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 is the impact that minimizing taxes has on their valuation when it’s time to transition.
Here’s an example:
A company does $15M in revenue. After COGS and all operating expenses they have a net income of $1.5M. They then work 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. Sounds good, 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 cash flow. The more addbacks you have the more risk is associated with the deal which could make your 5 times multiple a 4 times multiple. Also, all addbacks require proof. You paid $25,000 to have your driveway repaved and decided to expense it? You’re going to need a receipt. Decided to run some personal expenses through the business to “minimize taxes”? Going to need a receipt. I don’t know about you, but as a fellow business owner I don’t think I’m going to remember all that I did 3 -5 years ago to “minimize taxes.”
The tax man cometh whether you like it or not. Pay all of your taxes every year and you’ll be ahead in the long run.