On the Sell-Side: Why an Audit Isn’t a Substitute for Sell-Side Due Diligence | Podcast

Private Equity in Motion

In this episode of Weaver: Beyond the Numbers, Private Equity in Motion, Sean Muller and Brian Reed discuss why an audit alone may not provide the financial insights sellers need when preparing for a transaction. They explain how sell-side due diligence helps buyers and sellers better understand EBITDA performance, working capital trends and other key financial considerations that can help set expectations and reduce post‑deal surprises.

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Detailed Description of On the Sell-Side: Why an Audit Isn’t a Substitute for Sell-Side Due Diligence

00:00:00
Sean: I’m Sean Muller, and this is Brian Reed. And we’re going to talk more about the sell-side if you’re a seller looking to get out of your business.

And so one question that Brian gets all the time is: “Hey, I’ve got an audit, I’ve had a review done. Why do I need you to come in and do any sort of sell-side due diligence?”

00:00:15
Brian: I get this question a fair amount as people are asking me as I’m discussing the benefits or the advantages of doing a sell-side or not doing a sell-side.

And they’ll say, “Well, I already am audited. I mean, I don’t really need to — they should be fine with the audit.” And I’d say, “Maybe.”

00:00:33
Brian: But the reality is there are very different purposes for what an audit is meant to do versus what a sell side due diligence is meant to do.

The audit, let’s take, for example, you could have your financials, and you don’t necessarily make adjustments on a monthly basis or even a quarterly basis to accrue for things and do all the things that would be putting the books and records in accordance with GAAP, as an example.

00:01:01
Brian: You make those entries at the end of the year. Everything’s fine because audit is looking at a point in time.

And so if you’re looking at it as of a certain date, say December 31, and you’ve made the adjustments, you’ve made the accruals for the full year to get you in compliance, then you’re fine.

00:01:19
Brian: But the problem is when you’re looking at it from a transaction perspective, a buyer or an investor — or whoever it is — is going to want to look, to get a glimpse or understanding of how that business works on a monthly basis.

And so you’ve got to make adjustments, whether that be normalizing the accrual for bonuses or payroll accruals — whatever it is. Some of those things need to be looked at on a monthly basis.

00:01:44
Brian: And then also, it’s important, you know, we are going to have an in-depth look at a lot of these accounts and what’s going through them.

And our report itself will have a lot more detail and understanding about why things are changing. Why is EBITDA — what’s impacting EBITDA? What’s changing? Was it sales impact? Is it a cost impact? Whatever it is.

00:02:09
Brian: The audit is there to specifically identify the accounts and address disclosures related to those accounts, but it’s not going to go into the detail that helps an investor or buyer understand the business from a financial perspective.

00:02:20
Sean: And so by doing this monthly analysis versus a cut in time, you’re really analyzing more of the income statement than just squeezing it, right?

00:02:29
Brian: Yes. And we’ve talked about the fact that we do a P&L focus, but there is also the other aspect.

The other aspect of what we’re doing — that we spend a lot of time on — is working capital, which in an audit, there’s not really a concept of looking at sort of working capital. It’s the balance sheet, the income statement, the cash flows, which is all the financial statement components.

00:02:53
Brian: We spend a lot of time understanding, okay, what are those impacts to the working capital because it’s a very integral part of the overall transaction process, to understand what the business is generating in working capital, what the normalized level of working capital is, seasonality issues.

A lot of these things are not — none of these things are going to be addressed in an audit.

00:03:13
Brian: They’re going to make the adjustments to record what the balance sheet items should be at that point in time rather than looking over a period of time.

00:03:21
Sean: Yeah, because when you look at working capital and there’s generally an adjustment, plus-or-minus, in the final transaction, right? Coming up with what the actual working capital is you need and taking into account the seasonality and different things like that.

Because if you say my working capital peg is $1 million and you’re like, “Well, you haven’t run in $1 million for the last three months,” or whatever it may be.

00:03:43
Brian: Yeah. That’s an important point is to look and see, just like you said, if you randomly set a peg based on nothing, there’s a good chance you’re not going to achieve that when the true-up period comes after the transaction.

And that could be detrimental because it’s a dollar-for-dollar adjustment to the purchase price.

00:04:06
Brian: So looking at working capital over a period of time — what has it been doing in the last three months? What has it been in the last six months, nine months? Is there seasonality?

All those things go into consideration when determining what that peg should be.

00:04:20
Sean: Okay, well, thanks, Brian.

00:04:22
Brian: Thank you.

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