If you’re within a three-to-five-year window to sell your business, you should be working on maximizing the amount of taxes you pay for those years.
Yes, you read that right. A business owner’s mentality is almost always set on minimizing the tax burden at the end of the year. And there are plenty of ways to do that. But if you’re building a business to sell, you’ll need to change your strategy. Here’s why:
Creative accounting costs you money when you sell the business.
Let’s assume that you and your accountant recategorize $100,000 of profit to Cost of Goods Sold. That reduces your profit and thus, your taxes. In the highest bracket (about 37%), that would save you $37,000 in taxes this year. But if you sell your business next year, that same $100K of profit could be part of a 3–5X multiple. That means you’d earn $300,000–500,000 from it. The math of paying taxes almost always makes more sense than the math of avoiding them.
Add backs and sudden profitability erode a buyer’s confidence in your financials
Add backs are defined as one-time expenses or personal expenses that an owner runs through the business. Many owners pay themselves a smaller salary (saving payroll tax) because they run expenses like their family’s phones, home landscaping, personal vehicles, or kids’ insurance through the company. They save on taxes and don’t pay for these expenses from their personal budget; it feels like a win/win.
But when an owner decides they’re getting ready to sell, they usually change the methodology. They eliminate all the add backs (brokers always recommend this as part of “cleaning up” the books.) Suddenly, a company that hasn’t made any money for the past five years is very profitable. That’s a red flag for buyers and lenders (and possibly the IRS), who now have reason to doubt the owner’s financials. That will set the tone for a more adversarial diligence process. If these numbers aren’t exactly above board, what else might I be missing? Clean financials and accurate tax returns build trust, which is the key to any successful business deal.
Owners will factor what they’ll need to invest to normalize costs and salaries into their offer.
We see this most often in companies that employ family members. Sometimes, a family member might be performing a function for nominal (or no) compensation. In other cases, a family member might be paid much more than the going market rate for that job. Either way, a buyer must calculate the cost of replacing the function based on current market value. That includes hiring a general manager to replace an owner who’s been overseeing the everyday operations for years. Owners who are still turning wrenches may be saving money for the present but lowering the value of their business for buyers.
We’ve seen cases where an owner must sell unexpectedly. Health issues, divorce, even death can change an owner’s plan without notice. If the company hasn’t shown any profit on tax returns for years, the company won’t have much value on the market. It’s better to change your tax strategy early so unexpected circumstances can’t derail your retirement or your family’s financial security.
The trendy social media buzz is about “maxxing” everything: looks, fiber, health, sleep – almost anything else you can think of. Here’s my challenge to business owners: be a trendsetter and make “tax maxxing” your goal for the next few years to maximize the value of your business.
