The Risks of Under-Reporting Income for Business Owners
One of the most critical questions for prospective buyers, investors, and lenders is understanding a business’s true income. However, it should come as no surprise that the party most invested in uncovering this information is the Internal Revenue Service (IRS).
Why is determining a business’s real income so difficult? While financial records should provide a clear picture, business owners often engage in practices ranging from minor adjustments to outright fraud in order to minimize reported income and reduce their tax liabilities. In fact, the IRS estimates that two out of three business owners under-report their income.
Even if a business owner somehow evades detection, this dishonest reporting can create significant challenges when it’s time to sell. Business owners, even those not yet considering a sale, should start preparing by presenting their company as a profitable, legitimate enterprise. A buyer will scrutinize not just the numbers, but also the history behind them. That means that any discrepancies between the books and the tax returns will be a red flag. A fresh narrative about the business’ potential is unlikely to convince a buyer, who will be more interested in tangible evidence of consistent and legitimate profitability.
Here are some steps for business owners to position their business favorably when the time to sell comes:
Think Long-Term
Instead of focusing on short-term tax savings, business owners should prioritize showing long-term profitability. Buyers are looking for businesses that demonstrate consistent, strong performance over a period of time. By ensuring your records reflect maximum profits for each quarter, you can create a more attractive picture for potential buyers. The more stable and profitable your business appears, the easier it will be to justify a higher asking price.
Review and Adjust Past Records
It’s important to take a step back and carefully review past financial statements. If your business has experienced growth, but that growth isn’t reflected in your tax returns or financial reports, now is the time to adjust those numbers. Go through the past few months of records and adjust them to present a clearer, more accurate picture of the business’ financial health. This work will not only improve your credibility with buyers but also set a more favorable stage for future negotiations.
Reconstruct Historical Financials
If necessary, look back even further to reconstruct your financial records in a way that reflects the true profitability of your business over a more extended period. This process involves carefully revisiting past transactions, correcting any under-reported income, and ensuring that your financial history aligns with the real growth of the business. Although it may require additional effort, having accurate financial records that reflect the business’ legitimate success will go a long way toward building trust with potential buyers and lenders.
List Tax-Deductible Expenses and Benefits
As part of your effort to present a more truthful financial picture, it’s crucial to itemize all tax-deductible expenses, such as salaries, fringe benefits, and other perks that are allowed by the IRS. These items provide ongoing value to the business and should be clearly listed in your records. Doing so can help increase the perceived value of your business. Buyers will appreciate knowing the business is efficiently managing its finances while taking full advantage of available deductions.
By addressing these areas, you can not only improve the appeal of your business to potential buyers but also enhance your chances with lenders and investors. Most importantly, truthful financial reporting will keep the IRS focused on someone else’s business.
Copyright: Business Brokerage Press, Inc.
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Understanding the Odds of Selling a Business
When it comes to buying or selling a business, we often get asked two common questions: “How many businesses are for sale?” and “What percentage of businesses on the market actually sell?”
To get a sense of the market, it’s important to break things down by business category. The industries that make up the majority of small to mid-sized business sales include: manufacturing, wholesale trade, retail trade, business and personal services, and household/miscellaneous services. Together, these sectors represent a significant portion of the approximately 30 million businesses in the U.S.
It’s commonly estimated that around 15-20% of small businesses are for sale at any given time, though this figure can vary depending on market conditions. Interestingly, smaller businesses—especially those with fewer than four employees—make up a larger portion of the businesses on the market. However, it’s generally observed that the sale success rates for smaller businesses tend to be lower than for larger ones. Smaller businesses, especially those with fewer than five employees, are often seen as having more challenges, such as incomplete financial records or unrealistic pricing, which can affect their chances of a successful sale.
So why do smaller businesses struggle to sell at the same rate as larger ones? Several factors come into play. Smaller businesses often face challenges like inaccurate financial records or unrealistic pricing. Some owners may not be fully committed to selling or may not be prepared for the complexities of the sales process. In some cases, owners might simply close their doors rather than attempt to sell.
Another key reason small businesses often struggle to sell is that their owners may not be properly prepared for the sale process. Many business owners, especially those with fewer than five employees, fail to plan ahead for the sale. This lack of preparation can include everything from neglecting to update financial statements and resolve legal issues to failing to optimize the business for sale by streamlining operations. If a potential buyer sees these areas as red flags, they might walk away, even if the asking price is reasonable.
To improve the odds of a successful sale, business owners should take a few proactive steps. First, they should invest time in cleaning up their financial records, ensuring that they are transparent and up-to-date. It’s also wise to engage a professional who can provide expert advice, market insight, and help with valuation. Additionally, business owners should focus on making their business more attractive to potential buyers by demonstrating a stable, profitable operation with room for growth. Taking these steps can significantly improve a business’s chances of selling successfully.
Copyright: Business Brokerage Press, Inc.
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