Here are 3 ways for you to maximize the value of your business using multiple arbitrage.
1. Make an investment in your books. It is common among business owners to view the cost of financial reporting (keeping the books and accounting) as an expense. It is seen as a “necessary evil”. The cost of the accounting department is viewed as a necessary expense incurred to do business. This view is wrong. I suggest you have a paradigm shift in regards to how you view the financial reporting for your business. Make an investment to have good books and records that will pay dividends of over 875%. One word of warning about this. You may experience some growing pains here. I’ve seen many businesses that have literally outgrown their CPA. You will need to “get real” with yourself and honestly assess the advice you are getting, the timeliness of service and quality of the reporting. Do not be loyal to a fault here. If it’s time to let go, then cut the strings.
2. Convert to full GAAP/Accrual accounting for internal reporting purposes. Business owners sometimes think that merely keeping the books on a cash basis forces them to not do full accrual/GAAP accounting for in-house purposes. This is simply not true. Keep the books on an accrual/GAAP basis in-house and on a cash basis for tax purposes to maximize the selling price of your business. Eventually the IRS will force you use accrual accounting for tax reporting, but your CPA will generally recommend that you stay on a cash basis as long as you can.
Be prepared for some backlash here from your CPA when you tell her what you are doing. She’s going to look at you over her black-rimmed glasses like you have lost your mind, but it is an INVESTMENT that will pay off. The important thing to remember is Investors buy based on GAAP/accrual basis financials. Many small businesses do their books on tax basis or cash basis accounting. Why? Tax basis or cash basis accounting minimizes short-term Net Income. When we sell or value a business, we seek to maximize the Net Income because buyers buy and value a business based on EBITDA (Net Income plus interest, taxes, depreciation and amortization) which is a derivative of Net Income. GAAP accounting maximizes Net Income. If you look at publicly traded companies, they do their financial reporting on a GAAP basis. Why? So they look good to their investors! This is precisely what you want to do when selling your business.
3. Pay more taxes. When the IRS forces you to go to accrual accounting pay your taxes and be happy to do it because the investment will pay dividends of 875%. I never thought I’d say this with all of the government waste (another topic, another time), but it is FAR BETTER for you to pay your taxes when positioning to sell a business. Here’s the math.
For every $1 you increase EBITDA you get $3.5 more dollars of selling price. For every $1 you show as income on your taxes it costs you roughly 38 cents in taxes. Invest 38 cents to get $3.5.
Now let’s convert that to real numbers. If you show an additional $100,000 of income, depending on the tax bracket you are in, you’d pay $40,000 of taxes. If you show an additional $100,000 of EBITDA, you would get $350,000 of income at the time of sale. The question I ask is: would you rather have $40,000 in your pocket now or $350,000 in your pocket in the future? Spending $40,000 to make $350,000 is an 875% return on your money. Where else are you going to get an 875% return?
Rick Krebs, CPA – Valuations Expert & Mergers and Acquisitions Professional. Creator of the MyBizValue system for business valuation and Principal at Business Sales Group. He graduated with a Master’s of Science Degree and Bachelor’s Degree from Utah State University. He has been valuing businesses for over 24 years.