I hear from many people and have experienced clients saying “Why did the buyer reduce the EBITDA multiple after we signed the LOI?” In many cases, the perceived fall in the multiple has led to the seller withdrawing from the process at worst and bad feelings at best. In many transactions, the multiple offered falls during due diligence as the buyer learns more about the company, but this can managed if the company is prepared for sale. There have been many things written about preparing a company for sale including a good piece by my colleague Eduardo Berdegué. But one of the items that doesn’t get much discussion is quality of the financial statements.
Many privately owned companies only ever prepare tax returns and in some cases even keep their books on a cash basis. When a buyer makes an offer, they base their multiple on audited GAAP prepared financials. Without going into many of the details, GAAP financials impose stricter requirements for revenue recognition, bad debt right-offs, receivables, payables and inventory. When preparing financials under GAAP many of the earnings numbers tend to go down, which tends to reduce the level of EBITDA from that calculated by the company when preparing its tax return.
When sellers look at the final offer they believe the buyer has reduced the EBITDA multiple, when in reality it is the level of their earnings. In order be more prepared for what the real offer will be and stop disappointment or a lost transaction, potential sellers should have an audit done prior to going to market.