On August 24 my phone buzzed with a news flash from The Wall Street Journal. It said the New York Attorney General is investigating the Trump Organization to see if the Organization and President Trump inflated his assets in financial documents. The reason is supposedly “to secure favorable loans and tax benefits.”
I’m not going to take sides but rather ask a few questions and tie this to what I see daily with the buying and selling of businesses. The questions:
How could this happen? His assets are mostly real estate and it’s easy to appraise real estate.
Why did this need to (supposedly) happen? In my world it means the deal doesn’t qualify on its own.
Why didn’t the bank(s) verify? This one seems easy. They wanted to make loans to a prominent borrower.
This can’t (easily) happen with business buyers. Yes, they can inflate their resume, like they do for jobs, and that’s why relationship is so important. A good seller will sniff out a buyer giving a line of baloney (and I really don’t mean baloney).
A business buyer can’t inflate their liquid assets because they’ll need to use those funds. They can’t inflate their real estate assets because banks will get an appraisal. In other words, the bankers in my world are a lot more thorough, aren’t desperate, or swayed by a big name.
It’s a bit different on the seller side. Can inventory values be inflated, sure, but if the deal says the lower of cost or market the value can’t be more than the cost. And dead inventory is not hard to determine. All you have to do it look at purchase dates and if it’s been around too long it’s not very salable.
Fixed asset values are a little trickier and I tell buyers and sellers the buyer’s real concern should be when the assets will have to be replaced (their remaining useful life) not the exact, current value. “Anticipated capital expenditures” is the key phrase.
Cash flow is, however, the tricky one. Small business accounting tends to make cash flow a moving target anyway and a lot of owners “manage by checkbook.” Meaning, when there’s money in the bank we’re doing fine.
It’s when we get into my term AAA, adjustments, assumptions, and add-backs (click here for more on this), that it starts to resemble the asset inflation mentioned above. There are three situations driving this:
- Either CPA driven or owner driven there’s an incessant need to reduce taxes. This is why owners will buy a new truck or piece of equipment they don’t need. I find it ironic when CPAs tell an owner to buy something they don’t need to save on taxes. I’d sooner have ~70% of after-tax cash than 0% plus something really not needed.
- Owners blend their personal and business checkbooks. The reasoning is the same as in point one.
- When it comes time to sell there’s the desire to get as much as possible (understandably). If the true value is not enough the numbers get manipulated. For example, the owner who brags at his or her club how important and indispensable they are to the business is suddenly an unneeded detriment to the business (so their salary is really profit). Or we’re not sure the marketing worked so let’s add it back to profit (because we won’t do it again).
Inflate the Swimming Toys Not Your AssetsI don’t know what really happens with mega-banks and mega-loans as in the opening paragraph other than greed rules. The borrowers want the money, the banker was the bonus, the bank wants a “name” customer. I do know it’s a lot more ethics and sanity in my day-to-day world, and I’m glad about that.