by John Mahoney
Partner, Mahoney Lawyers
In this third article in this series I want to talk about one of the most important things to look out for when contemplating the purchase of management rights for the first time – verifying and understanding the income form the business.
Like any business, management rights attracts the good and the bad. Some managers keep poor or distorted records. It is so important – indeed critical - to have an accountant that understands management rights carry out the income verification when buying. It is equally important to have an accountant that is truly independent with no connection to the seller and one who is quite happy to rock the boat if he or she feels that the claimed income is dodgy or unsustainable. You need an accountant who is truly independent and properly representing your interests.
Some in the industry deliberately discourage buyers from using certain recognised management rights accountants because those accountants are known for their thoroughness or toughness. A common problem we see, and which might only be picked up by an accountant doing his or her job properly, is not allowing for wages or enough wages. Some sellers stretch too far the concept of the work that a 2 person management team can carry out.
You should only select an accountant after carrying out your own investigations and satisfying yourself from speaking with other managers and your independent solicitor that the accountant is experienced, thorough and independent.
Remember also that there is no guarantee that the income that will be verified is the income you will receive. Firstly, that is merely the income that the business earned for the period covered by the verification. Depending on how close to the contract date the end of that period was, the income will be some months out of date by the time you settle. It is obviously better to see that the verification period is as close as possible to the date of the contract.
Secondly, the actual income received, for taxation and other purposes, will be somewhere around 10% less than the amount verified. That is because the wording in the standard REIQ contract about “verified net profit” does not take into account a number of expenses that you will incur. Make sure you budget accordingly – a good accountant will be able to help you do that as the accountant will not only verify the income achieved over the relevant period but will calculate the likely income gong forward and prepare a cash flow projection for you.
There are many more aspects of a financial verification than just those that I have mentioned above and your accountant will know exactly what to look out for in that regard.