Today’s question is from Charlie in West Cobb. Charlie is thinking about buying a business where the tax returns do not agree with what the owner says he really makes from the business. Charlie wants my counsel on what to do.

Listen to the following podcast for the answer…

Unreported Income [ 6:33 ] Play Now | Play in Popup | Download

Or, read the answer here:

First and foremost, I am not an attorney and cannot give legal advice. Second, I am not affiliated with the IRS or any law enforcement agency. Third, I am going to recite “stories” I have heard from “other” brokers during the last 23 years.

Let’s go case by case. An owner of a trophy shop said he was earning $145,000 from his business, but the tax return said $98,000. To prove the missing $47,000, he walked over to a desk drawer and pulled out a stack of customer invoices that all said “cash sale.” The buyer ran an adding machine tape on the 14 inch high stack, and the total came within $700 of the correct difference. The buyer then went through an entire year’s deposit slips and bank statements and discovered that never once was any cash or checks deposited. Only credit card sales were shown. The buyer concluded that it was very probable that the invoices were legitimate and that the owner kept all cash and checks from the business as unreported income.

The next situation was where the owners of a pizza parlor claimed they were making more than $100,000 a year but their tax return showed $49,000. The buyer asked the owners to prove the missing sales figures. The husband went to his Point of Sale cash register and printed out a very, very long report. The report showed sales by day, by week, by month and for the year. Then he printed out a second report that showed “voided transactions.” The total of the voided transactions report was $56,000. So the tax return plus the voided transactions report totaled $105,000, and the buyer bought the business.

The next situation is absolutely the most unbelievable story I have ever heard in 23 years of being a business broker. Two men who owned a liquor store said they would not sell for less than $300,000 all cash. They guaranteed a minimum inventory of $50,000. Their tax return showed that they earned $55,000, but they claimed they were making $159,000. When asked to explain the difference of $104,000, they said that each of them withdrew $1,000 cash a week for a combined total of $104,000. But the broker and the buyer wanted “proof” of this. The owners then pulled out 16 years of over-sized multi-column accounting spreadsheets. The older years were clearly very, very old, and the more recent years looked cleaner.

But the next part of the story is the 8th wonder of the world. They had kept track of sales for the past 16 years, not by year, not by month, not by week, not by day but actually by “hour.” As unbelievable as this may sound, they could tell you how much product they sold between the hours of 2:00 p.m. and 3:00 p.m. March 26, 1987 or between the hours of 9:00 p.m. and 10:00 p.m. on a Friday night in 1991. When the buyer saw the extraordinary “accounting records” they had been maintaining, he wrote them a check for $300,000 without any further due diligence.

The next situation is not outrageous like the last one. A buyer wanted to buy a light manufacturing company. When he compared the tax return to what the owners claimed they had made from the business, the difference was $22,000. The buyer asked the owners to prove where the missing $22,000 could be found. They went to a file marked “confidential” and produced photocopies of checks that had been written to them personally during the year. These checks totaled the exact amount that was missing, and it was obvious that they were never deposited into the company checking account.

I could go on and on with other stories, but the old adage “buyer beware” certainly applies in all cases. There is a reason for “professional due diligence” using a CPA firm. You want to avoid making the mistake of your lifetime by believing something too good to be true. You need to obtain “unassailable proof” before taking the plunge, and when in doubt, run, don’t walk from any situation where the owner has to work too hard to “convince” you of what he is making that cannot be supported by tax records validated with the IRS.

Author’s note. After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high.

Today’s question was submitted by Alice in Marietta. Alice wants to know what she should do when trying to sell her business.

Listen to the following podcast for the answer…

Top Ten Must-dos When Selling a Business [ 4:38 ] Play Now | Play in Popup | Download

Or, read the answer here:

