Owner Beware: Tax Gimmicks Can Hinder Financing Options

September 30, 2014

pic-lending-money-compuerEntrepreneurs face uncertainty and take calculated risks in every aspect of their businesses. Hiring, sales and marketing, and picking what vendors and partners to work with always involves trade-offs and an uncertain return on investment. Of course, one thing a business owner can be certain of is the need to address income taxes and unfortunately, a counter-productive approach to managing them is all too common.

Many of these business owners have been enabled by their CPAs and other advisers to avoid income tax at all costs—without realizing that this strategy is hampering the firm’s ability to access debt or equity capital to grow.

Generally, lenders and investors are hesitant to provide capital to a business that doesn’t demonstrate the ability to generate free cash flow. Without cash flow, the lender cannot be confident in its ability to get its loans repaid and the investor cannot expect the value of his or her stock to increase. While Dealstruck takes an open minded and creative approach to lending and does a good amount of underwriting to assess the true cash flow of a company, once something has been expensed on a tax return, it is virtually impossible to parse out what part of that cash is truly free to service debt repayments. Unrealistic deductions can also invite unwanted audit attention from the IRS, leading to an unexpected tax bill and lien loaded with fees and finance costs while being a drain on the entrepreneur’s already limited time.

All too often, I chat with potential borrowers about their cash flow and profitability and hear that, in order to avoid Uncle Sam, they have expensed items (including personal ones) just to get net income to 0 or slightly negative on their tax return. The vast majority of the time, these clients are looking to expand their companies, and aren’t looking to operate a “no-growth” lifestyle business.

A strategic CPA and adviser who understands that his job is to help the owner maximize the value of the business often treats income tax as an operating expense. In exchange, the business demonstrates a history of producing operating profits and can access growth equity or debt at a fair price in order to build the generational value of the company—which is almost always the ultimate goal of the entrepreneur.

Make no mistake, a common sense approach to deductions and expensing for tax purposes is valuable. But for companies looking to grow, a small tax bill is a tiny price to pay in order to access the financing needed to take the business to the next level and beyond.


* This article was contributed by Jason Fleming, Senior Financing Consultant for Dealstruck, an NSBA corporate partner.