Selling a Cash-Heavy Business With Thin Records

What a buyer can pay for

A buyer prices a business on earnings. They need to be able to explain those earnings to a lender, an accountant, and their own spouse. Every dollar of profit that the buyer can trace to a document goes into the price. Every dollar that rests on the seller's word gets discounted, and often it gets discounted all the way to zero.

That is the central fact for a cash-heavy seller. Nobody is accusing you of anything when they refuse to pay for income they cannot see. A buyer who puts their savings and a bank loan into a business is protecting themselves from the single most common reason acquisitions go wrong, which is that the profit was less than they were told. Lenders go further. An SBA lender underwrites on the tax returns, and if the returns show a small profit, the loan will be sized to a small profit. Our post on SBA loans in acquisitions explains why that makes a difference to the buyer pool.

Some buyers pay cash and are willing to do more work. They exist, they are fewer, and they have more room to bargain. Expect them to ask for a lower price, a longer review, and more of the price tied to results after closing.

Where thin records come from

It is worth being specific about what we mean, because the fix depends on the cause. In businesses like restaurants, salons, car washes, laundromats, small retail shops, vending routes and repair services, the pattern is usually one of a few.

Some of the cash never reached the register. Some reached the register but never reached the bank. Some reached the bank and were booked as something other than sales. Some expenses were paid out of that cash drawer with no receipts. Personal spending went through the business, and business spending went through a personal card. In a few cases the sales were recorded perfectly and the books are thin only because the owner never had a bookkeeper, never closed the months, and has a shoebox of statements.

These are different problems. The last is only a cleanup. The others are questions about what the earnings are, and a cleanup cannot answer them.

Evidence that sits outside your books

What you can often do is show earnings through sources your bookkeeping did not create. A buyer's accountant will rely on them because a third party generated them.

The point of sale system holds every transaction with a time, an item, and a tender type. If it has been in use for years, the reports show sales by day and by hour, and a buyer can see how steady the business is. Card processor statements do the same for card sales. Sales tax filings, where they apply, state the sales you reported to the state, and bank statements show deposits. For a business that takes cash, the relationship between the cash that was counted, the cash that was deposited, and the sales in the system is the thing a buyer's accountant will examine first.

Purchases are a second line of evidence. A restaurant that buys a certain volume of food and beverage from its distributors, a salon that buys a certain volume of color and product, a car wash that buys chemicals and pays for water: these purchases imply sales within a range. Accountants test this by comparing the cost of goods to what the sales would have had to be. When the implied sales are well above the reported sales, the gap is visible to anyone who looks, and a buyer will look.

Your own records of cash also count for something when they were kept as the cash came in. A daily log signed by two people, deposits made on a regular schedule, and expenses with receipts all help. A log reconstructed from memory last month does not carry much weight.

What a buyer's accountant will do

Expect what is sometimes called a proof of cash. The accountant takes a period, often a year, and reconciles sales in the system to deposits in the bank and to the books, and explains every difference. They sample invoices from suppliers. They walk the business on a few days to count customers. Some buyers station a person in the parking lot or the dining room. A reasonable seller allows this under a nondisclosure agreement and with a cover story that protects the staff from knowing. Our post on quality of earnings reports describes the review in more detail, and a seller who commissions one before going to market often controls the story.

The adjustments the accountant is willing to make will be documented and limited. A buyer may agree that some personal expenses are add-backs, as covered in our post on add-backs. They will rarely agree to add back cash that cannot be traced to a deposit.

Choices you have

There are, broadly, four paths and your accountant and your attorney should weigh in on each.

The first is to sell on what the returns show. This is the cleanest and it usually means a lower price. For some owners it is the right answer, especially if they are tired and the number still works.

The second is to build a record before selling. Starting now, run every sale through the system, deposit every receipt, pay expenses from the business account, and hire a bookkeeper to close each month. One year of clean months is helpful and two years is better. A buyer who sees the improvement and a trend of growing reported earnings will pay for the later period, and will often accept that earlier years were weaker. This is slow, and it also tends to raise your taxes in the meantime. Talk to your accountant about that before you start, as it is a business decision you should make with the numbers in front of you.

The third is to amend prior returns. Some owners consider it, and it can be done in certain circumstances, but it has consequences that belong to your tax adviser and attorney and not to a sale advisor. We do not suggest it and we do not discourage it. Ask the right professional.

The fourth is to structure the deal around the uncertainty. A lower payment at closing, a note paid over time, or an earnout tied to future results lets the buyer pay for the cash flow as it appears. If the business does what you say it does, you collect the rest. See seller financing and earnouts and holdbacks for how those are put together. You carry some risk, and in exchange the price reflects what you know about the business.

What not to do between now and the first buyer call

There are habits that make a hard situation worse. Do not bring a stack of handwritten notes and ask the buyer to trust them. Do not tell one story to the buyer and another to the accountant. Do not deposit a large amount of cash in a hurry to make the bank statements look better, since the timing and pattern are easy to see and a lender or accountant will ask where it came from. Do not tell staff before you have to, because employees who handle cash often have views about what comes to light.

Also decide what you will say when the buyer asks directly. Honest answers delivered calmly keep deals alive. Evasive ones end them. A buyer who has seen cash businesses before is rarely shocked and is often more interested in how you answer than in what the answer is.

A realistic way to start

Pull the last three years of tax returns, bank statements, processor statements, and point of sale reports into one place. Ask your accountant to compare them and tell you where the gaps are and how large. That conversation alone usually shows what is feasible, a sale now at a price based on reported earnings, or a sale in a year or two at a price based on a record you are building.

If a sale is some time away, the value of starting right now is large. Every clean month adds to the evidence. Our posts on getting your financials ready and preparing a business for sale describe the habits to build. Business Advisors of America can look at your records with you and tell you plainly how buyers are likely to read them, and then you can decide whether to wait, restructure, or go to market as you are.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.