It sounds like a simple question: How much do you make each year in your business? For some owners, it can be surprisingly hard to give an exact answer. Here’s why it’s important to know.
First, if you’re thinking about selling your business, it’s critical that you know the number you want to walk away with. Assuming you’ll want to maintain your current lifestyle after you sell, you’ll need to know how much that lifestyle actually costs.
Owners tell me they base that on their salary. “I take a salary of $120,000 and my wife takes the same.” But I find that many owners use their business to fund other expenses that add up quickly. Health and life insurance, cell phones and electronics, vehicles, gas, meals and entertainment, can all be legitimate business expenses. But they’ll also have to be funded in your life after business ownership. You’ll need to add those expenditures to the income you’ll be planning on after the sale.
The second reason it’s important to understand what you really make is because these addbacks will have to be cleaned up before your business can be valued accurately for a sale. It’s one of the complexities of selling your business: as an owner, it’s in your best interest to write off every expense you can. Your goal is to minimize tax liability.
But when you become a seller, you’ll need to add those expenses back into the books so the new owner can see what the company is really bringing in before they can determine what it’s worth to them. They certainly don’t want to pay a multiple on tens of thousands of dollars of annual addbacks, and they shouldn’t have to do the work of determining which business expenses are legitimate and which are personal.
And that can be problematic. If the buyer is seeking SBA funding, they’re dealing with the federal government. That means your financials will be scrutinized closely. If your tax returns don’t match the actual income you’ve been making, you could be facing some uncomfortable questions.
That’s why I always recommend that owners who are thinking about selling take the time to clean up their books, separate all their personal perks and expenses from legitimate business expenses (including any that might be gray areas.) Adjust your salary so you can afford the expenses you’ve been covering through the company. You will take a tax hit in the near term, but you’ll be able to show a potential buyer what he or she can really expect to earn as the new owner. That will pay off in the long run.