1. Know why you want to sell your business. Make sure it’s a good reason and not just to dump your problems into someone else’s lap.
2. Give some thought as to what you will do with your time after your business sells. Finding yourself with nothing to do can be very demoralizing.
3. Make certain that your taxes are current. This includes sales taxes, unemployment taxes, payroll taxes, state income taxes and federal income taxes.
4. Document all your policies, procedures and controls. Not only will this help during the transition period when you train the buyer, but this will make your business more appealing to the corporate buyer who is accustomed to formal documentation.
5. If possible, develop and train a strong “second in command” who can fill in for you when necessary. The buyer might be hands-on or hands-off, and having a strong assistant provides flexibility. Many business sales are lost when there is no depth of management.
6. Review each employee’s strengths and weaknesses and show when they were last reviewed and when they next need to be reviewed by the new owner. Not reviewing an employee on time can cause anxiety and diminish loyalty.
7. Make sure your financial statements and tax returns are “bullet proof.” You do not want the transaction to fall apart when the buyer or buyer’s CPA finds discrepancies.
8. Prepare a business and marketing plan that will help a new owner understand where the opportunities for growth exist. This plan should include an Executive Summary that explains why the business was started, how it progressed to its current status and what a new owner should do to take it to the next level.
9. Select an asking price that is based on reality – not fantasy. Be able to justify it based on a multiple of Owner’s Discretionary Cash Flow. Bad reasons include “it’s what I want”, “this is what I have in it”, “this is what I owe the banks” “I have put blood, sweat and tears over x years into the business.”
10. Be willing to be flexible on price, terms or both. Deal structure can make or break a transaction. When each party to the transaction is willing to bend, there is a higher probability of success.

Author’s note. After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high.

Today’s question is from Stephen in Norcross. Stephen would like to know the best time for him to sell his business.

Listen to the following podcast for the answer…

When is the best time to sell my business? [ 6:32 ] Play Now | Play in Popup | Download

Or, read the answer here:

1. When sales and profits have been increasing. Nothing speaks louder than success. When buyers see an upward pattern, they are inclined to believe all is well with the world and will pay a premium price for the business.
2. When your employee base is stable with as many long-term, happy and loyal employees in place. This will reassure the buyer that he or she is inheriting a solid workforce to provide them with technical support in running the business.
3. When your outstanding accounts receivables average 30 days or less. This has two advantages. It gives the prospective buyer the impression that your clients are financially solid and satisfied with your products and/or services. Additionally, if accounts receivables are part of the purchase price, it is unlikely that they will be discounted. Thus you will receive dollar for dollar at closing.
4. When your accounts payables are less than 30 days old. This will reassure the prospective buyer that you are paying your obligations in a timely manner and vendor relationships have not been damaged. It is most important for a buyer to inherit existing vendors so they can receive similar credit and not have to be on a COD basis.
5. When your equipment is in the finest working condition. Make sure you can show when the last time maintenance or repair work was done on each piece of major equipment. Point out if you have been using a preventative maintenance program to keep all equipment in top notch order.
6. When your entire inventory is fresh and not out of date, stale or obsolete. Sell off or dispose of any inventory that is not up to par, since you do not want “bad eggs” to surface during a physical inventory prior to closing. You can jeopardize a business sale by making the buyer suspicious when he or she finds unacceptable inventory items that cannot be sold or contributed.
7. When all your tax returns have been filed timely and correctly. If a buyer has to wait for you to file a tax return that could have or should have been filed many months ago, you will create ill will unnecessarily and cause red flags to surface. Make certain that sales tax, property tax, income tax, withholding tax, unemployment tax, etc. have all been completed and submitted on time.
8. When other investments don’t look quite as attractive as owning a business. If you see that the stock market has declined 40% during 2008, there are many individuals who now see business ownership as a superior “investment” to other types of investments.
9. When long-term capital gains rates are favorable. Many business owners are trying to have their businesses sold by December 31, 2009, since the long-term capital gains rate is 15%. If it were to become 28% during 2010, a $1 million dollar business sale would leave the owner with $130,000 less in his/her pockets.
10. When you still have enthusiasm for the business. If a prospective buyer sees you as a burned out and unenthusiastic owner, they will find it hard to get excited with the prospects of owning a business that ran you down so low. You want to be able to “sell” the buyer on the business with as much energy as possible.
11. When you have a good reason for selling. Good reasons are retirement, health reasons, relocation, aging parents, birth of a child, the commute has become excessively long etc. Bad reasons are the business is losing money, I can’t stay current with my rent, I am undercapitalized, I spent all my money on build-out and had nothing left for marketing, I am burned out, the business takes more time than I thought it would, I lost a major customer, a major supplier went bankrupt, etc.

Author’s note. After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high. In the above situation, the seller and buyer stretch the truth for the common good and peace of mind of everyone concerned.

