What do Users of Private Company
Financial Statements Want?
Cheryl Graziano, Vice President
Bill Sinnett, Director of Research
Financial Executives Research Foundation, Inc.
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Research Foundation (FERF)
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Private Company Financial Statements
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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What do Users of Private Company Financial
Statements Want?
ƒ Research project was sponsored by the National
Federation of Independent Business (NFIB)
ƒ FERF staff worked with FEI’s Committee on Private
Companies (CPC) to develop interview questions
ƒ FERF staff interviewed preparers, commercial bankers,
and investment bankers
ƒ One preparer and four commercial bankers completed
survey questionnaire in lieu of interview
ƒ FERF staff drafted report
ƒ NFIB, CPC and FERF Research Advisory Council
reviewed draft report
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Today’s Agenda
ƒ What About Your Company?
ƒ Research Interviews
ƒ Research Themes
ƒ Next Steps
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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What About Your Company?
ƒ Your role
ƒ Who uses your financial statements?
ƒ What information do they require?
ƒ What other information should be provided?
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Research Interviews
ƒ Seven preparers of financial statements
– 1 completed a survey
ƒ Nine commercial bankers
– 4 completed a survey via American Bankers Association
ƒ Two investment bankers
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Preparers
ƒ A: Small medical device manufacturer
ƒ B: Mid-size high-tech manufacturer
ƒ C: Mid-size health care provider
ƒ D: Small retailer
ƒ E: Mid-size mining company
ƒ F: Small manufacturer
ƒ G: Mid-size restaurant chain
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Company A: Small Medical Device
Manufacturer
ƒ Owned by 300 physicians and a venture capital firm
ƒ We send out a stockholder letter every two months.
ƒ The most important metric is the timetable to
commercialization (how long to revenue)
ƒ We provide financial statements to anyone who
provides capital and anyone doing due diligence
ƒ We prepare GAAP statements, but we have problems
accounting for options and warrants
ƒ I have issues with Sarbanes-Oxley, and I support the
recommendations of the SEC Advisory Committee that
smaller companies be exempted
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Company B: Mid-Size High-Tech Manufacturer
ƒ Owned by LLC that is multi-generational trust
ƒ Good cash flow is our main objective
ƒ Financial statements go to management and owners
four days after month end
ƒ Incentive plans are based on financial statements
ƒ I don’t like the idea of two sets of GAAP
ƒ But I do like different footnotes for private than for public
companies
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Company C: Mid-Size Health Care Provider
ƒ Owner entirely by the employees
ƒ 3 employees own a controlling share of the company
ƒ Monthly financial statements (modified cash reports)
sent to each profit center
ƒ Quarterly financial statements sent to board, banks, and
investment banker
ƒ Annual financial statements have exceptions to GAAP:
– FSP 150: Mandatorily Redeemable Shares
– FIN 46: Consolidation of Variable Interest Entities
– FAS 133: Accounting for Derivatives
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Company D: Small Retailer
ƒ 97% family owned
ƒ GAAP not necessary for internal management financial
statements
ƒ Internal financial statements adjusted for external users
ƒ Only debt is a credit revolver with a bank syndicate
ƒ Banks require annual audited GAAP financial
statements
ƒ If we want to open a new store, the new landlord may
ask for GAAP financial statements
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Company E: Mid-Size Mining Company
ƒ 46.5% owned by CEO, 46.5% owned by outside
investor group, and 7% owned by others
ƒ Financial statements are only a portion of our
communication with investors, bankers, and others
ƒ The CEO and the outside investors want monthly
operational data
ƒ Banks want quarterly measures of liquidity, as specified
in debt covenants
ƒ Insurance companies are satisfied with annual audited
GAAP financial statements
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Company F: Small Manufacturer
ƒ Three owners, including CFO who was interviewed
ƒ Bank wants annual audited GAAP financial statements
ƒ Banks also want:
– Detailed aged payables, receivables and inventory
– Monthly loan covenant calculations
– Collateral reports
– Quarterly cash flow coverage
ƒ Banks use financial information to calculate loan ratios
ƒ Vendors want financial statements, but we give an
Altman Z score instead
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Company G: Mid-Size Restaurant Chain
ƒ Privately owned by stockholders, with no plans to go
public
ƒ Most important financial information is internal financial
reports used to run the business
ƒ Banks want annual audited GAAP financial statements
