The Impact of Tax Cheating on Selling Your Business

I recently visited a prospective client with an interesting, growing business that he wishes to sell.  According to the government he wasn’t profitable and he paid no taxes, but in reality the business produced over $1 million in earnings.  As I learned more, I began to worry that he had crossed the line, and it would make it difficult to sell the business.  Where is that line?

 

I often hear from business owners, “everyone does it”.   That isn’t true, but it is true that many do indeed fudge a little on their taxes.  Here are some scenarios, starting from the, “probably not a problem”, to a very real risk of fines/jail if caught.  By the way, I have seen all of these items.

 

Scenario A

-          Has company car, but not used much for business

-          Takes spouse on business trip, expensed as business

-          Family plan cell phone bill is expensed as business

 

Scenario B

-          Golf club dues paid by business

-          Fudging inventory levels to minimize profits

-          Personal RV expensed as mobile office

-          Significant use of personal expenses as business

 

Scenario C

-          Business work crew used to build vacation home

-          100% personal-use airplane ( in one company I visited, a King Air used for Las Vegas jaunts) expensed as business

-          Multiple 100% personal, exotic cars expensed as business

-          100% personal Caterpillar D9 tractor hidden under “office supplies” (I know, what does one do with a personal D9?  When I asked that, the owner pointed to it in his back yard, and said he wanted to build a bridge down the road)

-          Any scenario involving hiding revenue

 

I think it really comes down to the amount of money taken from the government.  A little bit, and it isn’t worth their time to go and get it.  SBA loans are approved with scenario A stuff disclosed all the time, so in a way one agency of the government is giving pseudo-approval.  But if you take a lot of money from the government you can find yourself in a lot of trouble, to put it mildly. 

 

Business buyers are a risk-averse group, and they do not want to be even remotely engaged in an action with IRS.  They all have different risk levels and most if not all are fine with scenario A stuff, but when they get an indication that significant tax evasion has gone on, they start dropping off.  It definitely limits the number of buyers.

 

It also puts the seller more at risk.  The seller wants the full value for the business, so they are going to be claiming a high earnings level based on the adjustments for the tax maneuvers. A buyer is going to demand proof of these adjustments, in order words proof of the dirty deeds.  Some buyers hope to just verbally explain the actions, but a smart buyer (or rather, a smart buyer’s attorney), is also going to want to limit liability by having the seller acknowledge his actions and agree in writing to take responsibility for them.  As you can imagine, it can be tough to work that out.

 

Woodbridge once had two offers on the table for one of our clients.  It turns out (we didn’t know until he disclosed it to the buyers), that the client was involved in a couple of Scenario C activities.  He was also indispensable to the business for at least a few years post-close.  The buyers were warned from their legal counsel that the seller risked a jail term if caught which would be very damaging to the business.  That killed the deal for both buyers and the business didn’t sell.

 

These types businesses are sold every day, so it is possible.  But heavy tax evasion does limit the number of buyers and does push the value down since it is difficult to capture all the adjustments (not to mention the difficulty of getting financing…).  If you are a Scenario B/C person, the best strategy (in regards to selling the business) is to show your earnings and pay taxes for a year or two before you sell.   

 

Wish to learn more?  Download my free eBook at www.compasspointcapital.com