Cautionary Tales #8

Cautionary Tales #8Often in this series we only have one cautionary tale to share, but sometimes we have more than one, so this article will have shorter stories about three different real-life scenarios we’ve seen around the office recently.

PPP Money Isn’t Income

While we don’t expect business owners to have forensic financial savvy, we do expect them to be able to look at their books and see irregularities.  One such irregularity happened because a fractional CFO had convinced a business owner who had become one of our clients that he had M&A experience.  Yet that experience missed the fact that a significant amount of the reported earnings for the previous year (more than a third) were not earnings at all, but were PPP funds!  Needless to say, that meant that the multiple and the price for the business had to fall significantly, and for some reason, both the business owner and the fractional CFO seemed upset about this.

But there wasn’t any reason to be upset.  A business is worth some multiple of real earnings.  A government bailout is not only taxpayer-subsidized, but it has nothing to do with the value of your business.  Adding it to your earnings and thinking that a serious buyer won’t laugh or that a serious bank will offer financing for inflated numbers is not a serious way of thinking about selling your business.

PPP Funds Aren’t Slush Funds

Some businesses who had no need for PPP funds received them anyway and ended up spending them on personal desires.  Since the loan forgiveness program had no real auditing or certification process, businesses who treated PPP funds as lottery funds now have books strewn with irregularities:

  • PPP funds classified as income (like our first example)
  • New company cars (including, in one case we saw, a company Rolls Royce)
  • Home improvement (no kidding, we saw $250,000 spent in this manner)

This is going to trigger distrust on the part of the buyer.  If you’re willing to be so cavalier with government funds in the last two years, what else has happened in the previous four or eight?  

CapEx Won’t Always Be Part of Your Sale Price

Sometimes the specialized equipment needed to deliver your product or service won’t figure into a sale.  This can happen when an acquirer already has better equipment than you and excludes them from the purchase, leaving you to liquidate them at whatever the market will pay.  Other times, there is no market to sell your equipment.

This happened recently with a client who is in beverage systems and has their equipment in restaurants, event venues, convenience stores, etc. all around the Kansas City metro, totaling almost $1M in capital expenditures. The problem is, the business only has $250,000 in cash flow.  So not only is the buyer unwilling to add another $1M to the value of the business, it’s unlikely that even if a buyer were willing to, that a bank would finance at that “valuation.”  Using capital expenditures to justify a price can only work if there’s a ready market to dump that equipment (at fire sale prices, if necessary).  But there’s simply no local buyer who’s looking to buy a bunch of this specialized equipment on its own, unattached to a business.

The client had always thought of these capital expenditures as effectively loans that would get paid back to him, but in this particular case, that wasn’t true, and led to a 4X devaluation of what he felt entitled to, price-wise, for his business.  It’s a tough pill to swallow, but it’s reality, and one that should be accepted by other owners in similar situations with their CapEx.

We don’t take any joy in sharing these cautionary tales.  We only do so to make sure that future buyers and sellers don’t repeat the same mistakes.  Need advice on dealing with one of these situations above?  We can help.  Give us a call.