In part II of this two part series, we speak to a veteran WISP broker about how an ISP's accounting is a fundamental part of its business.

by Alex Goldman ISP-Planet Managing Editor [January 7, 2005]

Tom Millitzer is president of Milwaukee, Wisc.-based New Commerce Communications, and has been buying and selling ISPs since 1997 (and, before that, local cable companies when the cable industry was being rolled up into the giants of today). Check into the website for market notes. As 2004 ends, Millitzer notes that values are slightly higher than 2003 and that business customers are in demand.

Like Hal Hayden, the accountant in Part I of this series, Millitzer reads many ISP financial statements, and he has a lot of advice for ISPs (more, in fact, than we were able to discuss for this article).

Get the basics right
Accounting starts with the basics. ISPs have to understand that accounting is about how they are viewed (like wearing professional business clothing). "Accounting is a presentation about your company," Millitzer says. "Even if you're buying an ISP, the seller may look at your financials, especially if some of your payment is after the sale. If, for example, you give the seller a promissory note promising payment after one year for part of the amount of the acquisition, they'll want to see your financials. That really turns the tables."

In accounting (like editing) it's important to be consistent. "It's a pet peeve. Somebody sends me their financials for Q2 and Q3 and I'm trying to reconcile them, and one quarter has lines that the other does not. For example, you cannot put the price of your T-1s under 'cost of goods sold' one month and under 'telephone' the next month. If the phone bill goes from $800 per month to $8,000 per month, that raises a red flag."

The bottom line (so to speak) is simple. "You have to be consistent year to year and within a year. You don't want to be saying, 'well, sometimes we put this item here, sometimes here, and sometimes here.' If you're selling the company, you don't want the buyer to have to do a lot of work. Sometimes that's my job, if I'm representing the seller. I make the reporting consistent when you're not."

Capitalizing versus expensing
A professional accountant can explain the benefits of the many accounting decisions a small business has to make. For example, an ISP may choose to capitalize its labor or expense it. "Let's say you have a guy working on a NOC for 9 months, costing $60,000 in labor. If you capitalize the labor, by accounting for the cost on your balance sheet it, it increases your EBITDA. It also increases your asset base which and makes you look good to a bank or buyer."

"If the owner expenses the labor they may save $15,000 in current year personal income taxes. If you capitalize the labor, it is depreciated over a number of years and the depreciation lowers your earnings in future years, which lowers your taxes in future years."

That $15,000 in taxes this year may be attractive today but may end up an expensive proposition, Millitzer says. "Let's say you sell your ISP for 4 times EBITDA. If your EBITDA before the $60,000 payment was $200,000, and you expensed it, your EBITDA is now $140,000, and your implied value is $560,000. If, on the other hand, you capitalized it, your EBITDA is $200,000, and your implied value is $800,000. That's a $240,000 improvement. So, always ask your accountant before you make an accounting decision like this. The real world will be somewhere in the middle, but when selling you always want to put your best foot forward"

Personal items
"Every business has personal equipment," says Millitzer, and we don't understand what he means, so he explains. He explains that a business may buy a desk, or a PC, or a van, and park it at their home instead of at the business, and the van might be a lawn mower, or maybe a small airplane.

The point is that most small businesses have items like this. They're called "excluded assets" which means they're not for sale. The existence of the "excluded assets" is no problem at all. However, if they are not identified early on in the process, then there is a problem.

The remedy is simple. "Either don't put these items through your company accounts, or, if you do, identify them clearly. Asking if there are excluded assets is fine and normal in M&A work."

He elaborates. "If a firm like NCC understands your financials they can prepare a supplemental normalized financial statement which defines these items, which more often than not increases the profitability of the company."

On the other hand, if they find out about that airplane because your gasoline expenses seem too high, you won't look very good, because they don't want to buy the airplane.

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