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Business Owner Blind Spots: Part 2 – How Much Are You Getting Paid From Your Business?

Business Owner Blind Spots: Part 2 – How Much Are You Getting Paid From Your Business?

When I ask a typical business owner how much they make from their business, they can tell me their annual salary that shows up on the W-2.  They can probably even tell me how much they took in distributions the last several years.  And that’s where the knowledge stops and the blind spot takes over.

Because almost every business owner I’ve ever met runs many expenses through their business that post-transaction will have to be paid out of their own pocket.  The most common expenses that fall into this bucket include:

  • Car Lease Payments
  • Gasoline
  • Cell Phone
  • Life Insurance
  • Health Insurance
  • “Wages” paid to the kids
  • Dining Out
  • Country Club and Golf Fees
  • Business Travel (that really isn’t)

When the expenses are paid by the company, they disappear from sight, mind and memory – until the day after closing, when all of a sudden you’re getting bills in the mail every day that you never used to have to think about.

Why should you care?  Two reasons:  valuation of the business; and understanding how much you need to sell the business for to generate enough income to support your lifestyle.

First, let’s talk valuation. When I’m recasting financial statements for presentation to a buyer, I want to pull out all of these expenses and show them as “add-backs” to the profitability of the company, since a third-party buyer won’t have those expenses, meaning your business actually generates more profits than it at first appears.  And since buyers are usually paying a multiple of earnings (4 times? 8 times? 10 times?), the value of these add-backs can be pretty significant.  I’ve seen these types of expenses add up to $25,000 or $50,000 on an annual basis for small companies, over $100,000 for larger companies.  Apply a 5x multiple to it, and that’s a lot of extra purchase price.

Which brings me to my second point – you’re going to need all the purchase price you can get!  Post-closing, you will be depending upon your investments to generate the cash flow that used to come from your business.  And that $50,000 worth of expenses that have been paid by the company in the past have also probably been deducted by the company, so you were paying them with pre-tax money.  Once you’ve sold the business and you’re paying them out of pocket – the IRS isn’t going to let you deduct them, so now you’re paying them with after-tax dollars – so instead of them creating a little tax shield, you need about $75,000 in pre-tax money to pay $50,000 in expenses.

Do you need help understanding how a buyer will view your business and how much they’re likely to pay for it?  Contact us to learn about our Business and Value Assessments.

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