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The accounting policies of family-owned businesses—which are typically small and medium-sized—are subject to different practices than those of large corporations. In addition to retaining financial resources within the business, optimizing the tax burden is often a key priority. Within the framework of tax law, this remains true for the prudent businessperson. After all, even former Chancellor Helmut Schmidt gave his blessing to this approach with his famous quip: “Those who have a duty to pay taxes also have the right to save on taxes.”
However, if a sale of the company is imminent—for example, in connection with a planned succession—different principles apply. To ensure the company’s attractiveness to potential investors, the top priority is to present the company’s assets transparently. This includes, in particular, hidden reserves on the balance sheet, which should be realized whenever possible. This remains true even if realizing hidden reserves results in a higher tax burden in the short term.
Off the Balance Sheet
As a general rule, the balance sheet total should be reduced as much as possible. All balance sheet items that are not clearly attributable to the company should be removed from the balance sheet. On the asset side, this includes vehicles and, less commonly, real estate, provided these are also used for personal purposes. On the liability side, the largest item to be adjusted is usually a pension provision for the business owner. This should also be removed from the balance sheet by means of reinsurance through an insurance solution. To the extent possible, shareholder loans should also be repaid or replaced at an early stage. The overarching goal is to clearly separate the interests of the existing shareholders from those of the company being sold in the run-up to the sale process. This has the positive side effect of generally improving the balance sheet ratios.
Align Valuations with Market Value
All assets must be reviewed for their realistic fair market value. Have receivables been appropriately written down? Are inventory and stock assets valued realistically, or has accounting flexibility been exploited? As a general rule prior to a company sale, inventory should be kept to a minimum and cleared of old stock and slow-moving items. Fixed assets must also be reviewed for plausible market values or replacement costs. In cases of doubt, an external valuation report should be obtained. Of course, this may reveal both hidden reserves and liabilities.
On the liabilities side, provisions must be reviewed for adequacy. For example, are warranty provisions realistic at the amounts reported on the balance sheet? Is the use of the accumulated provisions actually planned? In light of the intended sale, all major investments should be deferred anyway, or the investment decision should be left to the new owner. In conservatively managed, profitable family-owned businesses, hidden reserves are frequently found in the accounting treatment of provisions.
Start the balance sheet cleanup in a timely manner
When selling a business, the last three fiscal years are of particular importance. They are the focus of the buyer’s due diligence. Conversely, this means that the business owner should address the issue of financial reporting well in advance of their planned retirement. During this period, no significant long-term binding contracts should be entered into that would burden the income statements after the sale of the business. Moving away from tax-optimized, conservative accounting practices may result in higher income taxes for these fiscal years and, if applicable, for prior years. At the same time, both the company’s operating profit and its key financial metrics improve.
The last three fiscal years are also the focus of the historical analysis conducted as part of the business valuation and play a key role in validating the projected figures. Since business valuation is nothing more than the “discounting” of projected results, the purchase price that can be achieved later increases. Adjusting the balance sheet helps to partially bridge the gap between the buyer’s and seller’s expected purchase prices.
Of course, the seller can leave the analysis and identification of balance sheet reserves to the business valuator or investor. However, as in any market, there is fierce competition in the market for business transactions. Therefore, the initial impression of the numbers must be positive in order to attract the right investors and generate sustained interest in the company. Experience shows that the following adage applies when optimizing purchase price terms: Do good and talk about it!
