As a business owner, you probably want to pay as little in taxes as possible, right? Fair enough, and with a sharp accountant on your team, you can reduce your tax burden quite a bit. But, if you can envision potentially selling your business in the foreseeable future, stop what you’re doing, before you damage your company’s salability any further. This 5-minute read might make you rethink driving down your net profit just for the sake of tax savings.
Tax Mitigation 101
Financial manipulation is part of running a business. I mean, does anyone really like to pay high income taxes? No. So, what do we do? Here are a few of the most common ways business owners reduce their taxes – let’s see how many of them apply to you.
- Defer revenue into the upcoming year
- Prepay large expenses for the current year deduction
- Pay family members more than they are worth
- Pay for personal expenses
- Purchase higher priced goods and equipment
- Accept side work and/or cash off the books
Whether you do one or all of these things, your mindset is like everyone else: “When I make less in income, I pay less in taxes.” Again, totally understandable, and we defer to your accountant when it comes to tax advisory.
What You Show is What We Can Sell
The problem with making your business appear less profitable is that you simultaneously make it appear less attractive to buyers. I won’t call it common sense, because I meet so many business owners who never thought of it that way. But I will say that I hope it makes perfect sense now that it’s out there. If you’re deliberately undercutting your net profit, you have to understand that you’re hurting the figure buyers gauge a business by.
“But I made more than that,” owners will say.
Great, but if you didn’t show the income, we can’t sell the income. Although we can show “add backs” or recast the financials it is still much easier to sell what is shown. Also, a bank will only be able to use your reported financials for any financing qualifications. You can tell me that you took a $100,000 side job or sold $200,0000 worth of scrap metal. I believe you wholeheartedly, but unfortunately, anything that wasn’t reported to the IRS can’t be credited in the sale price. Higher revenue with higher personal expenses won’t do the trick, either. It’s all about profit.
Let’s say you’ve made the decision to sell and we determine that the sales price is based upon a 3x multiple of your net income If you reported that your business shows $500k in net profit last year then the sales price would be 3x that, or $1.5 million.
That means that for every $100,000 of deferred income, cash taken, prepaid expenses or any other strategy you used to lower your income tax lowers the sales price by $300k.
When you decide you want to sell your business you have to show the real income and pay real taxes in order to maximize your value. It’s can be tough to find balance when that means evaluating your year-end financial mindset between minimizing taxes and maximizing profit.
What Buyers Are Looking for in a Business
When you’re producing financial reports, consistency and growth are the two things you want to show if you’re going to sell your business. If you are willing to accept a little more in taxes to exhibit higher profits and year-over-year increases for both income and net, you will be in a great position with buyers when you’re ready to exit. After all, everyone wants to buy a business that is growing.
There is a balancing act between your personal vs. business finances, the present vs. the future, and saving now vs. selling later. Let us help you keep it all synchronized with honest, straightforward consulting specifically geared toward selling or exiting your business. Learn more here.