You Should Pay the Tax Man

You Should Pay the Tax Man

It seems that more and more businesses are operating in tax-avoidance mode. I 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 problem.

The Problem

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.

Here’s Why

When you’re thinking about avoiding taxes, you are not thinking about creating wealth. As business owners we should be more focused on maximizing after-tax revenue to build wealth rather than focusing on tax avoidance. I run into many business owners who have been in tax-avoidance mode, and when they need to borrow money from their bank or another lending source, they run into trouble. 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.

Bankers like to apply a simple ratio to your business—the debt-to-equity ratio—and this is how they set limits on how much you can borrow. Typically, it’s a two-to-one ratio, meaning for every dollar of equity you have retained in your business, the bank will let you borrow two dollars. No equity or retained earnings, no borrowing. 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. As my mentor and friend Phil Symchych likes to say; “maximizing earnings will maximize your wealth.” We should be focusing on wealth creation, not tax avoidance.

If you would like to earn more money, gain better control of your business financial situation, and maximize your wealth, give us a call at 503-312-3145. Or visit: http://garyfurr@garyfurrconsulting.com