Forget Tax Exemptions – Turn Entrepreneur Now*

The enterprising Deepak Shenoy shedding light on how being an Entrepreneur you could save a ton of taxes as compared to a salaried employee. A very interesting and informative read…

Here’s an extract of the article from his blog

Starting your own business seems to be the fashionable thing to do nowadays, what with so many early stage funds, incubation companies and startup events in every city. But it doesn’t only take an “ecosystem” to help startups click, they get the kind eye from the taxman as well.

Taxes

Tax benefits help people who set off on their own. As an employee, you’re at the bottom end of the tax chain. Your equation goes somewhat like this:

Salary -> Pay tax at source -> You get what’s left -> You spend on stuff

Some exemptions are available of course, like an 800 rupee per month travel allowance, a certain part of your rent and certain medical expenses. But for a consultant or a business the equation is slightly more complex:

Income -> Minus small amount of tax -> Business expenses -> Taxes paid in stages -> You spend on personal stuff.

“Business expenses” means what you can write off what it costs to have earned your income. That means internet bills (even at home), mobile phones, the cost of your car depreciated over time, petrol bills and so on. Of course, you will need to segregate what you spend for personal use versus official – but consider this: As a salaried employee, when you pay your broadband bill, travel in your own vehicle on a business visit, or buy a vehicle or laptop, you will have to use your post-tax money.
Effectively: If you’re an employee, you pay tax and then spend money; if you run a business or are a consultant, you get to spend the money and then work out what your taxes will be. Some taxes are deducted at source – usually 10% – but this offsets your eventual tax liability.

While it’s true that the income-tax department will catch you if you declare something out of the ordinary (like attempting to expense a toy-train as a business expense), there is a lot more you can charge as expenses that you ordinarily will not demand from an employer – from magazine subscriptions to the new iPad.

Interestingly, businesses – including consultants – have to pay tax in phases, not every month. The idea is to pay some part of your taxes in June, September, December and March. This gives you more freedom than having it deducted every month, and you might choose to spend more on the business instead of paying taxes. In addition to income tax, for most consultants, you need to charge an additional 10% as service tax, but that can be offset against service tax paid for input services (like those charged in telephone bills). Try getting that back, as an employee.

Alternatively, to access his full article do visit his column on Yahoo!

Note: * The title of our blog post differs from that of the original article.

4 Reasons to Sell a Business -Contd.-

Abstract: This is a continuation of our previous article where in we outlined some of the reasons why entrepreneurs consider selling their profitable businesses.

Monetize

No surprises here! After all, one of the primary goals of every entrepreneur when starting a business is to “make a lot of money”. However, most have no idea after a couple of years into running the business as to how to actually achieve this.

A growing business requires almost all the excess cash to be re-deployed towards further capital expenses. This is especially true of small and mid-sized IT Services firms that have little or no access to working capital financing from the banking sector and have to invest all their excess cash towards routine working capital financing.

To illustrate:

A business with the following financials:

  • Sales Turnover: $7 Million
  • Projected Sales: $8.5 Million
  • EBIDTA@20 % of Sales: i.e $1.4 Million
  • Receivables Collection: 30-60 Days
  • Advanced Tax@12% of Sales: $0.840 Million

Assuming, this is the first year of business the actual cash and equivalents at the end of the Financial Year left with the business would amount to less than $100,000. That is assuming the founders are not taking cash from the business above an average market salary. (For a detailed calculation and assumptions refer to this excel sheet)

To expand by 20% the business would typically need to grow its delivery (engineers), Sales and Administrative staff by at the least 18% on the current base. The costs for such a business to scale up would be:

  • Hiring Expense:

One time sunk-in cost of hiring (for advertisements, referrals, interviews etc.) at approximately 8-12% of annual salaries for the new staff. This would amount to a minimum of $50,000.

  • Infrastructure Expense:

Adding in the cost of additional office space (upfront expense only) that would need to be leased and furnished (Furniture and machinery) to accommodate the new hires would typically be in the range of $65,000.

