by Dave Driscoll
Cash flow is the common denominator in determining the value and ultimate selling price of your business. Yet owners are loath to put the actual number on the page for many reasons, most of all taxes. Just the thought of compensating Uncle Sam, who has no investment in the business, drives some owners to be overly creative in reducing the business’s taxable income.
When you are preparing to sell your business, your creativity may put you at odds with the goal of maximum value for your life’s work.
The most important question to buyers is: Does the business create enough historical cash flow to recover buyer investment in a reasonable period of time? Right out of the gate the seller must defend his/her asking price. If the seller’s stated cash flow does not support the asking price, the seller must explain the gap between stated cash flow and actual. If the differences are not identifiable and documented, the whole process melts into a pool of unrealistic expectations, lack of trust and frustration. Not a good way to sell your business for maximum value.
Don’t feel like the Lone Ranger when it comes to tax minimization strategies. The game was created when the Act of 1862 established the office of Commissioner of Internal Revenue. Since that point, citizens have been challenging the IRS with very creative ways of minimizing business income. Every buyer expects the seller to have used whatever legal tools are at his or her disposal to minimize tax liability. The seller just needs to identify and document the expense. Once identified, the amount is “added back” to the stated cash flow of the business and cash flow is now “normalized.” The goal is to define the adjusted normalized cash flow of the business – the amount of cash the business generates through normal business operations that is at the discretion of the business owner.
The buyer will then look at the historical predictability of the normalized cash flow to repay the investment to buy the business in a reasonable time period, typically three to five years. (This is the source of the term “multiples” relating to business sale.)
Determining historical cash flow may present a problem if the seller just began planning an exit in the year he/she wants to sell the business. Remember, the buyer is looking for three to five years of predictable cash flow; therefore, the seller must “normalize” the business cash flow for that time period. Reconstructing expenditures is time-consuming and frustrating and can be expensive. Expenses like interest and depreciation are easy, yet what about those items that – because of tax minimization strategies – were expenses during the year that could have been capitalized? Travel and entertainment accounts can also be hard to reconstruct. The price of missing expenses that add back to earnings is measured in the “multiple.” So $50,000 of legitimate normalized cash flow missed can cost the seller $150,000 to $250,000 in selling price.
How do you avoid the potential loss of value of your business? Plan ahead to exit your business by documenting the tax minimization strategies used in each three- to five-year period. This record builds the defense of your asking price at some future date, and when it’s time to sell, you’ll be ready!
Dave Driscoll is president of Metro Business Advisors, a business brokerage, valuation and exit planning firm helping owners of companies with revenue from $2 million to $15 million sell their most valuable asset. Reach him at DDriscoll@MetroBusinessAdvisors.com or 314-303-5600. For more information, visit www.MetroBusinessAdvisors.com.
Submitted 10 years 61 days ago