Here’s an interesting thing about working in the trades: there are more customers willing to pay you in cash. I’m not sure whether it’s about expressing solidarity with the working man or an acknowledgment that accepting cards can cost a small business between 1.5% and 3.5% per transaction. And some business owners are not averse to saving both card fees and taxes on a job. But if the goal is to sell your business, the math doesn’t support it. Here’s why:
Keeping some jobs off the books is not only illegal but also hurts your credibility about everything. Most business owners, on the advice of their accountants, practice a tax mitigation strategy. In the highest income tax bracket, you could owe 37 percent of your annual income in taxes. So it makes sense to show less profit and more expenses, in a way.
But when you’re trying to sell your company, you can’t get paid for income you haven’t proved. Buyers want to know they’re getting the full picture of a company’s profitability. If they can’t base their offer on tax returns, they start to doubt everything. The deal might very likely fall apart. It’s cleaner and easier for everyone if all your income and expenses are accounted for in your tax returns.
When you don’t report some income but report all the expenses associated with it, your bottom line is skewed. When a customer pays cash for the job, your cost of providing the service doesn’t disappear. You purchased a part and paid the technician. You paid for gas to get to the job. When all those expenses go on the books, without the income to support them, your profit margins start to look thinner and thinner.
Buyers are buying cash flow, which is why owners who are building a business to sell should keep personal expenses off the books as well. Addbacks are complicated, and they make buyers nervous because they obscure the company’s true cash flow. And if you’ve been underreporting for years, then suddenly clean up the books when you list the company, the “hockey stick” profitability trend means both your buyer and lenders will have serious doubts about financing the deal.
Here’s how the math works. In the scenario above, every dollar that’s not reported as income saves the owner 37 cents in taxes in the current year. But it also reduces the amount a buyer is willing to pay. 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.
For an owner, the math is pretty simple. You can save 37 cents in taxes on every dollar you make now, or you can make 3X or 4X on every dollar of revenue when you sell. If you have a 2-3 year window for retirement or selling your business, the time to make a change in your tax mitigation strategy is right now.
