Buying a Business? Don't Count on Income You Can't Verify

Posted by Richard Parker on 12/13/2007 at 8:34 AM
Posted in Entrepreneurship

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It happens often when people are buying a business - and generally quite early in the negotiating process. The seller takes the prospective buyer aside and quietly makes a statement that goes something like this:

“Well there is the income you will see in the books. But you also need to know that we also get a substantial amount of unreported cash income too (wink, wink). When you buy the business, you can count on that too, so make sure you figure that into your valuation.”

All I can say is that if the seller has been taking unreported cash from the business, then good luck to them! And if you factor that into your valuation, and buy that business expecting that income, then good luck to you too! That is a choice that I would never encourage anyone to make, especially the students in my course The Art of Buying a Business.It’s a massive risk you should never take.

Unfortunately, many small businesses generate cash revenue and do not report it. Now, you may be wondering why used the word "unfortunately" in describing that decision. There are a number of reasons:

While trying to hide the income, that seller has shot him or herself in the foot and crippled any chance of getting the highest price for the business. Unless the seller has bulletproof documentation of that income (which they never do, because it was hidden), how can any buyers include the mystery amount when they value the business? It’s like throwing darts with a blindfold on. The tax advantages of hiding income always pale in comparison to how much extra money they will get when the time comes to sell the business - if they would have properly reported income.

The business itself is being robbed. Isn’t it far better to put accounted-for money back into the business for marketing or other growth expenses? You see, hidden money drops out of the growth cycle.

If the seller is hiding cash income, you can almost bet that the employees are doing so too. A culture of dishonesty at the top has almost certainly trickled down and caused dishonest, income-sapping activity through the ranks. Is that the kind of business you want to own?

And one more thing! If the previous owner of your business was hiding income, there's always the chance that the Feds will find out. What a mess that will become for the seller.

While you may come across an interesting business where there is unreported income, and some may in fact be worth pursuing, your strategy regarding unreported income must be unwavering. If the seller makes reference to income that can’t be documented, your response must be, “If you can't prove it, then I can't pay for it." It will be among the smartest business decisions you will ever make.

If you give in on this point you are more than likely setting yourself up for a very costly mistake.

Trump University Professor Richard Parker developed Trump University's self-paced multimedia home-study course on Buying a Business. Professor Parker bought his first business when he was 12 and sold it for a profit when he was 13. He has now bought more than 10 businesses and is a national authority on the subject.

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