I heard a story recently from a very successful businessman and friend of mine that literally made my mouth drop open. Now, I am in the business of selling businesses and have been for many years and with me being in such a business I love hearing and reading about individuals who have started out in life without a lot of formal education nor a silver spoon in their mouth and have been able to go from rags to riches. It is always good to hear such stories and it is even more interesting if you actually know the individual instead of just reading about them.
This is the case of my friend who started out with nothing and worked his tail off in several different businesses and through luck and his intelligence to realize he had a good thing worked and built his business into a very profitable company. And to add to his luck another company came along and realized what a good job he was doing and wanted to acquire his company.
As he explained the transaction to me the two companies had synergies between them that made the two of them a good fit and they began the due diligence process, whereby the acquiring company inspects all of the details of the selling company to verify all of the numbers and the things that they had portrayed about the company was true. After the due diligence process was done then the financial numbers were stated and the price was set between the two parties based on the EBITDA of the company. EBITDA means earnings before interest, taxes, depreciation and amortization. It is the true net income of the company and once this is determined then a buyer and seller come to an agreement on what the multiple is (every business is different, but for convenience stores with real estate it is generally between 4.5 and 5.5 times the EBITDA) and that is the selling price of the company.
As the story continues the eventual selling price was $30 MIL. Now in my book and most people’s book $30 MIL is quite a bit of money, especially if you don’t have any debt against the company and as the story goes he didn’t have any debt. So I know you are probably thinking the same thing I was. Wow! This guy has got it made how can there be a problem with this story? Well as he continued to share with me the deal was closed in January and the taxes that he was going to have to pay on the sale of the company were not due for 15 months. Meaning that if you get the income on January 2008 then you would not have to pay the taxes until April of 2009, but the tax amount was based on the sale price of $30 MIL that took place in January of 2008. (Please keep in mind that the dates have been changed as to not reveal the company or the person in this story). And I didn’t ask, but I assumed that the selling entity must have been a C-Corp, because he said that the taxes that were to be paid on the $30 MIL was $12 MIL (40%) so let’s assume that it was a C-Corp. But as he explained to me that was not a problem, because he had fully invested all of the $30 MIL so that he would have the money available to pay the taxes and then some more, because he could work off of the $30 MIL and make more money in the 15 months before the taxes were really due. So far so good.
Fast forward 15 months later to when the taxes were due to be paid and guess what? The $30 MIL that had been invested was now down to $15 MIL. I didn’t ask him where he parked the money, because it would have been too much torture to put him through. So now he has $15 MIL in his account, he owes the government $12 MIL, which leaves him with $3 MIL a net of 10% of what he sold the company for. Was he broke? No, but a far cry from the original amount of the sale price of the company.
So what is the moral of this story? BE PREPARED. As I mentioned earlier my friend was a very intelligent and successful businessman, but I imagine he got involved into the selling process of his business focusing on the top number and didn’t do a lot of preparing in advance with a team of experienced individuals in all aspects of the selling of a business. As an experienced business broker I would have coached my client far in advance as to what his tax implications would be and would have worked to structure the transaction as to minimize the amount of taxes he would have had to pay. Many times there are several ways to legally reduce your tax liability if start preparing early enough. Selling a business is a team effort that requires many people with specialized skills with everyone focused on the same outcome. Getting as much money as possible into the seller’s pocket. A very simple goal. But must be executed in the correct manner or you could end up like my friend. Big sale number, little money in his pocket.