Why it matters
You usually see a seller's numbers in stages: a short teaser or listing, then an information memorandum (often called a CIM in the US) after the NDA, then management accounts, tax returns and bank statements in diligence. Each stage should confirm the one before. When the numbers move, what matters is which way they moved and why.
Some change is normal. A teaser may round figures, use an older 12-month period or quote a run rate rather than actual results, and new trading can move the numbers either way. The questions are whether the seller explains the change before you find it, and whether the explanation holds up.
The pattern to watch is figures that only ever fall as the documents become more reliable. Take Tallowmere Cabinet Works, a fictional US business. Its teaser shows SDE of $500,000, the information memorandum shows $430,000 and the accounts support $350,000. At a multiple of three, the gap between the first and last figures is $450,000 of price that was never supported. New or larger add-backs, a switch from net profit to SDE, or a change in which months count as the last 12 can all make a business look better than its accounts do.
If the lower figure is verified and the seller accepts a price based on it, you can price it in. Run each version of the numbers through the valuation tool to see how far the indicative range moves. If figures keep changing without explanation, or the seller holds to the original price, treat it as a reason to walk away.
An information memorandum is a detailed sales document about a business, usually prepared by the seller's broker or adviser and shared after an NDA. It is written to present the business well, not to test it.
Non-disclosure agreement (NDA)
A non-disclosure agreement is a contract in which a potential buyer promises to keep information about a business confidential. Sellers usually ask for one before sharing the business's name or detailed figures.
Due diligence is the investigation a buyer carries out before committing to a purchase, testing the finances, contracts, legal position and operations against what the seller has described.
How to spot it
- Keep a simple table of revenue, gross margin, profit, add-backs, period and profit type from each document as it arrives, so differences stand out.
- The profit label changes between documents, for example from net profit to SDE or EBITDA, without a reconciliation.
- The 12-month period quoted shifts, or the latest months are left out.
- New add-backs appear, or existing ones grow, as the underlying profit falls.
- Revenue in the information memorandum does not match sales tax or VAT returns, or bank deposits, for the same period.
- The public listing still shows the original figures after the seller has given you lower ones.
- Staff numbers, customer counts or growth rates differ between documents.
Gross margin is revenue minus the direct cost of what a business sells, shown as a percentage of revenue. It shows how much each sale contributes towards overheads and profit.
EBITDA is earnings before interest, tax, depreciation and amortisation. It helps compare operating profit across businesses, but it is not the same as cash.
Questions to ask the seller
- Can you reconcile the teaser figures to the information memorandum and the accounts, line by line?
- Which 12-month period does each figure cover, and is it actual or forecast?
- Which add-backs make up the difference between net profit and the stated SDE or EBITDA, and what evidence supports each one?
- Who prepared each document, and from which system?
- Will you revise the asking price to reflect the verified figures?
- Have any figures been restated since the accounts were filed?
The asking price is the price a seller or broker puts on a business when it is listed. It is an opening position, not a valuation, and what it includes varies from listing to listing.
Documents to request
- A written reconciliation from the teaser figures to the filed accounts
- Monthly profit and loss statements for the last 24 months, exported from the accounting system
- Filed accounts and tax returns for the same years
- Sales tax or VAT returns and bank statements covering the period quoted
- A schedule of add-backs, with invoices, payroll records or other evidence for each
- Any quality of earnings report or accountant's review already carried out
A quality of earnings review is an accountant's analysis of whether a business's reported earnings are accurate, sustainable and correctly adjusted. It is not an audit.