Hard to believe? Mark thought so when I told him he could retire in a little over 2 years if he invested another $45,000 in federal income taxes.
Mark makes about $160,000 a year in salary and ordinary income from his specialty equipment rental business. While walking toward the door he remarked, “I save at least that much by just running expenses through my business.” I convinced him to come back and listen.
At 61 he’s starting his exit plan for retirement. Mark wants to put his feet up when he hits 65 or when he has enough in investments plus Social Security to match his current income.
Like many small business owners, Mark’s business is his largest asset. The business value and sale proceeds will determine how soon he can retire.
So how do you get a great return on investment by paying more taxes?
I explained to Mark that in most cases the basis for the business value is the true cash flow after all business expenses. Every business and every valuation is unique with a lot of detail collected and several methods used to establish and test a defensible value.
Mark!! Why save .35 cents when you can make $3.40?
One of the methods used is the “Ability To Pay Method”. This is the one the Banks focus on because it asks, “How much can the business afford to pay for itself using current finance reality?” Part of that current reality is Small Business Administration guaranteed loans. SBA backed loans are becoming the standard financing tool for reducing the Bank’s risk. The Seller’s risk is also reduced by substantially increasing the cash to the Seller at closing. Hold that thought.
Remember the part about TRUE cash flow after all BUSINESS EXPENSES is the basis for VALUE?
Many small businesses have Lifestyle expenses. A lifestyle expense is a cost to the company that may or may not be essential to the business but does fit the needs and desires of the Owner.
In our example, a new Owner wouldn’t need the marketing expense of Mark’s golf and gun club memberships, excessive life insurance, vet bills for his Chihuahua guard dog, management development seminars in resort settings, three industry conventions each year or the annual board-meeting held in Alaska with Mark’s fishing guide half-brother.
These Lifestyle expenses can be explained when Mark goes to sell but he will be presenting 2 different cash flow pictures to potential Buyers and banks. The internal financial picture may show all the lifestyle expenses added back to increase true cash flow but the other picture will be the Tax Returns showing a much lower ability to pay. SBA loans are based on Tax returns with not much flexibility. A $150,000 swing makes a huge value difference.
Mark could have a rude surprise when the Buyer can’t get financed because the Tax returns don’t support the asking price and Mark is then facing the huge risk of holding a very large note with very little cash up front or a renegotiation to reduce the price.
The valuation on Mark’s business came in at 3.4 times true cash flow. So every dollar of true cash flow is worth $3.40 in selling price. The most Mark saved on every dollar he didn’t pay taxes on was .35 cents. So paying true taxes as part of an exit plan should be a very good investment.
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