Emerging Company M&A: Pre-Sale Accounting Best Practices for Buyers and Sellers

As buyers tighten their purse strings in a volatile economy, parties on both sides of startup M&A deals must ensure they are prepared to effectuate the transaction from a financing perspective as well as address the related financial reporting and other accounting implications.

At a Glance

• Solid exits for emerging companies are increasingly scarce as investors and strategics flee to quality in an uncertain economic landscape.
• Among many necessary tasks, founders looking to sell must ensure their books and records are properly maintained so the financial statements are able to withstand heightened due diligence.
• For buyers, it’s more important than ever to have a clear understanding of both tangible and intangible assets to be acquired and operational and contingent liabilities they will assume. Depending on the nature of such assets and liabilities, they may or may not be recorded at fair value on the seller’s balance sheet.

Scrutiny on early-stage and other smaller businesses engaging in a sale process is intensifying as VC, PE, and strategic buyers seek quality in a volatile economic landscape.

The resulting dynamic is one of haves and have-nots. “Large, established startups are landing outsized deals and more money, while the youngest or less sophisticated companies struggle with fewer investment dollars,” Crunchbase reported in late April, noting that global early-stage investment in the first quarter of 2025 fell to its lowest level in at least five quarters.

Meanwhile, the IPO market is at a standstill compared to prior years, and M&A activity remains more modest than many onlookers had hoped. As competition mounts, even those emerging companies that end up going public or getting an acquisition offer may struggle to secure a valuation commensurate with a seller’s expectations.

Given the challenging environment, it’s vital that both parties plan and execute such that the value of the transaction is maximized. Sidestepping consequential financial accounting and reporting pitfalls is one way to do just that.

Buyers: Understand What You’re Purchasing

In today’s market, it is especially important that prospective acquirers of emerging companies understand exactly what they are purchasing and how to allocate the purchase price among the assets acquired and liabilities assumed. Failure to perform proper due diligence can result in overpayment as well as unanticipated expenses and other contingencies subsequent to the transaction. To that end, buyers should ensure they:

Properly identify and quantify the value of intangible assets — Intangible assets like patents, trademarks, developed technology, and customer-related intangible assets are increasingly included in the core assets a business possesses—this is particularly true for tech startups. Global corporate intangible value grew by 28% in 2024, with the U.S. leading as the most intangible-asset-intensive economy. To avoid unnecessary tax liabilities and costs, emerging company buyers should ensure these assets are appropriately identified and recorded on a seller’s balance sheet. For example, a SaaS company that is acquired may hold technology assets that were developed internally as well as technology that was purchased in the open market. Most internally developed software will be classified as what is referred to as a Section 197 asset for tax purposes and subject to a 15-year amortization. Alternatively, previously purchased software acquired in a business combination will likely be amortized over a shorter period of time for tax purposes. This can ultimately have a material impact on cash tax consequences over time. Buyers should be vigilant in identifying an emerging company’s unrecorded liabilities throughout the due diligence process. Common pain points include the following:

• Sales and value-added tax liabilities
• State income tax
• Potential or ongoing lawsuits
• Expenses incurred but invoices not received or properly entered into the accounting system
• Escheatment liabilities
• Payroll taxes

Buyers should also be cognizant that preferred stock issued in conjunction with an acquisition could be classified as a liability in the financial statements of the entity acquired and require annual adjustments through the income statement to redemption value under GAAP, which can cause undesired volatility in a company’s financial statements. Given the potential impacts on the new entity’s financial results, buyers should best mitigate many risks associated with a transaction by ensuring the right team is in place, inclusive of third-party experts like CBIZ’s Financial, Accounting & Advisory Services group.

Watch out for deferred revenue and the corresponding accounts receivable balances — Many startups, especially SaaS companies, operate on a subscription model. That can create unexpected financial issues for both buyers and sellers.

Since subscription revenue, such as billings to customers, often occurs at the beginning of a subscription term. Depending on the date of a M&A transaction, a seller’s company will likely have received cash associated with services that, as of the date of the transaction, are unperformed (i.e., the remaining term of the subscription period. Alternatively, a seller’s company may have performed services for which billings have not occurred as of the date of a transaction. Understanding both of these scenarios will assist buyers and sellers in terms of reaching an agreement as it relates to any necessary working capital adjustments.

