The goal of every management is to increase or at least maintain the value of the company. This requires, in addition to a well-run day-to-day business, a well-thought-out strategy, a functional structure and well-run processes.
In this article, we show you the ways of value increase of your company with targeted measures.
We also wrote some time ago about property value increase, if that interests you too, have a look at our article about Amortization for a Property.
But now we will show you how to increase the value of your company with the help of four very concrete finance measures.
1. Focus on the last three years before the sale!
Why is it so immensely important as a selling entrepreneur to focus on the financial data of the last three years before the planned sale?
The answer is obvious. On the one hand, these form the basis for the company valuation, and on the other hand, these figures are often subject to strict due diligence by auditors and other advisors as part of the sales process.
In doing so, one can avoid many mistakes that can lead either to too low a sales price or to liability risks and legal disputes after the sale. This is particularly true if certain risks have not been adequately disclosed and, if necessary, risk provisioning has been neglected in the books.
The Influence of the 3-Year View on Business Valuation
As a rule, the financial figures of the last three years are considered in a business valuation.
If one assumes a company valuation according to earnings values or discounted cash flows, a planning calculation of a further 3 to 7 years into the future is projected based on these 3 years and the perpetuity is added.
But also in other methods, for example, the very common multiplier method or the simplified capitalised earnings value method, which is influenced by taxation, the last 3 years are used for smoothing or to confirm a trend.
2. Unbundle the company from private motives
The accounting of a non-capital-market-oriented company is often characterised by private motives. Often the goal is to minimise taxes by shifting expenses to the business sphere.
Avoid tax arrangements
For the vast majority of entrepreneurs, the first discussion of a planned business sale is with a tax advisor, and that is a good thing.
One should be aware of the income tax consequences and, if applicable, inheritance tax options. Often it is also the tax advisor who takes care of the bookkeeping and prepares the annual financial statements, business analyses, etc.
Be aware, however, that the tax advisor has to change his perspective in the case of a sale.
Up to now, his sole focus has been on keeping the tax burden for you as low as possible and on keeping the result as low as possible within the framework of the possibilities offered by tax law.
However, this is counterproductive for an intended company sale and will lead to a lower company valuation because you are not showing the true strength of your company.
In business practice, one sees here time and again tax arrangements in the grey zone (if not already far beyond it), such as:
- Fixed assets that are declared as business assets (cars, furniture, televisions, etc.) but are used privately,
- Family members working for the company, who may only be employed to the extent of their tax allowance or who are not paid in line with the market compared to non-related persons.
- Excessive rental payments for a business property or building that is privately owned.
- Consultancy contracts for former shareholders or other related persons
- Entertainment expenses for private meals
This list can be continued endlessly.
Therefore, in the first year, unbundle purely tax-motivated structuring options.
Check very carefully where you may have such constructs and also think about tax audit risks. These will often be part of a guarantee catalogue in the context of the sale, for which you generally continue to bear the risk.
Always be aware of where the tax structuring is in the foreground and what an economic picture would look like.
Any improvement in results will ultimately lead to an increase in the value of the business.
Entrepreneurial wage and risks
The unbundling of private and business can also go in the other direction. This is particularly the case if a company is not (or no longer) doing well and lacks an appropriate entrepreneurial wage. In this case, in addition to the entrepreneur himself, family members often work for free without their efforts being rewarded or visible.
In this case, the result is presented too well. In this case, the risk lies with the buyer to discover these constellations.
A more frequent case, however, is that risks are not or not sufficiently taken into account in the books and thus harbour considerable liability risks if they remain undiscovered.
If they are discovered in the course of due diligence, discussions often arise that can prevent a deal.
3. Dedicate yourself to your accounting!
As described above, the financial framework of the company is subjected to an examination during the sales process (so-called financial due diligence).
To exclude possible price-reducing factors and to convey a good overall impression, you should have your bookkeeping under control.
However, a few common accounting errors often show up here, which a careful auditor will find.
Here are a few examples:
- Trade accounts receivable have significant old balances that are already statute-barred and therefore no longer legally recoverable. However, no value adjustment has been made so far.
- The same applies to inventories. Old stocks and slow-moving items are valued too high in the books. Be aware of the valuation, especially in the case of high inventory assets, and use the next stocktaking for necessary value adjustments.
- Dispose of fixed assets that are no longer used and thus streamline the fixed asset grid.
- Accounts payable and accounts receivable can also be written off after the statute of limitations has expired if there is no actual obligation to the contrary.
- Accruals and deferrals of any kind are completely missing or have not been (correctly) reversed. High expenses can result here, for example, from the omission of accruals for employees’ holiday and overtime entitlements.
Vendor due diligence, i.e. an examination of the figures before the sale, can be a good solution here.
It is advisable to choose an independent auditor who was not involved in the accounting.
4. Make a risk inventory
Risks that are only discovered in the course of due diligence are always grounds for a reduction in the purchase price by the buyer. Risks that are not uncovered can later lead to high recourse claims under the guarantees given by the seller. This is very understandable because a potential buyer does not want to acquire any “inherited burdens”.
Incorrect assessments can quickly become very expensive.
The most frequent error in annual financial statements under commercial law and tax law is the failure to take risks into account in the form of provisions. Provisions are liabilities that are uncertain in terms of amount or reason.
These can be product liability risks, ongoing legal disputes, but also soil contamination or demolition obligations for rented premises, etc.
It is therefore essential to become aware of these risks within the framework of a risk inventory and to evaluate them according to the probability of occurrence and utilisation.
Concentrate on the last 3 years before the sale when assessing the value of the company. These form the basis for the business valuation and are usually subject to due diligence.
Disentangle the private from the entrepreneur and change your perspective: from a tax perspective to an economic perspective.
Clean up your bookkeeping and make a risk inventory. If you need support in this, use external auditors who have not been involved in the figures so far and have a clear view of the goal.
With these 4 measures, you are well prepared for the financial due diligence and the sales negotiations.
If you need any consultancy regarding this topic, contact our tax advisors in Barcelona by email or phone.