Middle Market Mergers and Acquisitions by Colonnade Advisors: MM M&A 005: It's All About Your Numbers (2024)

Aug 11, 2020

In this episode, Gina Cocking and Jeff Guylay continue theirdiscussion around the due diligence process related to the sale ofa company.

This episode is part of a four-episode series exploring the duediligence process that began with 003 on the business aspects ofthe due diligence process.

EP003: Business aspects of due diligence:https://coladv.com/podcasts/003/
EP004: Legal aspects of due diligence:https://coladv.com/podcasts/004-due-diligence-deep-clean-and-hygiene/
EP005: Accounting aspects of due diligence (today’s episode)
EP006: Technology aspects of due diligence (coming soon)

In today’s episode, we invite our featured guest, Joe Kaczmarek,to share his insights on how companies can best prepare for anM&A transaction. Joe is the National Fintech practice leader atRSM, a leading provider of audit, tax, and consulting servicesfocused on the middle market.

Show Notes:

There are six key takeaways from the episode(35:17)

Start early
Review your financials monthly
Keep books in GAAP (Generally Accepted Accounting Principles)
Get an audit
Prepare forecasts for your business and track achievement toforecast
Invest in the finance department. If your goal is to sell yourcompany, the number one action you should take (related toaccounting and finance due diligence) is to get a good CFO

In this episode, Colonnade Advisors addresses the followingquestions as related to the accounting aspects of duediligence:

When should an owner start preparing to sell theircompany?(01:20)

Gina: “It starts years in advance. At the very basic level, abusiness owner or leader of a company should be reviewing thefinancials on a monthly basis. The reason is to get comfortablewith the cadence of their business so that they can talk to thefinancials.”

Does a company need a public audit prior to selling thecompany?(1:40)
Gina: “We recommend all companies have a financial audit forseveral years before they go to market.”

What is the difference between an audit and acompilation?(01:58)
Gina: “A compilation is when accountants come in and put yourfinancials together for you. They may even do it on a GAAP basis.An audit means that the accounting firm is doing a deep dive intothe numbers. They’re looking at bank reconciliations. They’re doingdifferent types of testing for fraud and for receivables andpayables, et cetera. It’s a very involved process, but it is a mustfor a business that is planning for a successful sale.”

Do I need a financial forecast?(02:35)
Gina: “A company should keep a forecast and measure themselves tothe forecast and plan. The reason for this is twofold: 1) Ibelieve that you only get to where you’re going if you plan for it,and 2) buyers are going to look at the company’s financial forecastand how they are doing compared to that forecast.”

What other financial statements must be inorder?(03:54)
Gina: “Another good thing to prepare for a sale process is amonthly data book. This data book includes the income statement,cash flow statement, balance sheet, and MD&A (ManagementDiscussion and Analysis).”

How does a company select an accounting firm to work with onaccounting due diligence?(06:25)

Gina: “I usually recommend that companies not go with the localfirm that does their tax returns. Typically (I recommend) aregional accounting firm, or a national one, because you need ateam that can defend its choices in accounting principlesinterpretation.”

When should a company start working on accounting duediligence?(08:20)

Jeff (07:37): “The sooner the better. The first audit is theworst. After that, it gets a little bit easier. Getting thatprocess rolling is important.”

When is meeting the financial forecast key?(10:21)

Gina: “The financial forecast is crucial when we’re actuallyselling the business. The key is when you’re in the sale process,fromthe moment we release that confidential informationmemorandum (CIM) until the check clears and the business is sold,the company has got to make its numbers.”

What is the management team’s role in owning theforecast?(11:44)
Jeff: “It’s important that the management team understands and ownsthe forecast because they’re going to have to live with it. Thefinancial forecast obviously develops the metrics upon which you’regoing to be judged either through management contracts, earn outsor just general performance. You really want to be confident thatyou’re going to hit the numbers one, two, three yearsout.”

What is an MD&A (Management Discussion andAnalysis)?(13:45)

Gina: “A paragraph or a page and a half that explains thenumbers, e.g. ‘Revenues were up by X because we sold Y more;expenses were down by Z because we lost three people inheadcount.’”

How should revenues be broken out?(14:12)

Gina: “By number of products sold, pricing, number of customers;whatever metrics that are core to your business. Companies that cando that generally have a good finance department.”

What are some common missteps Colonnade sees in accountingpractices of middle market companies?(16:40)
Gina: “The finance department is looked at as a cost center.”Owners keep the books themselves or use a part-time bookkeeper.When companies don’t hire a CFO, there’s a potentialproblem.

