A question that occasionally comes up in our Business ProSell program is whether a seller can and should reveal to prospective buyers that the business produces extra income not reported on tax returns.
The purpose, of course is to let the buyer know there is more income to be made from the business than is posted in the business records, The expectation behind this admission, is that the buyer will be more inclined to make an offer and at a price that will satisfy the seller, if buyers learn there actually is more money collected than is posted.
But many small business entrepreneurs, particularly business sales intermediaries, think that lying to the government about the actual business income subject to taxation is a mistake. And bragging about it only compounds the error.
A number of business owners systematically under-report their companies income. Perhaps most get away with it. One reason they can avoid being examined by taxing authorities is that there are far fewer agents than there are business owners who don't pay their required share of taxes. One seller told me that some buyers are more inclined to get into a business, perhaps for the first time, when they learn that being a business owner offers ways to reduce their tax exposure - ways not available if they were working chiefly for someone else. A rather surprising reason some sellers feel they should tell all about unreported income is to make the buyer a co-conspirator in the crime of tax avoidance. It's insurance against being sued, one owner told me. His reasoning was that a buyer who is disappointed with performance of the company after taking over and has an inclination to accuse the seller of misrepresentation, will think twice about that idea. That's because he might have to testify in court that he is aware of the former owner's practice of illegal tax avoidance and is guilty of neglecting to report it to the IRS.
But it seems an unnecessary risk for the seller to take. And putting a buyer in that awkward position is not the best way to get a business relationship started. Most buyers don't want to hear about anything that is not documented. They don't want to take your word when it applies to the landlord's promise of a new lease, your customers' verbal pledges to remain loyal or vendor statements that they won't raise prices. Why would buyer prospects believe that you really collected $80,000 in discretionary earnings last year rather than the $55,000 stated in the books? As one buyer told me, "If I know the seller is not telling the truth to the tax authorities, what makes me think he'll be honest with me?" and talking to a business sales intermediary about unreported income is not a good strategy if you want his or her trust and cooperation.
An owner who admits his or her tax dodge when offering a business for sale may think the tactic will add appeal to the offering and increase chances of getting a sale at a desirable price. But that usually does not work and it's a plan that is likely to backfire with unintended and unwanted consequences.
About The Author: Peter Siegel, MBA is the Founder and President of BizBen.com. He is a SBA SCORE Counselor, author, consultant/coach (ProBuy, ProSell Programs), and advocate on the topic of buying and selling small to mid-sized businesses in the California marketplace. Having writen three books and hundreds of publication articles he has assisted small business owners/sellers, business brokers, agents, and business buyers for over 25 years. For a FREE consultation on how to best sell or buy a California small business phone him direct at 866-270-6278.
Categories: BizBen Blog Contributor, Buying A Business, Deal And Escrow Issues, Due Diligence Issues, How To Buy A Business, How To Sell A Business, Selling A Business
Comments Regarding This Blog Post
Everyone knows there are certain legitimate and discretionary advantages to small business ownership; but, one of them should NOT be hiding cash income.
I frequently encounter business sellers who are downright proud about how much income they hide from the IRS -- sometimes tens and hundreds of thousands of dollars. Frankly, it appalls me --- every dollar they don't pay has to be made up by someone -- the rest of us who report our income and pay our taxes.
So, when I'm confronted by sellers who insist that their business be valued on their "real" income; I make it clear: "you don't get two bites at the apple." When you tell potential buyers how much you hide you are really saying: "I'm a liar. I cheat the government. I make your tax burden higher because I'm not paying my fair share. Now, believe me about everything I'm telling you about my business." Really???
Sellers who have hidden their income should be thankful they haven't been indicted and thrown in jail ... and keep that information to themselves.
Contributor: Business Appraisals, Valuations Advisor
Years ago, when I first started selling businesses I was doing an appraisal for a potential client and I asked him to prepare a list of benefits he received from the business that were not necessary for the operation of the business. One of the items he mentioned was a yearly $100,000 plus in sales of rejected products that he sold in Mexico and pocketed the money. I told him he should destroy the list as this could create a legal problem with the IRS. I went back a few weeks later and the business was shut down with only his wife being present. She told me that one of their employees got their hands on the report and sent it to the IRS.
Do I need to say more about hidden income?