for consistency and accuracy
ƒ Banks focus on cash flow, and ignore non-cash items
and “funny money” items, like minimum pension
liabilities, that have no effect on cash flow
ƒ We use GAAP financial statements to compare our
company with other companies in our industry
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Commercial Bankers
ƒ A: Small Southeast regional bank
ƒ B: Large NYC money center bank
ƒ C: Small Midwest regional bank
ƒ D: Large Southeast regional bank
ƒ E: Large international bank
ƒ F: Small bank based in New Mexico
ƒ G: Small bank based in Virginia
ƒ H: Small bank based in North Carolina
ƒ I: Small bank based in Wisconsin
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Bank A: Small Southeast Regional Bank
ƒ Virtually all commercial customers are privates
ƒ Bank policy requires:
– Audited GAAP financial statements for credit exposures of $3 million or
more
– Audit reviews for credit exposures less than $3 million
– We can make exceptions for long-term customers with strong financial
performance
ƒ We look for liquidity, which can be determined from the
balance sheet or the cash flow statement
ƒ We often use income tax returns to confirm certain
information not available from GAAP statements alone
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Bank B: Large NYC Money Center Bank
ƒ Baseline financial statement requirements are specified
in the original loan proposal:
– Annual audited GAAP financial statements
– Quarterly financial statements without footnotes
– Monthly financial statements, with aged receivables and payables
ƒ We get the same information from private companies as
we do from public companies
ƒ We will make exceptions for GAAP accounting for noncash items if we can measure cash flow
ƒ We like borrowers to use auditors who we know
ƒ We consider GAAP financial statements to be a
standard management tool already being used
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Bank C: Small Midwest Regional Bank
ƒ A full set of GAAP financial statements are required,
including footnotes
ƒ GAAP financial statements provide uniformity for more
accurate historic and industry comparisons
ƒ The financial strength of the debtor is a driving factor for
how frequently we require financial information
ƒ At a minimum, annual audited GAAP financial
statements are required
ƒ Higher risk borrowers are required to provide more
frequent financial information
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Bank D: Large Southeast Regional Bank
ƒ We need good financial statements for proper cash flow
analysis
ƒ Audited financial statements provide more credible
financial information, so an audit is better than a review
ƒ GAAP provides consistency
ƒ We require audited financial statements for loan
balances over $5 million, but we do make exceptions
ƒ We do not require audited financial statements for loan
balances under $300K
ƒ For smaller loans, key financial information and
individual credit scores are reviewed
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Bank E: Large International Bank
ƒ The most important thing to the lender is cash flow
ƒ Financial information, in order of importance:
– The cash flow statement, income statement, and EBITDA will help you
determine whether you will get paid back
– The balance sheet will show existing obligations
– The balance sheet will also show the hard asset base, which will
provide security if the borrower is non-investment grade
ƒ We require an MD&A, either on a monthly or quarterly
basis, depending on the company
ƒ MD&A is always valuable, because it explains why
management does certain things, and it explains
changes in income and expense accounts
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Bank F: Small Bank Based in New Mexico
ƒ Financial statements are needed to monitor ongoing
trends
ƒ For small companies, we will accept self-prepared
financials
ƒ We require specific financial information relevant to the
credit being granted
ƒ We don’t ask for what we don’t need
ƒ For most loans, financials are only required annually
ƒ For more complex or risky situations, financials could be
required quarterly or even monthly
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Bank G: Small Bank Based in Virginia
ƒ Loan agreements generally require a company to
provide annually a balance sheet, an income statement,
and a statement of cash flows as of the fiscal year end
ƒ If financial statements are not audited, we will verify the
income statement against the company’s federal tax
return, prepared by a CPA
ƒ If a company is closely held, we also require copies of
personal financial statements and individual tax returns
ƒ However, we have more confidence in financial
statements prepared by a CPA according to GAAP
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Bank H: Small Bank Based in North Carolina
ƒ Size of total loan relationship is our determining factor
as to the sophistication of the financial statements
required
ƒ We typically ask for:
– Lists of assets and liabilities
– Profit and loss statements
– Cash flow statements, and
– Tax returns and other proof of income
