Every time I’m asked to speak to a group of business owners I get a collective “sigh” when I say the following:
“Pay ALL of your taxes.”
Every business owner wants to minimize their taxes. That’s understandable. What they don’t understand, and where you come in, is educating them on the impact that minimizing taxes has on their valuation when it’s time to transition.
Here’s an example:
Your client does $15M in revenue. After COGS and all operating expenses they have a net income of $1.5M. They then work with you to “reduce their taxes” by getting their net income down to $1.0M. Assuming a 30% tax bracket, that is a tax savings of $150,000 that year. You just earned your fee, right?
If that same business owner is looking to exit their business in the next 3 – 5 years they are shooting themselves in the foot by employing such a short-sighted strategy. Here’s why.
Assume the interest, depreciation and amortization addbacks for this business total $250,000. It was also determined that this company will sell for a 5 times multiple.
Scenario #1: Paying ALL Taxes:
$1.5M + $.25M = $1.75M x 5 = $8,750,000 purchase price
Scenario #2: Minimizing Taxes:
$1.0M + $.25M = $1.25M x 5 = $6,250,000 purchase price
Difference in Purchase Price = $2,500,000
It would take almost 17 years of $150,000 annual tax savings to make up the $2,500,000 difference in purchase price. A lot can happen in 17 years of running a business.
What about “normalizing” you ask? Good thought. This is not a dollar for dollar addback to your client’s cash flow. The more addbacks you have the more risk is associated with the deal which could make your client’s 5 times multiple a 4 times multiple. Also, all addbacks will require proof. They paid $25,000 to have their driveway repaved and decided to expense it? They’re going to need a receipt. They decided to run some personal expenses through the business to “minimize taxes”? Going to need a receipt. They’re busy running their business, who is going to produce the receipt or explanation 3 – 5 years after the fact? Probably you!!!
The tax man cometh whether we like it or not. Advise your clients to pay all of their taxes every year and you’ll get them more in the long run.