Beyond tax savings: How tax planning creates business value

Tax planning can create value beyond tax savings

Most owners think about tax planning in terms of tax savings. The broader benefits are easy to overlook because cash is usually the most visible result.

In reality, though, tax planning can increase and protect business value and help owners keep more of the value they create.

For example, a tax strategy that reduces a recurring expense may improve earnings and increase value. Addressing a tax exposure before a transaction may help protect value. Ownership and estate planning can influence how much of that value ultimately remains with owners and their families.

Seizing those opportunities requires looking beyond the tax bill.

How tax planning can increase business value

Consider a company that identifies an opportunity to reduce recurring property taxes, sales taxes, use taxes, value-added taxes or other indirect taxes. Assume the opportunity reduces annual tax expense by $125,000.

Those taxes were previously reducing earnings. Eliminating the tax expense may increase EBITDA by $125,000. If the business is valued at eight times EBITDA, that same improvement may increase enterprise value by approximately $1 million.

Importantly, the benefit continues every year the improvement remains in place. A recurring tax savings implemented 10 years before a transaction may create substantially more value than the exact same opportunity identified during the final stages of a sale process.

How tax planning can protect business value

Consider a company generating $5 million of EBITDA that expects to be valued at eight times EBITDA, resulting in an enterprise value of approximately $40 million. During diligence, a buyer identifies an unrecorded sales tax exposure totaling $750,000, including tax, interest and penalties.

If the liability reflects approximately $150,000 of annual tax expense that should have been recorded over several years, a buyer may adjust EBITDA by that amount. And at an eight-times multiple, the adjustment alone may reduce enterprise value by approximately $1.2 million. The buyer may also require an escrow for the potential back taxes.

In this situation, the discussion often extends beyond the tax exposure itself. Buyers may question whether the issue reflects weaknesses in reporting, controls, compliance processes or management oversight.

If confidence in future performance declines, the valuation multiple may decline as well. A reduction from eight times EBITDA to seven times EBITDA on a $5 million company can reduce enterprise value by an additional $5 million.

How ownership and estate planning can preserve wealth

Consider an owner whose business is currently worth $10 million. The owner expects significant growth but delays ownership and estate planning because they have not decided on a transition.

Several years later, the business is worth $20 million.

If the owner had planned earlier and transferred future appreciation into a structure designed to move expected growth outside of the owner's taxable estate, the $10 million increase in business value would no longer be subject to a 40% transfer tax. The potential tax savings associated with the appreciation alone could be approximately $4 million.

Depending on the structure and the facts, additional savings may be created through future income-tax payments made by the grantor or through generation-skipping transfer tax planning.

Many tax-planning opportunities are most effective when implemented before growth occurs. Once the value has been created, much of the potential benefit may no longer be available.

Why timing matters in tax planning

The examples above involve different tax issues, different planning strategies and different objectives. What they share is timing.

A recurring tax savings opportunity creates more value when it has years to improve earnings and compound. Tax exposures are easier to identify and address before they become transaction issues. Ownership and estate-planning strategies are often most effective before future growth occurs.

Unfortunately, some of the greatest planning opportunities exist before the future is known. The decisions that create the most flexibility often must be made before owners know exactly how the future will unfold.

Tax planning is often viewed as a year-end exercise focused on reducing taxes. Some of the most valuable opportunities, however, serve a broader purpose: strengthening business value, protecting business value, and helping owners keep more of the value they create.