When you are selling a business, you want the maximum price for your business. Prior to selling the business, you want to retain as much of the profits as possible and pay the least amount of tax. Unfortunately, aggressive tax planning may reduce the amount of money that you get for your business and it can also affect what is being sold. For tax purposes, it is cheaper for the owner to sell the shares of a business however if there is a lot of hanky panky going on in the business, no one will want to take on the risks associated with your aggressive tax planning. As a result, they will buy the assets of the business only which affects the net cash that you retain after the sale of the business.
What type of tax planning affects the price of a business? There are many types including:
- not reporting cash sales, this is illegal anyways however many people in the retail of food business often do not record all transactions in the cash register. As are result, the sales are understated, all the costs of serving that customer are recorded in the financial statements. This means that profits are understated.
- instead of paying taxes, the business owner starts to buy supplies and various items which goes through the business. Trying to explain after the fact that these expenses are not a normal operating costs may be difficult, as a results profits could be understated.
- combining holidays and business travel, how do you state that the trip was personal? Expenses are high and profits reduced.
- Selling to friends at lower profit margins, those customers may not stay for the new owner but excessive sales to related parties will mean lower margins for your goods
- if the business owners consumed goods for their own personal use i.e. food purchased in a restaurant, then the costs would reflect the true costs but revenue is understated
- if you own a real estate property and family members are staying rent free or a very low price, that will affect the revenue/profit and valuation of the business.
As you can see, saving taxes and selling the business work in opposite directions, the more that you reduce your sales, the lower the profits will be the lower and so will the purchase price. Buyers look at a three year average therefore not spending in one year will look like you are inflating the profits in the business just prior to sale therefore are making the financial statements look suspect.
Many years ago, a business asked for a valuation. It was a furniture retail store and claimed that most transactions were done in cash. It was suggested that there was nothing to value because since there was no traceable transactions. He would have been better to continue to operate for a period of time then close down the business because the tax consequences from the lack of reporting would have been greater than the selling price of the business. When you sell a business, you need to look 2 to 3 years out and plan for your retirement, leaving retirement to the last minute does not allow you to plan to stop abusing the business and concentrate on improving profitability.