Off-balance sheet items are those assets or liabilities that are not reported in the company’s financial statements. They are not on the balance sheet.
Off-balance sheet items are often not obvious. If a seller does not disclose these items at the beginning of the business sale process, the buyer’s confidence in the seller will be shaken when they are disclosed during due diligence.
During a business valuation for tax (and other) purposes, one of my standard questions to the business owner is if there are any Off-Balance sheet items.
The seller needs to be transparent with a buyer early in the process about these items. As I said before, the buyer will discover these anyway during due diligence – so just let the buyer know about it right away.
Here are some examples of Off-Balance sheet items:
- Contract obligations in the future. This would include pricing terms in sales contracts.
- Lease obligations, including terms such as escalation clauses and so on.
- Pending or potential litigation from vendors, ex-employees, or customers.
- Customer prepayments or deposits.
- Outstanding coupons or discounts offered to customers but not yet used.
- Work-in-process billing. This is often used by government contractors or those that manufacture large-value goods.
These all affect the value of a company and would not appear in the financial statements.
Off-balance sheet items can sometimes be overlooked by the seller without knowing. The seller should consider everything that affects the business that does not appear on the balance sheet or financial statements. A sophisticated buyer will find it out anyway, so just disclose it upfront.