Sellers: Get Your Financial House in Order

Most founders are (understandably) focused on their business, not technical accounting and/or tax matters. But as scrutiny and competition intensify, sellers will often need to make improvements to the financial reporting process. Discipline in this regard will result in a greater likelihood of a successful exit—M&A, IPO, etc. Some best practices include the following:

Make sure your books are GAAP-compliant

When conducting due diligence on a prospective target, the most sophisticated investors or buyers will often insist that the books and records be maintained in accordance with generally accepted accounting principles (GAAP). The following matters often require expertise to ensure the accounting is appropriate in the circumstances:

• Revenue recognition — Are you recognizing revenue in accordance with ASC 606?
  • Is your revenue being properly recognized up front or over time?
  • Ensuring that revenue is recognized by distinct performance obligations versus combined can have a material impact on the timing and amount of revenue being recognized.
  • Buyers are often looking for recurring revenue. Being able to accurately quantify historical and anticipated recurring revenues will be crucial in terms of maximizing the value received in connection with the transaction.
• Capitalized Software Costs — Under GAAP, capitalizing internal use software costs, including interest, is required. Many early-stage companies do not perform these calculations properly or at all.
• Lease Accounting — ASC 842 requires that all operating leases be recognized on a company’s balance sheet. This accounting can be complex and has resulted in many errors identified in connection with the preparation for a transaction.
• Debt versus equity classification of preferred stock, warrants or derivative instruments — Oftentimes, early-stage companies have complex debt, equity and/or derivative instruments that require expertise to ensure the accounting is appropriate in the circumstances.
• Expenses — Sellers need to ensure that they have performed an accurate cut-off analysis to ensure expenses in the proper period (i.e., pre- and post-transaction).

Ensure you are audit- and QoE-ready.

Companies contemplating a possible sale transaction are best served by proactively having an external auditor complete the financial statement audit and/or review for periods relevant to the transaction. Procrastination related to these tasks often results in a very condensed timeline in terms of when the work can be completed, as well as elevated costs associated with the exercise. In addition, sellers should also be prepared for the buyer’s Quality of Earnings (QoE) procedures/review, which will require that information associated with the following is readily available:

• Historical P&Ls and balance sheets
• Monthly/quarterly metrics
  • Non-recurring items
  • EBITDA adjustments
  • Gross margin
  • Potential cost synergies
• Revenue by customer and product
  • Concentrations of revenue
  • Recurring and non-recurring revenue streams
  • Retention/churn and cohort data
• Tax Matters
  • Historical tax compliance
  • Open audits
  • Loss carryforwards
  • Potential tax exposures
• Key Contracts
  • Significant customer, supplier, vendor, lease and other agreements
  • Change in control provisions
  • Termination rights
• Employee and management issues
  • Key employment agreements
  • Compensation and benefit plans
• Intellectual Property and Technology
  • Ownership
  • Protection of IP
  • Cybersecurity and data privacy practices

Accurate cash flow forecasts, supported by the underlying data, are crucial in terms of deriving the value of a business.

Asset Versus Stock Sale Tax Classification

The tax benefits of an asset sale versus a stock sale can be significant for both buyers and sellers. Coming to an agreement on which classification can often impact the negotiation process and the purchase price paid.

Asset sale tax classification:

• For Buyers:
  • The buyer receives a step-up in the tax basis of the assets to their fair value, which allows for higher depreciation and amortization deductions in future tax years.
  • Buyers can often “cherry pick” assets and liabilities to acquire, potentially minimizing exposure associated with unknown or contingent liabilities
  • Most acquired intangibles are amortized over 15 years under IRC Section 197
• For Sellers:
  • Sellers may face higher overall taxes because gains on certain assets are taxed at ordinary income tax rates
  • Potential double taxation may apply to C corporations (corporate and shareholder levels)
  • Allocation of sales prices to various asset classes may result in unfavorable tax rates for certain categories

Stock sale tax classification:

• For Buyers:
  • No step-up in basis of assets acquired, resulting in lower future tax depreciation and amortization
  • Buyers inherit all the sellers’ liabilities, including those disclosed and undisclosed, and contingent liabilities
• For Sellers:
  • Capital gains treatment versus ordinary income
  • Simpler as all assets and liabilities transfer upon sale of the stock

Act Now, Save Later

Uncertainty is not going away anytime soon. As a result, we expect dealmakers to be conservative when evaluating potential acquisitions so long as these conditions persist. Given the volatility of the marketplace, the complexity associated with the financial reporting and accounting for M&A transactions, as well as the potential for financial missteps, third-party accounting and tax experts are often utilized to supplement the existing management team.
In every case, proactive preparation is crucial to avoid common pitfalls, which can have immediate consequences as well as ongoing pain points. CBIZ’s Financial Accounting & Advisory Services group can assist buyers and sellers to ensure deals are properly structured and executed from a financial reporting perspective. Connect with us today.