ƒ Both GAAP financial statements and Federal tax returns
are important for our decision-making
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Bank I: Small Bank Based in Wisconsin
ƒ Most of our clients are privately held companies
ƒ With a few exceptions, our clients do not have internal
audit procedures or externally audited statements
ƒ We look at financial statements to determine a
company’s:
– Viability, as it relates to current net worth
– Ability to generate future earnings
– Asset base
– Cash flow and future cash flow
– Obligations to others
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Investment Bankers
ƒ A: Small Midwest regional investment bank
ƒ B: Small Southwest regional investment bank
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Investment Banker A: Small Midwest Regional
ƒ We need and rely on audited GAAP financial
statements
ƒ We also look for supplemental information
ƒ We are primarily interested in equity vs. debt
ƒ Buyers are interested in capital expenditure
requirements, which you cannot get from statements
ƒ Many buyers pay on EBITDA less cap ex
ƒ GAAP provides security
ƒ Fair value is important if the company is not liquid
ƒ Fair value is important for weak companies
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Investment Banker B: Small Southeast
Regional Investment Bank
ƒ GAAP is not always logical, but
ƒ We prefer GAAP financial statements for accuracy and
consistency
ƒ We look at private companies in the same way as public
companies
ƒ We request supplemental schedules, because GAAP
does not provide detailed information on revenues and
expenses
ƒ Compliance with Sarbanes-Oxley will make transaction
closing easier
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Research Themes
ƒ Themes by User
ƒ Use of GAAP
ƒ Debt Covenants
ƒ Internal Controls
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Users
ƒ Internal Management
ƒ Commercial Bankers
ƒ Investment Bankers
ƒ Investors
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Internal Management
ƒ Internal managers receive financial and operating
information for their businesses
ƒ Financial information is NOT in format of GAAP fulldisclosure financial statements
ƒ Operating information is provided weekly and monthly
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Commercial Bankers
ƒ Banks want annual audited GAAP financial statements
for accuracy and comparability
ƒ Banks want quarterly financial statements
ƒ Other financial information that may be requested:
– Detailed aged payables, receivables and inventory
– Monthly loan covenant calculations
– Collateral reports
– Quarterly cash flow coverage information
ƒ Financial statement data is entered into computer
models and databases to monitory compliance with
debt covenants
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Investment Bankers
ƒ Investment bankers only use financial statements of
clients and potential clients, companies looking for a
liquidity event
ƒ Want audited annual GAAP financial statements for
accuracy and comparability
ƒ Want supplemental information beyond GAAP, such as
history of capital expenditures
ƒ A Fair Value appraisal will be required if the company is
not liquid
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Investors
ƒ Want more information than is provided by GAAP
financial statements
ƒ Are often more interested in operating data than
financial data
ƒ Consider trend lines and year-over-year comparisons to
be important
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Use of GAAP
ƒ GAAP does not provide the detail needed by investors
or even banks
ƒ Certain calculations are difficult and time consuming
– FIN 46
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Debt Covenants
ƒ Not always standardized, and often based on the borrower’s
industry
ƒ Financial information required includes:
– EDITDA and Cash flow
– Tangible net worth (exclude intangibles such as goodwill)
ƒ EBITDA is a proxy for cash earnings, and is very important to
banks
– Segregate depreciation and amortization, so they can be added back
ƒ Debt covenants may require maintaining ratios such as:
– Leverage: Liabilities/Net Worth < 3:1
– Earnings: Debt/EBITDA < 3:1
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Internal Controls
ƒ The ONLY users requesting compliance with SarbanesOxley are investment bankers, in anticipation of sale or
IPO
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Questions?
ƒ ?
ƒ ?
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Next Steps
ƒ Suggestions for follow research on this project?
ƒ Suggestions for other types of research projects?
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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Stay in Touch
Cheryl Graziano
Vice President, Research and Operations
FERF
(973) 765-1064
cgraziano@fei.org
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
Stay in Touch
Bill Sinnett
Director of Research
FERF
(973) 765-1004
bsinnett@fei.org
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Private Company Financial Statements
© 2006 FEI. All Rights Reserved.
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