What are some other missteps management can make when gettingready to sell their company?(18:00)

Jeff: “When the CEO is the master of everything. He’s the headof sales, he’s the head of marketing, he’s the head of ITsometimes, and in a lot of cases, he or she is the CFO. That’s aproblem because an investor could come in and say, ‘Well, I’m notgoing to pay $50 million for this one guy or this one woman.Where’s the team?’”

When do you know that a company has the infrastructure to besold?(18:35)

Jeff: “The real enterprise value gets built when you say, ‘Thisis a business that is going to be my legacy, but I don’t need to behere as the CEO or the founder. I built this business. I built outa team. The finance function is all built out. The marketingfunction is built out. The sales function is built out. Thisbusiness runs on its own. And so if you want me here or not, that’sfine, but my team is really more important than I am.”

Why does a company wanting to be sold need aCFO?(19:00)
Gina: “Without a CFO, when a buyer comes in, they will do anegative adjustment to your historical financial statements to fillthat role. That CFO role will be built into your valuationregardless. So invest in the CFO. It’s going to be worth far morethan not doing it.”

What is the difference between GAAP and cashaccounting?(20:22)
Gina: “Here’s the non-CPA’s way of explaining GAAP. Under GAAP, thetiming of your revenues and expenses need to match, and they needto also match the timing of your liabilities, which means if youare selling a service that is a service for six months, you receivethe payment upfront, the revenue upfront, you’re going to have torecognize that revenue over six months.”

What is an example of GAAP accounting vs. cashaccounting?(21:00)
Gina: “ A common example is payroll. Accruals should be done forpayroll. Let’s say you pay your employees every other Friday. Themonth doesn’t always end on the fourth Friday, so you end up havingto pay in the following month, let’s say the Wednesday thefollowing month. (When you pay in the following month) you’repaying for the prior month’s work. You need to do an accrual forthat payroll so it matches the month in which it occurred. Soaccruals need to be done under GAAP and revenue needs to berecognized in line with what the services or the productsprovide.”

What industries can use modified cashaccounting?(21:36)

Gina: “We work a lot in the F&I (Auto Finance and Insurance)and administrator space. (These companies) can be sold on amodified cash basis. But that doesn’t happen in allindustries.”

How does modified cash accounting work when selling a businessin the F&I or administrator space?(22:16)

Jeff: The important thing is understanding the differencebetween the two accounting processes or procedures. In the caseswhere it’s beneficial to the clients to present themselves on acash or a modified cash basis, we’re certainly going to do that tomaximize value. There has to be a spreadsheet that says, here’s theaudit according to GAAP, and here are the cash financials that wewant you to value the company on, and here are the adjustmentswe’ve made to get there, and it has to be logical and make senseand be consistent.”

Gina invites Joe Kaczmarek, an expert in audit tax andconsulting services, to share his perspective on due diligenceaccounting aspects.

What is the difference between an audit and a sell side Qualityof Earnings (QOE)?(24:19)
Joe: An audit is to go back and verify information at a point intime. We’re validating the accuracy of your balance statement andyour income statement. When we do a quality of earnings (QOE)report, we’re really stripping out one-time expenses, one-timerevenues, and coming down to a real accreditable earnings number ona cash basis. From a quality of earnings perspective, it’s alsomuch broader.”

How many years back should an audit go?(27:02)
Joe: “What I typically say is, ‘If you want three years in themarketing documents, it typically presents the best if those areall audited.’ (Three years). But more importantly than how manyyears is having a firm that really understands the industry and isreally nailing down those things that could come up indiligence.”

What are the bare minimum processes and procedures a firm shouldhave in place before they go to market? (28:02)
Joe: “The big thing is having a CPA on staff and having thatperson really understand what’s required. We like to see monthlyfinancial statements, on not only a cash basis but an accrualbasis, a GAAP basis.”

What else should companies thinking of sellingconsider?(28:34)

Joe: “investing in your financial reporting group. That’s notsomething that’s providing revenue so it’s often overlooked. Youreally need to have the infrastructure there to be able to reportand provide the information necessary to go throughdiligence.”

How quickly should a company be able to close the prior month’sbooks?(29:07)
Joe: “It really depends on the complexity of the organization andthe systems they have in place. It can take two days to two months.(However,) those companies taking two months realize very quicklythrough this process that that’s not going to be adequate (fastenough). If it’s a private equity group coming in to acquire them,they’re going to need reporting on a monthly basis that’s going tobe out within a week or two from the month-end or theyear-end.”

