At FE International we argue that the finances are not always the most important factor in receiving a competitive offer on your business.
However, in order to keep the momentum behind a competitive offer through due diligence, it is important that everything tallies up making the financial verification a check-box activity, rather than a fact finding mission for a prospective buyer. Here are a few tips to make sure this does not affect your online business sale.
Prepare Your Online Business Accounts
Many business owners in the sub-$5M range often do not keep regular track of their income and expenditure. As part of the valuation process, this is one of the first items we ask for as brokers. Keeping a regular profit and loss account (at the most basic level) can be done easily and effectively using accounting software such as QuickBooks, FreshBooks or hands-off accounting solutions, such as Bench. If you’re using QuickBooks, we found this great QuickBooks tutorial from our friends at FitSmallBusiness.
At FE International, we require the last 12 months of income and expenditure broken down by month to complete a detailed valuation. Ahead of listing the full records are required as buyers will certainly ask for all financial history in due diligence.
Keeping regular track of the finances of a business (beyond being essential for a sale) can also have the added benefit of helping to identify cost saving or revenue maximizing opportunities. E-commerce businesses, for example may find improved efficiencies in managing stock levels by integrating their e-commerce platforms with accounting systems in order to analyse all data in an easy-to-manage manner.
Further, having multiple websites under one accounting entity (such as a LLC) can cause verification issues and slow down the due diligence process. Prepare these separately, or at least have the ability to track elements separately in a verifiable format (i.e. merchant account statements, bank statements, tax returns, etc.)
Should I Use Accrual or Cash Flow Accounting?
Accrual accounting is considered to be the standard accounting practice for most companies.
Accrual accounting records economic events regardless of when a cash transaction takes place.
Accrual Accounting Example
A company sells electronic goods to a customer using a credit card. The accrual method will recognize the sale at the point where the customer takes ownership of the goods as it is likely (if not certain) that the business will receive the future revenue as the sale has been made. This is booked as an ‘accounts receivable’ on the balance sheet. This is an asset to the business as there is a legal obligation for the customer to pay the short-term debts to the business.
In the same situation, under cash flow accounting, the revenue will only be recognized by the company when it is received.
Conversely, should an expense be entered into but not required for payment directly (i.e. an annual subscription), under accrual accounting this should recorded at the time the subscription is an obligation of the business and spread to termination/renewal. The same occurs for the cost of inventory, etc.
Under cash flow accounting, this sum would appear as a cost as and when it is paid.
Accrual Accounting Examples in Online Businesses
|Summary||This allows the cost of inventory to be spread over its lifetime and not when paid up front. This will avoid an erratic profit and loss statement and the potential for loss making months derived from large outflows to the business at points of inventory restocking.|
|Summary||Both can be used, although if prepared under accrual a new owner may be required to rebate the original owner for cash flows not paid out on net +30 or net + 60 payment terms.|
|Business Model||Software/Saas (recurring monthly)|
|Summary||Both can be used. Depending on development requirements, accrual may be preferred to spread the costs over the development lifecycle. Annual recurring subscription payments may also favour accrual accounting.|
|Summary||With typically low operating costs and varying payment terms depending on the size of the business (and the advertising partner, i.e. net + 15, net + 30, net + 60), cash flow can provide an accurate and simple representation of the business’ finances. It will also normalise payment terms across advertising partners, should the business use several.|
|Business Model||Lead Generation|
|Summary||With refunds and scrub rate adjustments to be made monthly, cash flow provides less ambiguity and can be easier to record and reconcile over long periods of time. Again, depending on the lead generation partner and the product(s) in question, payments may vary from net +7 to net + 90. If a business operates with several lead generation partners paying out on different terms, cash flow can prove a more consistent method.|
|Business Model||Digital Products|
|Summary||No strong preference to either, although if prepared under accrual a new owner may be required to rebate the original owner for cash flows not paid out on net +30 or net + 60 payment terms.|
|Business Model||Digital Services (i.e. SEO service)|
|Summary||This allows the cost of fulfilling projects to be spread over its lifetime and not when paid up front. This will avoid an erratic profit and loss statements and the potential for loss making months derived from large outflows (i.e. paying staff to deliver services ahead of payment). It will also allow for booking of projects when they become due.|
Seller Discretionary Earnings and Add Backs
Add backs are used by brokers and business owners to adjust accounts to show the true operating costs of a business (SDE). Allowable add backs include:
- Income taxes
- Non-operating expenses
- Non-recurring expenses
- Depreciation and amortization
- Interest expense
- Owner’s total compensation for those services which could be provided by a sole owner/manager
Having a clear and concise record showing the costs to the business before and after any adjustments will remove any opacity when presenting the business to a buying party. By working with a website broker, you should be presenting these as default to the buying community.
While SDE can add significant costs back to the business, the same method of removal needs to be applied to:
- Non-operating income
- Non-recurring income
- Interest income
SDE is a common and well used methodology and most buyers are well versed in what should and show not be included/removed. Honesty pays dividends when applying add backs.
An essential part of pre-listing and buyer due diligence is being able to verify financial claims. Whilst for many small business owners it may seem onerous to track financials monthly, it does make it easier to provide proof when it comes to time of sale.
Buyers and/or the broker may request any of the following:
- Bank statements
- Merchant account statements
- Advertiser/affiliate account statements
- Purchase orders
- Tax returns (usually optional)
Have all relevant documentation prepared and clearly traceable. Online businesses are rarely audited by third party firms in great detail, especially in the sub-$5M range, but there has been a rise in third party financial verification through services in recent years (this is set to continue). By offering multiple mediums of proof, unwarranted assumption in due diligence can be largely avoided. This can be easily covered well in advance of a sale by working with a broker.
Don’t let paperwork decide when you are able to sell. Follow these three simple, yet vital steps and you will be well placed to come to market when the timing is right for your business.