By Joan M. Gruber Ridley, CFP™, CEPA, CBI
President, Business Wealth Solutions
Growth Phase Tax Planning
Like most business owners you have probably developed your own tax reduction strategies and your CPA has gone along, even if he or she did not entirely agree with your aggressive approach. Legitimate tax reduction strategies are a good thing, but not at the expense of creating value. Let me explain. Your operating expenses might include a few personal perq’s that are questionable business expenses. When we talk about personal perq’s, we are referring to writing off a speed boat because it has your company name on the side which you call advertising, or an airplane because you sometimes use it to visit with clients or to take clients on trips. While these goodies are sometimes used for business, they really do not add value to your enterprise. Legitimate tax reduction strategies that add value to your business would be better use of your company dollars.
While you might be able to reduce taxes now by claiming that these items are truly business expenses, a serious, qualified buyer might not share your view about the effect these expenses have on enterprise value. Buyers typically place value on your company, initially, based on a multiple of net income plus add-backs, or, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). The multiple is determined by current market conditions, the type of industry you are in, certain aspects of your business, and several other factors.
Example: If EBITDA for your company is $2MM and the multiple range is 4x to 5x, then the value of your business, very simplistically, would be $8MM to $10MM. There are many other factors that are included in determining the value of a business, but determining EBITDA and a multiple of EBITDA is a start.
Although a strategic buyer would likely be willing to pay more for your business, that entity will go over your financials meticulously just as a financial buyer would. There is a limit on what any buyer, financial or strategic, would pay because all buyers are looking at your business from the standpoint of risk versus reward. How you arrive at your bottom line is very important in terms of a conversation about value. Further, your acquirer’s banker will have a limit as to how much it will lend based on your company’s numbers and that will greatly influence how much a buyer will be willing to pay.
So, while you might be saving tax dollars today by writing off personal goodies as a business expense, in the end you could be sacrificing a multiple of your bottom line and you are not growing your asset value. If you spend current revenues on goodies today, rather than investing in the business to facilitate its growth, you might be viewing your business as a job rather than an asset. The former might be acceptable so long as you are investing wisely outside your business in a prudent portfolio. If you are not growing enterprise value, you might not have an asset to sell when you are ready to exit. In that case, your investment portfolio would be available to replace the income and all those goodies that were previously once provided by your business. Another point to consider is if you tax deduct quasi personal expenses and then represent to a buyer that these same expenses were not really business expenses and should therefore be added back to increase EBITDA, you could immediately lose credibility, and, quite often, a qualified buyer.
Value-Enhancing Tax-Deductible Expenses
Here is a short list of tax-advantageous expenses and systems that could add value to your business:
If you really need all those planes, boats, luxury cars, and exotic vacations, increase your salary and pay for them personally, rather than with corporate dollars. Some ownership salary might be an add-back. If you must continue using corporate dollars to fund your special needs, discontinue this strategy at least three to five years before you plan to exit. That way, you will have three to five years of clean records to show a buyer and his banker. But, keep in mind that when qualified buyers and lenders willing to fund transactions are scarce, the company that has prudently reinvested in the enterprise is more likely to sell, and sell for top dollar.
Pre-Exit Tax Planning
If you are hoping to exit your business in the next decade, explore and implement strategies that will save you tax dollars now and a great deal more when the time comes to leave your business. The sooner you begin planning, the greater the opportunities you will have available to maximize the amount you walk away with. Pre-exit tax planning is beyond the scope of this article and will be addressed in a future communication. However, always consult with a qualified tax advisor before implementing any tax strategy.
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For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall at Eric@EdisonAvenue.com or 239.738.6227. Also, visit our Edison Avenue website at www.EdisonAvenue.com or my personal website at www.BuySellFLbiz.com.
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