Gross vs net revenue in acquired brands: what diligence doesn’t carry forward

Every figure in the left column is accurate, and it is what a buyer heard before the deal. After close, only the right column can sit next to the other brands in a board pack.

Sold revenue grew faster than installed revenue here because the backlog grew by $1.0M, so the 22% and the 14% are measuring different things. Moving commission and dealer fees into cost of sales lowers gross margin but leaves EBITDA alone; the $0.5M gap in EBITDA comes entirely from adjustments. Some portfolios take dealer fees off revenue instead of putting them in cost of sales, which is fine as long as every brand does it the same way.

Before the acquisition, a brand’s numbers were read by customers, recruits, lenders, manufacturers and, at the end, a buyer. All of them want to know how big the brand is and whether it’s growing. Sold revenue is the bigger number and it shows up first. A margin with commission and dealer fees left out looks better than one that includes them.

None of that is improper while the brand stands alone. After the deal, the reader is a board comparing five brands, each of which set its definitions for a different reader. KPI and EBITDA glossary

Diligence is there to work out what the business earns on terms the buyer accepts. The quality of earnings work normalizes EBITDA as of the deal. It tests the adjustments, looks at one-time items and run rate, ties earnings to cash, and analyzes the normalized working capital that informs the peg. That work supports the price and the financing.

Revenue cut-off, backlog and customer deposits get tested because they affect earnings and working capital. The brand’s own operating numbers, such as sold revenue, close rate and pipeline, are mostly read for context and taken as management reports them. Since those numbers don’t set the price, that’s a sensible use of diligence time. But it means they come into the portfolio defined the way the brand defined them. Adjusted EBITDA diligence questions

The diligence numbers are fixed as of a date, in a report, a model and a purchase agreement. The brand’s monthly reporting carries on separately, and its operating pack often keeps the old definitions, with sold revenue still the headline number and commissions booked where they always were.

Some of the diligence definitions do carry over, into an earnout or the credit agreement’s EBITDA definition. Those definitions are written for the contract, though, and the board pack doesn’t use them. Adjustments the buyer turned down at the deal can turn up again in the brand’s monthly EBITDA. Redoing the diligence work for the board pack has to be someone’s assigned job. Acquisition KPI integration

A platform built by acquisition has one set of diligence definitions per brand, each fixed at a different closing date for a different deal. The consolidation adds the brands up without changing any of those definitions. Add up platform growth from the brands’ operating reports and the total mixes sold with installed revenue, gross with net, and adjustments one deal accepted and another didn’t.

The consolidated numbers still reconcile, but they can’t show how much of the change between periods came from operations and how much from brands being measured differently. EBITDA growth since acquisition

The board pack needs the right-hand column of Exhibit 1 for each brand each month, which means the finance team has to:

• Approve a portfolio definition for each measure that matters, saying whether it’s gross or net and what comes out.
• Record each brand’s own definition next to it, and write the difference down.
• Reconcile each brand’s submission to its source records on the portfolio definition, and name any gap.
• Keep the definitions current as brands are added and systems change, so each period records which definitions it was measured on.

Brands can keep quoting gross numbers to customers and recruits, as long as the portfolio holds both versions and the reconciliation between them. How to compare performance across acquired companies

Start with the earliest acquisition and work forward, since its definitions have had the longest to drift from the numbers the price was based on.

• What revenue, gross margin and EBITDA did the quality of earnings work conclude for this brand, and on what definitions?
• Which adjustments did the buyer decline, and do any of them appear in the brand’s monthly EBITDA today?
• Does the brand’s operating pack lead with sold or installed revenue, and does the board pack say which?
• Have dealer fees or sales commission moved lines since close?
• On what date were the brand’s diligence figures fixed, and what has changed in its systems or definitions since?
• Which of these figures can be traced to individual jobs, and which exist only as monthly totals?

For the definitional questions to ask of a target before close, see Acquisition KPI integration.