By: Patrick Ungashick
One of the most common questions business owners ask us as we help them prepare for exit is, “Do I need to get audited financial statements?” It’s an important question because the wrong answer can lead to wasted money, greater risk of your exit falling through, or both.
With compiled statements, your accountants collect your company’s data and organize it into financial statements that meet your specifications and commonly-held accounting standards and principles. Your accountants neither analyze nor verify the data with a compilation. As a result, the accountants provide no assurances on the data’s accuracy.
A review provides limited assurance on your company’s financial statements. During a review, the outside accounting team will examine selected portions of your company’s data and make limited inquiries related to the accounting practices and principles used by the business.
The accountants also may analyze certain figures, such as current-year and prior-year balances, to verify they meet expectations. In this way, a review can provide limited assurance about the company’s financial statements, but not to the same degree as a full audit.
An audit provides the highest level of assurance of a company’s financial statement accuracy. An audit explicitly states that the company’s financial statements are free of material misstatement or fraud and conform to generally accepted accounting principles.
In an audit, the accountants will obtain evidence of the financial data’s accuracy by thoroughly examining source documents, meeting with company management, and verifying information from important parties such as customers, vendors, and lenders. Then the accountants will rigorously test the data to verify accuracy in the final financial statements.
Audited financials require the most work and thus cost the most money, but they provide the highest level of assurance to creditors or buyers.
Do You Need an Audit?
Now we can explore if you need to invest in audited financial statements as part of your exit planning. The first step to answer this question is to know your likeliest exit strategy.There are only four ways to exit your business: sell to an outside buyer, sell to an inside buyer (typically one or more key employees), pass it to family, or shut it down. Knowing which of these four will be your exit strategy goes a long way in determining if you need an audit.
If you intend to pass your business to family or shut your business down, rarely would you need to invest in an audit. That leaves the remaining two exit strategies of selling to an inside buyer or selling to an outside buyer.
If you intend to sell to an inside buyer, then typically you will not need an audit as long as a large portion of the sale will be financed by you, the seller. However, you may need an audit if you intend to bring in significant amounts of outside debt or equity to help finance the sale to your inside buyer, as lenders or investors may want assurances that an audit creates. (Ask us how to do this.)
So, if you intend to sell to an inside buyer, you might need an audit, depending on how you structure the deal. Therefore, you have to plan ahead.
The fourth possible exit strategy is to sell to an outside buyer. Under this strategy, you will typically want to invest in the audit prior to selling the company. Most outside buyers including strategic buyers and financial buyers will finance some portion of the deal, and their lenders will prefer or outright require the audit.
However, there’s more than just the buyer’s requirements to consider. It helps to look at the audit as an investment, not as an expense. Audited financial statements may help your company command a higher sale price and/or receive a greater portion of cash paid at closing.
Additionally, an audit may shorten a buyer’s due diligence period, which saves time and money and reduces deal risk for you. (Ask us how an audit reduces deal risk.)
Meet with Your Tax and Exit Advisors
Ultimately, there is no one-size-fits-all answer, but the above information should help you get started in the right direction. You must meet with your tax and exit advisors to discuss this question and determine your best course of action — ideally several years before you plan on exiting, because many outside buyers prefer to see three years or more of audited historical statements.
Knowing the right answer to this question will likely save money, time, and energy. A wrong answer, or waiting too long to answer the question, can derail your exit success.