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When Taking an Extra Tax Break Costs You More

Many owners work closely with their CPAs. Owners are careful in tracking and itemizing business deductions to maximize their tax savings. The less one has to pay the Government, the better. Maximizing your eligible tax deductions improves your operation’s cash flow. Even though the tax return reports operating losses, this tax strategy generally benefits small operations in their early years. When it comes to Exit Planning, this approach may not be the best approach.

As an owner begins to view Exiting the operation, Enterprise Value becomes more important that tax savings. For small business owners, every dollar of operating profit is worth, on average, $2.70 in Enterprise Value. So, $1,000 in extra operating profit could mean an increase in Enterprise Value of $2,700. In the time leading to Exiting the operation, reducing discretionary spending and operating more cost-efficient should be the emphasis, not maximizing tax savings. Some argue that expensing as much as possible through the business is still the best approach. Buyers adjust for these extra expenses through their recasting process (i.e., converting tax returns into economic statements). What this view fail to realize is that such a strategy puts the Seller at a negotiation disadvantage. The Seller must explain why one’s tax returns do not represent economic reality. Poor tax returns could lead to heavy price discounting by Buyers or, even worse, not attracting Buyers who would normally consider purchasing the operation.

Use sound business practices in your Exit Plan. Those practices should promote rational business-only spending, minimize waste, and discourage unnecessary discretionary spending. Does the proposed activity drive profitability and, in turn, value? Does it enhance the operation’s reputation or quality of service? Is the spending needed to cure an existing detriment to the operation (e.g., deferred maintenance) so to preserve Enterprise Value? Focus on these Earnings Impact activities when developing your Exit Plan.

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