Thinking of Selling Your Business?
Not showing the true earning power of your business on your tax returns and thinking of selling your business now?
When it comes to selling your business and getting the valuation your business deserves, it doesn’t pay to cheat “Uncle Sam”. If you’re not paying the government its share, you are losing out on much larger gains when it comes time to sell your business for its true value.
Let’s say for example, that you’re an S corporation and your tax rate is 26.9%. You have been running a lot of personal expenses through your business and often accept cash and don’t show all this income on your tax return. You did some home remodeling over the last few years and the business paid for these expenses and for a very nice personal toolbox and some incredible tools.
You decide it’s time to sell your business and were referred to a business broker who sold a friend’s business. The broker performed an Opinion of Value and feels that when you add back the personal expenses that aren’t necessary to run the business, you have a value of around $950,000 which is a multiple of approximately three times cash flow. You and the broker agree to market the business for $1MM.
A few months go by and several qualified buyers are interested in acquiring your business, and you really like two of the potential buyers and feel they would both be a good fit to continue the legacy of the company, treat the employees well, and continue its growth. One buyer has similar personal interests as you and is a strong competitor with a great reputation, has a strong net worth and credit score. Soon you receive a letter of intent for the full price offer of $1MM from this individual and you’re so excited about moving on, getting out of debt… Everything is falling into place.
The buyer submits the brokers report with the requested financials and a full explanation of the add-backs used to determine the cash flow to three SBA preferred lenders. The seller cannot prove the cash pulled out of the business but has the receipts for the home improvements, toolbox, and tools. All three lenders explain that they do not accept all the add-backs the broker submitted, and that the seller would have to carry a large note and the buyer would have to come up with more money since the business doesn’t cash flow enough to provide the buyer with a suitable salary, working capital and enough income to cover the debt service on the loan.
The financials possibly justify a valuation of about $650,000 but when it really comes down to it, the bankers aren’t interested in lending on this opportunity. This leaves the seller with the choice of carrying a huge note and possibly lowering the price to get the deal done. That is providing the buyer is still interested in moving forward.
Sometimes the seller must come to grips with lowering the price or holding on to it for another year or two, showing the true earning power of the business by having clean books and records and paying its rightful share of taxes.
Putting more money in your pocket for the last three years costs you a substantial amount in business valuation. In the above scenario, the seller saved $116,667 in taxes but lost $350,000 in valuation (3x cash flow) for a net loss of $233,333.
When it comes to selling your business for maximum value, you must “pay the piper” as you really cannot have the cake and eat it!