Recently, Dealstruck CEO Ethan Senturia and myself appeared on the It’s Your Money radio program. Our co-guest for the evening was Sean Puckett, Senior Vice President of Regents Bank.
Early in the program, Sean picked up on a theme that Dealstruck has noticed in our conversations with prospective borrowers, particularly during tax season. Throughout his career, Sean has consulted with thousands of small business owners who, in attempting to access affordable credit to grow their companies, have been stymied by showing minimal or even negative profits because they were too focused on avoiding income tax. Further, 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.
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 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 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 the 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.