Business owners who are using their businesses as tax dodges will have a problem when they’re ready to retire, business valuation experts said Wednesday at a Delaware Small Business Development Center seminar at Dover Downs.
“Investors are not interested in break-even businesses, but many small-business owners run their businesses so that they break even on paper,” said Judity Scarborough, C.P.A. and director at Master Sidlow & Associates in Wilmington. “They’re motivated by a tax advantage, so they run all kinds of personal expenses through their business.”
When it comes time to sell, the real value of those businesses is hidden. The profit doesn’t show on the five to eight years of tax returns the buyers want to see.
Your tax returns should show your profit, she said. If you have a good cash business, but it all doesn’t hit the records, you have no proof of profitability. Ditto questionable expenses.
“The thing we find often in small businesses is the owner has a lot of benefits that are running through the businesses. There are family members. In some cases, they do work in that business. In some cases, they couldn’t find their way to that business.”
Scarborough said business evaluators will follow the rule that if you can’t prove it, it didn’t happen. “Don’t expect that people are going to trust that your business is worth 50 percent more than what you show on your tax returns,” she warned.
The very benefits that make your business your baby might be problems when you go to sell, she said, so she recommended owners get their financial houses in order.
David K. Bernstein, principal of RLS Associates, a Wilmington mergers and acquisitions firm, said prospective buyers look for one thing when evaluating a business – sustainable, transferable profitability. If you run personal expenses through your business or have family members on the payroll who are not providing economic benefit, that reduces your profitability in the eyes of a buyer.
“If you’re going to own a company, your number one job is to build shareholder value – even if you’re the only shareholder,” Bernstein said. To sell, you first have to get anything that detracts from the business’ value off your books, he said. Owners who try to save on taxes by deducting personal expenses wind up losing much more when they sell because their businesses look less profitable on paper.
“Clean up your house if you can before you get ready to sell,” Bernstein said. “Clean the finances. Buyers will notice and do care.”
The event was sponsored by the SBDC, Bank of America, Harvey Hanna & Associates and the Delaware Business Times.