[vc_row css=”.vc_custom_1548289356400{background-color: #bcbcbc !important;}”][vc_column][vc_single_image image=”4627″ img_size=”full” alignment=”center”][vc_column_text css=”.vc_custom_1753489535427{padding-right: 19px !important;padding-left: 19px !important;}”]Spending your profits at the end of the year to avoid paying taxes is a short-term strategy that can have long-term negative repercussions for your business. Bankers look to retained earnings to loan you money and as a business owner you should be focused on building wealth in the business rather than tax avoidance.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column][vc_column_text css=””]
Chapter 12: Pay the Tax Man
I am running into 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 was not 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; quite simply, 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. This, however, 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.
Building Wealth Is Better than Avoiding Taxes
When you are 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 do not 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 is 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 is 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 3ñ5 multiple of EBITDA that is, earnings before interest, taxes, depreciation, and amortization. Mid-market companies tend to have a valuation of 5ñ7 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). This 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.
Success Steps
- Understand your financials.
- Change your mindset from tax avoidance to maximizing after-tax revenue and building wealth in the business.
- What is your EBITDA? Ask your CPA to help you determine this and track it.
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Fundamental Steps to help business owners learn what it takes to grow their business and increase their revenue.
As the former GM and COO of a $40 million company with seven locations I have learned what it takes to be successful in business. In this book, I share some keys to sustainable business growth and acceleration and the way to close the gap between your performance and your dreams.
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