As we wrap up another tax season, I am seeing more and more businesses that are operating in tax-avoidance mode. I completely understand the desire to not pay the tax man more than your fair share, but in minimizing your tax burden, you may be creating bigger problems.
A very successful business owner told me how they had been in tax-avoidance mode for years. At the end of each year, they would pay out their profits to themselves and their employees in the form of bonuses to minimize the tax burden. The funny thing about this is that although the business wasn’t paying as high a tax rate, the owners and their employees were paying the tax. When it became necessary to do a major remodel of their building, they went to their bank to discuss borrowing the money to remodel. The bank declined their request because they had minimal retained earnings in the business and there were not sufficient retained earnings to support the debt load.
As a business owner in tax-avoidance mode, you are likely trying to spend your money at the end of the year to avoid taxes. But this is a short-term strategy that will likely have a long-term negative impact on your business. Unless you are spending that money on assets that will generate additional revenue moving forward, then you should reconsider.
When you’re thinking about avoiding taxes, you are not thinking about creating wealth. As a business owner, you should be more focused on maximizing after-tax revenue to build wealth rather than focusing on tax avoidance. Tax avoidance nearly always results in difficulty borrowing money from the bank or other lending source. The problem is that bankers don’t lend from the P&L or income statement; they lend from the balance sheet. When the business owner presents their financials, the banker turns to the second page of their balance sheet and looks at retained earnings, or wealth (equity), in the business. That’s where the trouble starts: The tax-avoidant business owner has not built any wealth, which makes the banker reluctant to lend them any money. No equity or retained earnings, no ability to borrow. Quite simply, minimizing taxes reduces your borrowing power.
Selling Your Business
Another common pitfall related to tax avoidance occurs when it comes time to sell your business. Because you have been in tax avoidance, your business is not worth as much as it could be. Small businesses typically have a range of value at a 3–5 multiple of EBITDA—that is, earnings before interest, taxes, depreciation, and amortization. Mid-market companies tend to have a valuation of 5–7 times EBITDA. When business owners have been avoiding paying taxes, they have not maximized after-tax revenue, and therefore they have not built wealth (retained earnings), which impacts their business valuation. In other words, your business is not worth as much as it could be because you have been in tax avoidance rather than wealth creation.
Success Steps
- Understand your financials.
- Change your mindset from tax avoidance to maximizing after-tax revenue and building wealth in the business.
With over 40 years of C-level business experience and an MBA in organizational development, I am uniquely qualified to help you achieve success in your business. Call us if you want to eliminate the status Quo and make significant improvements in your success. 503-312-3145
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