Valuation for Buy-Sell Agreements

Valuations for Buy-Sell Agreements

In business accounting, it is not the computation of numbers, but the details behind those numbers that count far more.

Therefore, in business-related buy-sell agreements, forensic accounting helps ensure that the financial figures that are presented during an economic valuation of the business are identified, explained and verified objectively and transparently.

Financial records of the company are critical to the buying or selling of a business unit or the entire business. Forensic accountants will be able to identify if the numbers are fudged to mislead the buyer, and will be able to verify if the numbers are genuine.

Normalization Adjustments in Buy-Sell Cases

When a company or business unit is being valued for selling purposes, normalization adjustments could be applied. The purpose of these adjustments is to neutralize the effect of any non-recurring event (such as a legal settlement, severance pay, or a one-time capital gain on asset sale) or any discretionary expenditure.

This allows for the determination of the normal level of business finances. Discretionary expenses are particularly hard to identify and verify, and a forensic expert may have to apply complex accounting techniques to uncover these entries.

Adjustments made from discretionary expenditures commonly include:

  • Abnormally high compensation to the CEO or owner
  • High salaries to the owner’s family members that are not actively involved in the company’s management
  • High personal expenses billed to the company (such as vacations and personal gifts)

It may appear on the surface that these accounting adjustments are obvious, but they are often difficult to identify.

A forensic accountant can utilize specialized skills, including finance, auditing, investigative, research and interviewing techniques to throw more light on the numbers that the books are showing to a potential buyer of the business.

For instance, while valuing a business in a matter of shareholder litigation, questions may arise regarding the company’s cash levels and accounts payable. The forensic accountant may discover that the financial ratios of the company are not in sync with the rest of the industry.

Through detailed forensic investigation and targeted interviewing and research, the forensic team may discover that the payables to the suppliers are getting redirected to pay off the personal debts of the director’s wife (which is a non-business expenditure).

The example shows why in buy-sell agreements a blind reliance on the financial records of the for-sale business could lead to serious valuation mistakes. This is where forensic accounting can help to determine accurate records and enable mutually beneficial buy-sell business transactions.