SME Acquisitions and the Added Value of a Registered Auditor
Daniel Kroes | March 23, 2015 |
In Belgium, small- and medium-sized entities (SMEs) represent 97% of companies and 55% of jobs. An acquisition of an SME is a true challenge, and approximately 320,000 enterprises are expected to be taken over between now and 2020.
If barriers—in particular those of a fiscal, financial, and psychological nature—can constitute obstacles, it seems that hiring a registered auditor when acquiring an SME, helps to reduce obstacles and increase the success of the acquisition.
In this context, the Belgian Institute of Registered Auditors (IBR-IRE) organized a congress “Acquisitions (Transfer and Takeover) of SMEs: Approach, Risks, and Valuation.” The congress aimed to address questions such as: How can a registered auditor advise you? Participants also discussed the added value of the due diligence process and techniques for securing the transfer of SMEs. It was supported by the UCM (Union of Medium-Sized Businesses), Unizo (Union of Independent Businesses), UNPLIB (inter-professional organization), and FVB (Federation for Free Professions).
Research conducted in preparation for this congress showed that, in the case of an acquisition, a registered auditor is mainly consulted to perform due diligence, to provide advice on business valuation and to carry out a future cash flows analysis in order to examine the reimbursement capacity in light of financing or a business plan.
IBR-IRE considers due diligence engagements to be engagements sui generis, showing several similarities with agreed-upon procedures engagements regarding financial information (ISRS 4400) and also with advisory engagements.
A due diligence engagement is a contractual assignment, not formally subject to international standards. The procedures to be implemented are agreed upon between the client and the registered auditor, who will need to comply with ethical requirements. Independence and confidentiality are, hereby, key elements.
A publication issued within the context of the congress provides guidance to registered auditors on the ethical framework and standards to be applied when due diligence engagements are performed. It also emphasizes the need to inform stakeholders about the role and added value of a registered auditor in an acquisition transaction.
The publication also showed that the lack of a specific legal framework can be partially overcome by an engagement letter, which sets out clearly each party’s responsibilities and tasks. In an SME acquisition, the seller has the duty to provide exhaustive information, and the purchaser has the duty to perform an investigation. An investigation of the accuracy of information provided to the purchaser from a financial, tax, and legal perspective as well as in other areas such as IT, environment, and staff, sometimes leads to price adjustments. Indeed, depending on the nature and extent of the risks identified during the engagement and on their importance for the purchaser and the seller, the parties will determine their views on the progress of the proposed acquisition (terms of the transaction, renegotiation of the purchase price, adjustment of the transfer structure, and contractual protection). It is, therefore, important to draft accurate legal documents that provide adequate contractual protection to all parties.
The expertise of the registered auditor extends beyond merely the audit of financial statements. Indeed, the audit professional can add value in a number of areas, including, among others, target screening, valuation and identification of synergies, due diligence—particularly financial—and risk analysis.
Regarding the valuation, the Discounted Cash Flow (DCF) method is the most commonly used valuation method, but this requires that the financial information be normalized first. Overall, five major challenges are often encountered with respect to the valuation of SMEs:
- Less reliance is placed on historical financial statements because, for example, the cost related to the CEO is higher or lower than market practice (financial information needs to undergo a normalization process);
- SMEs have limited access to capital markets;
- The company’s shares are often illiquid;
- There is strong dependence on the owner; and
- There may be risks impacting the company’s value, such as non-diversification, among others.
Due to the above, though the principles are basically the same, the valuation of an SME is often more difficult than the valuation of a publicly traded or larger company.
Finally, as concluded by Inge Saeys, member of the IFAC SMP Committee and Board member of IBR-IRE, who chaired the aforementioned congress: “As far as the due diligence process and business valuation are concerned, the registered auditor can provide significant added value as coordinator, expert, coach, and advisor.”