Updated: Apr 12
Some years ago I was early into a CFO assignment and I needed to put together a debt schedule. This company had several debt instruments with related collateral and covenant obligations, and both I and the various lenders needed to understand the entire debt picture. I began with what I thought would be an easy step: collecting all the loan documents. What I thought would take an afternoon ended up taking several weeks. I received responses to my inquiries such as, “Oh, I think Bob signed that one, go ask him if it is on his hard drive,” and, “Sally was here when that one was signed, but Jenny is using her computer now so you might want to check there,” and, “oooh… that one is probably in one of the boxes in the warehouse.” After multiple weeks of searching, we embarrassingly needed to turn to a couple of the banks to ask them for new copies of our obligations to them that we had lost. This move didn’t increase their confidence in the company.
Then a sales tax audit happened.
I put in place internal policies that all company information (not just bank documents) needed to be in a centralized location. This got a lukewarm reception. Then a sales tax audit happened. A period from three years earlier was being audited. Several hundred invoices needed to be pulled to definitively show if the company had paid sales tax on each. And each time an issue was found, the auditors embraced the opportunity to dive deeper and made even more information requests. Unfortunately bank documents weren’t the only type of company documents that had been scattered about. Invoices had been stored in boxes in various warehouse locations and no one was sure exactly what filing system had been used. This time instead of weeks, what could have taken an afternoon took months of searching. An intern was even hired to go through each box. In addition to the company spending money it shouldn’t have needed to, this poor intern spent a large part of her summer doing meaningless work in an un-airconditioned warehouse. Oh, and taxing agencies don’t stop their penalty and interest clocks while you are looking for the information they’ve requested. Those clocks keep on ticking. Internal resources (the time paid for the intern, senior people at the company, and me) plus the penalties and interest all summed to tens of thousands of dollars. All completely unnecessary.
So what does this have to do with business valuation? Everything.
As we’ve written before, business valuation has to do with future cash flows of the business and the riskiness of those cash flows. Two companies with the exact same cash flows can sell for dramatically different prices. This is not just theory. We see it happen all the time. When buyers start determining what they might want to pay for a company, they start attempting to quantify the odds that they’ll get the required return on their investment. Obvious things like over-reliance on an owner or a large customer concentration will increase the risk and therefore lower the amount the buyer is willing to pay. Information management is less obvious, but just as critical.
When buyers realize that a company is poor at keeping its information straight, they start getting nervous about gremlins.
When buyers realize that a company is poor at keeping its information straight, they start getting nervous about gremlins. Is there a covenant default that the company is unaware of? Even if there is not one now, does the company’s slo