Founder FAQ: Is a Financial Audit Required When Selling Your Business?

When thinking about selling your business, you might wonder if a financial audit is necessary. The answer isn't simple and depends on the details of the deal. In this guide, we explore when financial audits are needed and look at other financial checks that can help make the sale go smoothly.

The Role of Financial Audits in M&A

A financial audit is when an outside accounting firm reviews a company’s financial statements to make sure they are accurate and follow the rules. For founders looking to sell, an audit can make the company seem more trustworthy and reassure buyers that the financial information is correct.

However, a full audit isn't always needed. It depends on the size and type of the business and what the buyer and seller want.

Due Diligence: A Critical Component

In the sales process, due diligence is a vital step where the buyer thoroughly checks the company's finances, operations, and other key details. This often happens after signing a Letter of Intent (LOI) — a non-binding agreement outlining the proposed deal's basic terms.

During due diligence, the buyer checks to make sure the seller's financial and business claims are true. This includes looking at financial records, confirming income, and checking how profitable the company is by looking at Adjusted EBITDA—the company's earnings after removing one-time or unusual expenses.

Sell-Side Quality of Earnings Report

To get ready for the buyer's due diligence, sellers might get a sell-side quality of earnings (QoE) report. This report gives a detailed look at the company's financial health and performance, focusing on the earnings' stability and reliability.

An independent accounting firm does the QoE report. It helps sellers prepare for any questions or concerns the buyer might have. The report checks that the financial statements follow GAAP and points out any needed changes. Having a QoE report can make the due diligence process smoother, build trust with buyers, and reduce surprises that could delay or stop the sale.

Benefits and Drawbacks of Financial Audits

Benefits:

1. Enhanced Credibility: An audit ensures that the financial statements are accurate and reliable, which can increase buyer confidence and potentially lead to a higher sale price.

2. Reduced Risk: Audits can find and fix any financial reporting problems before they become an issue during negotiations.

3. Streamlined Process: With audited financials, the buyer’s due diligence may go more smoothly and quickly because they can trust the audit’s findings.

Drawbacks:

1. Cost: Audits can be expensive, especially for small or mid-sized businesses, because they require a thorough examination by a qualified accounting firm.

2. Time-Consuming: Audits take a lot of time, sometimes weeks or months, which can delay the sale.

3. Resource Intensive: Preparing for an audit needs significant resources, including staff time and effort to gather and present financial data.

Making the Decision

When selling your business, deciding on a financial audit depends on how big and complicated your business is. Talk to financial advisors and legal experts to see if you need an audit or if something like a QoE report would be better.

Key Terms Explained

Letter of Intent (LOI): A preliminary agreement between the buyer and seller that outlines the basic terms of a potential sale. It is usually non-binding and serves as a guide for further negotiations.

Due Diligence: A thorough review by the buyer to check a business's assets, liabilities, and potential, aiming to find any risks or issues before finalizing the sale.

Adjusted EBITDA: A measure of a company's operational profitability, excluding one-time, non-operational, or exceptional items, to give a clearer view of ongoing earnings potential.

In conclusion, while a financial audit can offer significant advantages when selling a business, it is not always necessary. By understanding the role of audits and alternatives like quality of earnings reports, sellers can make informed decisions that best suit their business needs and goals. The key is to work closely with trusted advisors to navigate the sales process and ensure a successful outcome.