Why SMEs Need Extra Scrutiny

Most of the businesses that SMEs want to buy are family-run or founder-led. They're usually vibrant and successful, but they tend to be run with loose financial practices. The accounting reflects what the owner cares about, not what a buyer needs to see. The numbers might not be fraudulent—the owner probably followed all the rules—but they're almost never a fair starting point for valuation.

If you take the numbers at face value, you will overpay. Count on it.

Issue 1: Owner Remuneration and Personal Expenses

This is by far the most common accounting distortion in founder-led businesses.

Founders typically pay themselves below-market salaries to minimize personal income tax. Instead, they take their wealth out through dividends, company cars, business travel, insurance policies, and other personal expenses that run through the company.

The impact on EBITDA can be huge. Imagine a business reporting $500,000 in EBITDA with a founder taking only a $60,000 salary. If you replace that with a market-rate salary for a replacement manager—say $160,000—the adjusted EBITDA drops to $400,000. If you're paying 4× EBITDA, that $100,000 adjustment costs you $400,000 at the negotiation table.

You need to identify and normalize all of these:

Below-market owner salary. Replace it with what you'd actually have to pay to hire someone to do that job.
Personal expenses running through the business. Cars, travel, meals, entertainment, insurance, home office items—all of it.
Family member salaries. Are these people actually doing real work at market rates? Or are they on the payroll as a family arrangement? Adjust accordingly.
Related-party transactions. Any deals between the founder and other businesses they own (property leases, service contracts, supply arrangements). Are these at arm's length, or have they been structured to benefit one side?

Issue 2: Revenue Recognition Irregularities

Founder-led businesses often invoice sporadically. They recognize revenue when cash arrives, not when they actually earn it. Sometimes they accelerate or delay invoicing for tax reasons. In a deal context, this means:

The revenue shown in their financial statements might not match the actual work they performed
Deposits and advance payments might be recorded as revenue way too early
Rebates, returns, and credits might be inconsistently deducted from gross revenue

Ask for both the financial statements and the underlying tax returns for at least three years. Compare them side by side. If there are significant differences between the book revenue and the taxable revenue, dig into why. Those divergences are usually a sign of either sloppy accounting or something more deliberate.

Issue 3: Inconsistent Management Accounts

A lot of smaller SMEs don't prepare formal management accounts every month. They do their financial reporting once a year, usually prepared by an outside accountant primarily for tax purposes. This creates gaps:

You might not have reliable financial data from mid-year
Expenses get dumped in at year-end in big batches instead of being recognized consistently throughout the year
Asset values on the balance sheet might just be what they originally cost, not what they're actually worth

If management accounts do exist, compare them to the audited or year-end accounts. Look for unexplained variances. If you keep seeing differences between what management was reporting and what the formal accounts show, that's a red flag about governance.

Issue 4: Working Capital Distortions

Net working capital, the difference between current assets and current liabilities, gets negotiated hard in every M&A deal. Family businesses often have working capital problems:

Aged debtors. Invoices to related parties or old, loyal customers that were never collected but are still sitting on the books
Inventory overstatement. Slow-moving or obsolete stock still valued at cost
Under-accrued liabilities. Wages owed, supplier invoices, tax provisions, and other expenses that were omitted or minimized to make the balance sheet look stronger
Pre-closing cash extraction. Owners taking dividends or reducing working capital right before the sale, which messes with the baseline you're supposed to be buying

Don't look at working capital at just one point in time. Look at it over a rolling 12-month period. If it's a seasonal business, this matters even more because working capital needs swing throughout the year.

Issue 5: Off-Balance Sheet Items and Contingent Liabilities

Family businesses commonly carry obligations that don't show up on the balance sheet at all. The most common ones:

Personal guarantees provided by the owner that effectively guarantee company debt—these might expire or change when ownership changes
Informal pension or retirement commitments to long-serving employees, sometimes agreed to verbally and never written down
Environmental liabilities for property or equipment, especially in manufacturing, logistics, or food production
Warranty or defect claims that haven't been formalized yet but management knows about
Undeclared tax positions or pending tax audits that haven't surfaced

These are dangerous precisely because they might never appear in the financial statements. You uncover them through conversations with management, employees, suppliers, and through legal due diligence.

Issue 6: Key-Person Dependency Risk and Its Financial Implications

In a founder-led business, the founder often is the business. Their relationships with key customers, suppliers, and employees are personal—not locked into contracts or systems. This risk doesn't show up in the accounting, but it's real. When ownership changes, you might lose customers, suppliers might renegotiate, and employees might leave.

During due diligence, identify which revenue streams depend on the founder's personal relationships. Estimate the probability and financial impact of losing them. That's your real business risk.

M&A - Common Accounting Issues in SMEs

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