Truth is truly stranger than fiction, and I continue to be amazed at how many times a business owner with their head in the sky comes crashing down to reality in a very painful manner.

One such case was when a woman owner of a high end men’s and women’s boutique shop in the Virgina Highlands area of Atlanta called us to help sell her business. Now for those of you who are unfamiliar with Virginia Highlands, it is one of those “hot” areas of town where merchants want space and will gladly dismantle an existing business to install their own concept.

When my partner and I met with the owner and asked her how much she wanted for the business, she said $455,000 which I thought to be a rather odd number both due to it being very specific and considerably higher than the business was worth based on its financial performance.

I always ask an owner how their asking price was arrived at, and most of the time I hear one of the following answers: 1) It’s what I want; 2) It’s what I have invested in the business; 3) It’s what I owe the bank; 4) It’s what I need to pay all my debts and to pay back my loans; 5) I put blood, sweat and tears into this business, and I will not sell for less, etc.

I have learned long ago that trying to convince an owner that their expectations are unrealistic when I first meet them will get me shown out the door very quickly without receiving the listing. So I prefer to set the listing price at whatever the business owner wants and let the buying public establish what they feel the business is worth.

So I took the listing at a price of $455,000 all cash knowing full well that no one would buy the business. And six months passed before we received any bonafide offers. At that time, we had two women and one man making offers between $300,000 and $325,000 with differing terms and conditions. Long story short, the owner rejected all three offers because she felt they were not suitable and did not represent the true value of the business as she saw it.

Twelve months into the listing, one man presented an “all cash” offer of $250,000 for the business. This offer was summarily dismissed by the business owner. Now I would like to point out to you that this latest offer was $75,000 less than the best offer previously received.

Eighteen months into the listing, an offer of $184,000 with terms was received from a man. The business owner was so burned out that she accepted the offer even though it was $271,000 less than the listing price, $141,000 less than the first bonafide offer with terms and $66,000 less than the “all cash” offer. The business owner wanted and needed closure so she could move on with her life.

And now the story takes a wicked turn. On Monday of the week of closing, the buyer changed his mind and backed out of the deal. So the business owner and I were left shaking our heads over what a disaster had just taken place, and the light at the end of the tunnel vanished in an instant.

If she had decided that freedom was more important than money when we first met, she could have been less aggressive with her asking price, attracted more buyers and probably sold her business for between $300,000 and $325,000 within 6 months. Then, at long last, she would have been free to pursue anything she chose. But greed reared its ugly head, and the business owner paid the ultimate price of closing her business and receiving nothing for her many years of hard work.

Author’s note. After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high.

1. Do not put a ‘for sale’ sign in the window or on the property. Selling a business is much different than selling a home. You cannot broadcast to the world that your business is on the market. Discretion and confidentiality are critical.
2. Do not stop doing the things that must be done on a daily, weekly or monthly basis. You need to operate your business as if it will never sell. If you let down in any area and sales and/or profits start to suffer, you will regret it forever.
3. Do not build up inventory in advance of a sale. In fact, you should work it down to the minimum level necessary to operate the business. You should do this for several reasons. You want your inventory to be fresh and current or else it will be discounted at closing. It will take less time to take a physical inventory prior to closing. A buyer doesn’t want to tie up their working capital in unnecessary materials or products.
4. Do not let your accounts payables get into arrears. Not only will you damage your vendor relationships, but you will unduly alarm the buyer. He/she may wonder if you are undercapitalized or operating inefficiently.
5. Do not let your accounts receivable go uncollected. Not only will this create cash flow problems, but the buyer may be lead to believe that your clients are not financially stable.
6. Do not use withholding taxes for working capital. Not only is it illegal, but you will be severely penalized with interest, penalties and a possible jail sentence.
7. Do not keep your business looking like a slum. If a buyer sees a physical building or leased premises that is not properly maintained, they may think that is how the business is operated. If the business needs to be painted, hire a painter. If the business needs a good cleaning, bring in a cleaning crew.
8. Do not listen to your friends and business acquaintances when they ask why are you selling. Ignore questions like, why don’t you just hire a manager, why are you giving up making so much money, etc. Quite frankly, it’s none of their business why you are selling. You do not owe them an explanation.

Author’s note. After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high.