The owner prepares for a sale by thinking about the presentation and the prospects of the market. Meanwhile the buyer opens the balance sheet and the profit and loss account and in thirty minutes forms an opinion that barely changes afterwards. Here is what he is looking at.
First: the relationship between revenue and cash
Profit in the accounts and money in the bank are different things. The first thing the buyer does is compare profit against the movement in cash balances and against trade receivables.
If profit is growing but receivables are growing faster, it means the company is selling on credit and financing its customers. That kind of growth is not worth the money being asked for it.
Second: the structure of revenue
How many clients there are and what share the largest one accounts for. A single client above thirty per cent is no longer a business, it is a relationship, and the buyer will be asking whether that relationship transfers to him.
At the same time he looks at the contracts: is there a change-of-control clause entitling the client to terminate if the owner changes.
Third: costs that will disappear, and costs that will appear
The classic of small business sales: the owner shows a profit that takes no account of his own work, of rent paid to a related party at a below-market rate, and of relatives working for nothing.
The buyer recalculates all of this at normal market cost — and the profit falls. Normalising the figures is a standard exercise, and it is better to do it yourself before the talks than to hear it from the buyer.
The reverse situation: one-off costs that will not recur — a relocation, litigation, a write-off. These are stripped out of the calculation, but only if there is documentary evidence that they were one-offs.
Fourth: liabilities that do not show on the balance sheet
Guarantees given for third parties. Leasing. Warranty service obligations. Claims in litigation for which no provision has been made. Tax exposure from earlier periods, particularly where there has been dealing with questionable counterparties.
These are the items that most often become the subject of separate indemnity arrangements in the transaction.
Fifth: the quality of the accounting
Whether the management accounts reconcile with the statutory ones. Whether there are breakdowns of receivables and payables by counterparty. Whether results are tracked by business line.
If the owner has two realities — one "for the tax office" and one "for himself" — the buyer builds in a discount for unreliability. He cannot verify what is not in the documents, and he will not pay for words.
What raises suspicion immediately
A sharp rise in revenue in the final year before the sale after stable earlier years. Profit increased by cutting spending on maintenance, marketing and staff — that is, at the expense of the future. A change of auditor or accountant shortly before the deal. Large transactions with related parties. Big loans to the founder. A discrepancy between physical stock and the accounting records.
Every one of these signs can be explained, but explain it you will have to, and the explanation has to be documented.
What to prepare in advance
Three years of management accounts in a single format, with breakdowns and an explanation of the methodology.
Normalised profit with a transparent list of the adjustments.
A register of contracts with the key terms and dates.
An inventory of assets with proof of title: real estate, equipment, trade mark, domain name, software.
A list of risks with your own assessment of each. Yes, prepared by you. The buyer will find them anyway, and a risk you disclose yourself costs less than one he uncovers.
Why this affects the price
A buyer is not paying for profit, he is paying for confidence that it will happen again. Every opacity is an uncertainty, and he prices uncertainty in money and deducts it.
A year of preparation usually delivers more than a year of revenue growth: the same business with the same cash flow, but with the paperwork in order, sells for more.
I set out how pricing works in my first reply, before any work begins.
I provide legal services through the company Kovalev & Partners LLC — kovalev.moscow. Advice on the value of a business is not valuation activity under Federal Law No. 135-FZ.
