Joe has owned a successful tire business in suburban Boston for 31 years and has decided it’s time to seriously consider selling and retiring.
Joe’s sales are up, the economy is booming, bank loan interest rates are dropping, and there is a whole new generation of potential entrepreneurial buyers. He’s tired and burnt out and thinks that now may be the perfect time to maximize his sale price.
Like many small business owners, Joe’s income tax returns do not always accurately portray full profitability due to some unreported sales, personal expenses run through the business, and other creative ways to minimize taxes. What’s the next step for Joe? He should immediately contact his accountant with his intentions to discuss the preparation of the 2019 corporate tax return. While many accountants advocate for keeping an owner’s personal expenses separate from the business, Joe’s accountant has done a great job of perfecting the art of minimizing taxes. Since most buyers focus their analysis and sales offer on the previous year’s financial results, 2019 is the year to highlight the “full” profitability and maximize the “sellability” of the business.
Prospective buyers will be valuing his business based upon the net income on the books and other legitimate add backs. In fact, for every dollar of additional cash flow, most buyers will increase their purchase offer by an extra $2 to $3.
Joe’s Specific Action Items to Increase the Sellability of the Business
After discussions with his accountant and business broker, a list of concrete steps were documented to improve the appeal of the financials and 2019 tax return to potential buyers and to show positive cash flow growth trends as they report monthly results in 2020:
- Joe will commit to report all sales and supplier cash rebates in 2020 and end cash bonuses to employees. This will result in demonstrating true monthly revenue that can be extrapolated, while also highlighting increases over the comparative monthly sales figures for 2019.
- Unlike prior years where Joe’s accountant “tweaked” the ending inventory value on the tax return to increase the cost of goods and decrease the profit, this practice will not be employed on the 2019 tax return.
- Joe will reach out to his suppliers to return slow moving inventory items and replace them with fast moving items to increase inventory turns and potentially lower the total inventory value.
- The prior practice of burying personal expenses that cannot be documented will not be employed on the 2019 tax return. Personal expenses that can be documented and other fringe benefits will be recorded clearly so that they can be added back to cash flow when the broker recasts the financial statements.
- Joe will identify records of parts and tires that were purchased by the business and installed on vehicles of his friends and family.
- Joe has only six years left on his building lease, so he will talk to the landlord and request an amendment to add additional renewal options, as buyers and banks want a minimum of 10 to 15 years remaining on a lease.
Recasting: Because a Buyer is Buying His Future, Not Your Past
Creating an action plan to properly prepare your business for sale is the first step toward increasing its sellability. A 2019 tax return that shows a reasonable amount of “Ordinary Business Income” is the starting point for calculating “Seller’s Discretionary Cash Flow,” or the full owner benefit of the business through a process that brokers call “recasting.”
One of the biggest mistakes a seller can make is simply providing a buyer a copy of the business tax returns or unadjusted financial statements. If you want buyers to get excited about your tire business, they need to truly appreciate the full financial benefit and actual income-generating ability. By “recasting” or adjusting the financial statements for presentation purposes, Cash Flow is increased with legitimate add backs such as depreciation, interest payments, personal expenses, and non-recurring items that would not be applicable to the buyer.
Through the recasting process, the full Cash Flow is revealed and the seller has the best opportunity to maximize the sale price of the business.
Joe’s tire business is a hypothetical business and suggestions contained in this article are for illustrative purposes only and not to be interpreted as tax or business advice. The reader is cautioned against implementing any of the suggestions without first consulting with their Accountant. For more detailed information on the process of selling your tire and auto service business, or to initiate a no-obligation confidential consultation, call Art directly at 610.246.1154 or visit www.art-blumenthal.com