What is your view on QuickBooks?(30:36)

Joe: “Depending on the industry that you work in, Quickbooks maybe adequate. QuickBooks could be fine for smaller companies andmidsize companies. But you’ve got to realize what the limitationswith QuickBooks are (such as controls, access, andintegration).”

How should companies account for a PPP loan?(32:40)

Joe: “There is going to be a portion of it that’s going to beforgiven, if not all of it. You should record it as debt. Then asyou get approval for that forgiveness, that’s the point in timewhen it should flow through your income statement for GAAPpurposes. If you look at a transaction, that’s one of thoseone-time items that will most likely be backed out, and I would saythat’s non-operating revenue, so it should be down below theline.”

What’s one piece of advice you would give a company that’s aboutto go through an M&A process?(33:47)

Joe: “Engage a reputable firm to conduct sell-side duediligence. Sell-side due diligence firms will dig into thecompany’s financial information and figure out where there may beissues. If identified issues are likely to be deal-breakers, thenthe company will need to pause the process until the issues arefixed.”

Featured guest bio and contact information:

Joe Kaczmarek

Email: joe.kaczmarek@rsmus.com


Joe Kaczmarek services as the National Fintech leader at RSM. Inthis role, he is responsible for driving the firm's strategicobjections in fintech, while assisting traditional financialservice clients with their digital transformation. Joe also leadsRSM's specialty finance practice for the Great Lake Region. Joe hasexpertise servicing fintech and online lenders, direct to consumerlenders, sales financing lenders, purchasers of automobiles andother retail installment contracts, rent-to-own companies, titlelenders, purchasers of distressed debt, mortgage originators andservers, and various types of commercial lenders. Joe has vastexperience providing and supervising audit, consulting, and riskmanagement services to entities ranging in size from startupcompanies to international organizations. Joe also has extensiveexperience in transaction advisory services working with privateequity groups, venture capital firms, and clients. Joe earned hisbachelor's degree and MBA from Eastern Illinois University.


Host Information

Gina Cocking

Gina Cocking serves as the Chief Executive Officer of ColonnadeAdvisors. She returned to Colonnade as a Managing Director in 2014.Gina began her career in investment banking at Kidder Peabody, wasan analyst at Madison Dearborn Partners and an associate at J.P.Morgan & Co. She was a Vice President at Colonnade Advisors from1999 to 2003. She left Colonnade to gain operating experience asthe Chief Financial Officer of Cobalt Finance, a specialty financecompany. She went on to become the Chief Financial Officer ofHealthcare Laundry Systems, a private-equity backed company forwhich she oversaw the successful sale to a strategic acquirer. Ginaserved as the Line of Business CFO – Consumer Banking and Lendingat Discover Financial Services. Gina serves on the Board ofDirectors of CIB Marine Bancshares, Inc., a bank holding companybased in Waukesha, Wisconsin, that operates banking offices inIllinois, Indiana, and Wisconsin. Gina received her BA in Economicsand an MBA from the University of Chicago. Additionally, Gina holdsthe Series 24, 28, 79, and 99 securities licenses.

Jeff Guylay

Jeff Guylay is a Managing Director of Colonnade Advisors. Priorto joining Colonnade in 2000, Jeff was an investment banker at J.P.Morgan in the firm's Mergers & Acquisitions and Fixed IncomeCapital Markets groups in New York. He also spent several years inJ.P. Morgan's Chicago office. Jeff has over 20 years of M&A andinvestment banking experience and has served as lead executionpartner on over 25 M&A and financing transactions at Colonnade.Jeff received an MBA from Northwestern University's KelloggGraduate School of Management and a Master of EngineeringManagement from the University's McCormick School of Engineering.Jeff received a BA from Dartmouth College and a BE from Dartmouth'sThayer School of Engineering. Jeff holds the Series 7, 24, 63, and79 securities licenses. Jeff serves as a director of the non-profitNurture, an organization dedicated to enhancing the nutrition andwellness of children and families.

About the Middle Market Mergers & Acquisitions Podcast

Get the insiders' take on mergers and acquisitions. M&Ainvestment bankers Gina Cocking and Jeff Guylay of ColonnadeAdvisors discuss the technical aspects of and tactics used inmiddle market deals. This podcast offers actionable advice andstrategies for selling your company and is aimed at owners ofmiddle market companies in the financial services and businessservices sectors. Middle market companies are generally valuedbetween $20 million and $500 million.

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For more information, read Colonnade's blog post, Accounting DueDiligence: https://coladv.com/blog


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To learn more about Colonnade Advisors, go tohttps://coladv.com/

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Middle Market Mergers and Acquisitions by Colonnade Advisors: MM M&A 005: It's All About Your Numbers (2024)
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