I thought it may be an opportune time to brush up on the Verification of Financial Records Clause 12 K as it appears in a management rights contract of sale.
Given this year already it is reported in industry circles that an excessive amount of contracts have been terminated due to non satisfaction of financial records. Over the past 17 years or so I have seen various examples of vendor presented profit and loss statements that are to form part of the sale process.
In the current market (this has always been my policy) a current industry accountant’s prepared profit and loss along with explanatory notes should be the normal. The problem that occurs is that the accountant and his or her assistant or number cruncher tend to consult with the vendor and so called add backs are allowed that in fact are actual expenses.
We need to examine the two words fact and actual and adhere to the meaning of net operating profit.
I come to the following analogy: The very difficult and at the majority of times impossible task of the broker handling the contract of sale is trying to be the negotiator between the accountant who constructed the net operating profit and loss report and the accountant appointed by the purchaser trying to adhere to the verification clause of the contract. Along with the vendor who supplied the report after negotiation with their accountant and a purchaser believing in only what his appointed accountant is verifying.
All this of cause is during the 14-day verification clause contained in the contract of sale.
Without handing the blame to any particular party the contract is now dead or slowly dying, so let’s have a look at the following scenario and definition of the two key words in any net operating profit
1. An event or thing known to have happened or existed
2. A truth verifiable from experience or observation
3. A piece of information
1. Existing in reality or as a matter of fact
2. Real or genuine
3. Existing at the present time, current
Unfortunately the above two words and their meaning tend to be forgotten when the preparation of a net operating profit for the last 12 month’s trading is undertaken.
Let me give you an example that occurred in the last 12 months. The vendor’s accountant asked the vendor if the night answering service was necessary. This was an actual reoccurring expense utilised for late arrivals and key collection arrangement. It was agreed that this expense was to be omitted from the report. At time of sale the purchaser’s accountant, as expected, saw this expense (reoccurring) and included it as an expense.
Fact: An event or thing known to have happened or existed
Actual: Existing at the present time, current
Hypothetically let’s say this expense was $3800 per annum at five times the year’s purchase factor which equates to $19,000 now overstated in the management rights contract of sale. You be the judge!
Let’s go a little further and give another of our industry professionals “the valuers” a little exposure. A contract of sale occurs, terms, conditions and pricing agreed by both parties, signed and exchanged. The sale was constructed using the market value formula: “The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction, after proper marking wherein the parties has each acted knowledgeably, prudently and without compulsion.”
All goes well with this particular sale and naturally finance is subject to valuation. The net profit is $720,000; the valuer uses three management right sales as a comparason. Our multiplier is 5.15 times the year’s purchase factor. The comparable net profits are $120,000, $255,000 and $310,000. Unfortunately no large management right sales have occurred in this area for the last 15 months. Hardly “an apple for apple” comparison. The valuer’s opinion was a 4.85 multiplier. The words fact and actual ring in my ears, however that is a story for another time.
In conclusion the management rights industry is alive and kicking and busy as usual, multipliers are steady, the higher the actual net profit the higher the multiplier.
On a personal note my enthusiasm is as strong as ever, the Crystal Ball is all dusted and polished and I am supported by an already great team, with new and experienced brokers wanting to join the family.