Selling Your Business Isn't Always Financially Prudent Even If You Want To

by Dave Driscoll

A business owner recently contacted me for a business valuation. He was considering selling, but before jumping into the sales process, he wanted an idea of what his business is worth and how much he would realize from the sale after fees and taxes.

I commended his thoughtful approach to a life-changing transition. My readers know “it’s not what you sell it for; it’s what you keep!” — meaning it’s the after-tax proceeds of the sale and the impact on your lifestyle that really matter.
Before diving into a very detailed valuation process requiring historical financial statements, interviews, and identification of discretionary owner expenses paid but not related to business operations, I had a conversation with the owner.

We discussed the history, market share and current level of business activity. The business has a very secure position in the market and is growing at a steady, sustainable rate. The company has been operating profitably for more than 30 years, providing a secure lifestyle for the owner and his family. These are very good indicators and are considered “value drivers” a business is being analyzed.

Then the conversation continued.

The business has revenue in the $1.7 million range, profitable with an approximate owner benefit of $200,000. But, surprise! Actual annual sales are about $100,000 higher. Clarification was required…

The business has a “cash and carry” component. The owner was not recording $100,000 in cash payments that were being diverted directly to him. Professional business valuation experts don’t make judgments; we just deal with what can be proved through evidence. In the industry, we say, “You can’t sell what you can’t prove.”

The conversation shifted from the business to the owner’s lifestyle. Like all owners, he wants to continue his presale lifestyle after the sale. He wants more freedom to travel, spend time with family and do the things he enjoys without the responsibilities and commitments of owning a business.

Lifestyle expectations are extremely important for owners evaluating the potential sale of their businesses. At Metro, we want sellers to have a clear understanding of what their “walk away number” will be after the tax on the sale.

This brief overview led to my high-level assessment of estimated cash flow of $200,000 and an unvalidated, pretax value of the business of around $575,000. But this number was irrelevant. What after-tax value could be realized? And how would that impact the seller’s future lifestyle?
Unfortunately, the business was structured as a C corporation, mandating two levels of taxation on the sale. In contrast, an S corporation structure requires only one level of tax. The C status means that more than 50% of the proceeds could be subject to taxation. Yikes!

With the potential of 50% of proceeds devoured by taxes, investing the remainder of the proceeds (roughly $287,000 at full asking price) would clearly not allow the seller to maintain his current lifestyle. The sale would substantially underfund the owner’s retirement needs. Yikes again!

I recommended not selling the business. Appointing someone reliable to run the business can provide the owner with some flexibility for things he enjoys, while continuing to own the business provides him with the opportunity to save money to support his eventual post-sale lifestyle.

This owner is trapped. His choice to benefit from the company’s pretax annual earnings, plus the unreported cash, supported a comfortable current lifestyle, but he had not considered the negative impact for his future retirement. Although this message was difficult to hear, it’s best for the owner to avoid coming to the realization that he could not sustain the family’s lifestyle after a sale.

Dave Driscoll is president of Metro Business Advisors, a business brokerage, valuation and exit planning firm helping owners of companies with revenue up to $20 million sell their most valuable asset. Reach Dave at DDriscoll@MetroBusinessAdvisors.com or 314-303-5600. For more information, visit www.MetroBusinessAdvisors.com.