What are your thoughts on the following US federal income tax situation
August 10, 2021
by a searcher in Salt Lake City, UT, USA
I am doing due diligence on a company that is much larger than others I have looked at so far. The company is very asset light so depreciation would be minimal and amortization has been ignored due to the long write-off period. The acquiring entity will be taxed as an S-corp and I will have 100% equity. The following thought came to mind. Imagine the following scenario:
EBITDA/cash flow: $2,500,000
Enterprise value: $10,000,000
Equity injection: $1,000,000
Bank financing: $4,000,###-###-#### year term, 6% APR, $55.5k monthly payment)
Seller carry: $5,000,###-###-#### year term, 6% APR, $77.3k)
Net Income (ignoring amortization - EBITDA less interest payments): $1.989mm
EBITDA after debt service: $905.9k
US federal taxes due on Net Income in the first year: $903.4k
Am I missing something here? If I do this deal I will barely be able to afford the taxes. As loan payments shift to have lower interest each month/year the situation only worsens. If I'm thinking about this correctly, how can I make this work? What creative yet legitimate ways are there to decrease my tax liability?
Thanks for any and all help.
from IE Business School in Seattle, WA, USA
As others have mentioned, the goodwill amort is material & shouldn't be ignored, even though it gets amortized over 15 years.
However what's also causing problems for you is that your largest source of funding has the shortest term of repayment. Seller Financing (or Earn Outs, etc.) can be great, but they come with a catch because every Seller I've spoken to isn't comfortable going past ~5 years for payback. After you make the adjustment for goodwill amort, change your debt repayment modeling such that $4m is repaid over 5 years and $5m is over 10. If the Seller is willing to carry 50% of the price & the business cashflow supports it, great, but what I found is that the numbers looked more achievable when you cap the Seller Note at ~30%, with the rest being carried on a longer term note. If your business is eligible for SBA financing you might be able to get a $5m 7(a) loan that is amortized over 10 years.
There are also some banks (Live Oak being one) that occasionally pair a non-SBA loan with an SBA loans for larger deals. I believe ^redacted & ^redacted hosted a webinar on this topic, it was titled something like "Landing a Whale" & you might be able to find the recording on this site, or ask one of the admins to point you to it. If you can't find it, shoot a note to Heather or Lisa, they're great & always happy to chat with Searchers!
from University of Virginia in New York, NY, USA
Why not acquire as a C-Corp. You will be repaying debt at a much lower % as it appears you live in a state with high taxes. This way you will repay at 21% fed + state C corp tax. Once you get some breathing room you can augment salary (within IRS guidelines) to get cash out during holding period.
On exit you will avoid taxes on first $10 million assuming you sell stock (buyers less concerned as step-up in assets will be minimal). You can also hold stock in trust / spouse who each will have $10mm exemption
Not sure what type of business but watch out for change in working capital impact on cash flow as well. Could be positive or negative depending on company.