in revenue. Last year, we made $1.5 million. This year, we’d like to make $1,750,000," but that would be the extent of their budgeting process. All of our companies go through a formal budgeting process each year. The outcome of that is a monthly budget that includes a revenue and expense forecast, capital expenditure plans, investment plans, etc. In the first year, those budgets are pretty basic. As we go forward, budgets become more detailed and integrated with the company’s overall strategic plans such that significant strategic items that require funding are included in the budget plans. In the strategic plans, there are, for example, revenue growth plans based on a per customer or per product basis that will be incorporated into the revenue budget. In the end, our teams find the budgeting process to be extremely helpful and a great tool to help them improve how they are running the business.
Prior to signing a letter of intent with a target company, we try to have detailed conversations about the question, “What’s going to change?” The time and energy that’s required to complete each of the items outlined in this article series are unique to each company. Our interest is in identifying those things that we think are particularly time consuming or risky in the context of the transaction and work together to come up with a plan to cross that chasm. This helps lower the chance for negative surprises during due diligence and closing a transaction. The sale of a small company involves change regardless of the type of buyer. The goal of this article series is to help business owners gain a better understanding of some of the most common changes involved in a deal with a private equity buyer.
For the full webinar recapping what to expect when you sell to private equity, watch the recording here.