So, while the business would add close to $1.4 Million in sales for the year in which it is expanding its resources the upfront investments would amount to $180,000 at a bare minimum.

Even in a best case scenario the founders of an IT Services business growing at a respectable 20% rate would be hard pressed to reward themselves more than $150,000 in any given financial year including their base salaries.

The only way to really monetize the value of such a business would be to sell!

Team Fatigue

Although a fairly taboo topic after a lot of careful thought we have decided to put this out there. Most businesses are founded not by an individual but by a team of people. They could be colleagues in a previous firm, batchmates from an engineering college or just friends from un-related fields. However, it takes a lot of moral support to establish a good business and the process has its ups and downs. It is always nice to come across a well balanced group of individuals who have co-founded a successful business together and contribute to its growth by leveraging unique skill-sets of their own.

It is fairly rare though that a team of founders no matter how well balanced and well-knit would continue to share a vision over an extended period of time for any business. Besides the obvious EGO, things like individuality and strong conviction (ironically, a hallmark of most successful entrepreneurs) do come in the way of operating together.

It is our considered opinion that all founding team members should have a formal process to smooth out the rough edges that may come up during bad and good times both. But it is also, necessary to keep in mind that the differences between the founders should not be allowed to get to the stage where the business starts suffering from a lack of focused vision. It is always a good idea to try and monetize the value of your business if you are ever at a point where the probability of founders splitting is strong. In some cases, we have helped one set of founders (or individual) to buy the rest of his co-founders out. However, this requires a significant transition in not only the role of the individual who continues to own and run the business but also, a significant change in the operating environment for the business which is always a risk to further growth.

Conclusion

We have covered some of the trickier reasons for why as the owner of a profitable business you should consider selling. Next week we will showcase our thought on how you should value your business. Disclaimer: We do not share the tendency of the popular financial press to address valuations from an “Overall Value” perspective. We believe that any body with a little common sense would take the first step towards selling their business on the basis of Day Zero CASH and not “promised Earn-outs” that stretch over several years.

If you are one of those running a profitable IT Services business and wondering how you could get the 3-5 times Multiple to Sales valuation and retire to a private island do give one of the “other” investment banks a call! We are more interested in win-win deals where the Entrepreneurs working with us are far more concerned with whats coming in their bank accounts than what gets reported in the financial daily! Cheers!

Do comment if you have any queries or, protestations to make regarding the content of this article.

4 Reasons to Sell a Business

Abstract: In this week’s article we will be exploring the decisions that influence the sale of a technology business. Whilst, this article is in keeping with our focus on Information Technology firms and is specifically targeted towards them, we think the broader principles would apply to sale of any business

Every year there are hundreds of technology entrepreneurs that after years (sometime decades) of hard work, time away from their families and after investing their own (and their family, friends and investors) funds finally decide to sell the business that they have created.

We briefly touch upon the factors that influence such a monumental decision for each and every one of these organizations.

Loss of Momentum

On the face of it most entrepreneurs would rather slog through a loss of morale (after all which business does not have its down days?) rather than take a decision to quit/sale. After all that’s what makes great organizations ‘great’. To differentiate between an entrepreneur’s zeal of implementing their vision through sheer will power and what we are referring to here let us illustrate what we mean

  • Challenges in Scaling up the Business:

Over 50% of the entrepreneurs and founding teams that we come across typically fail at recognizing that their businesses have started stagnating. Moreover, very few of them realize that it takes a completely different skill set to scaling up a business compared to starting it in the first place.

When confronted with managing a sales force and delegating responsibilities for customer management most entrepreneurs face the issue of lack of skilled manpower. The difficulty that a small/medium business faces in attracting smart managers is often understated. These could be due to lack of branding, not being able to effectively demonstrate a career path for the managers or several other such factors combine. The reality is that beyond a key revenue point/product roadmap almost every entrepreneur needs to empower a second line of managers that can grow the business exponentially.

If your business is unable to acquire and manage such talent no matter how hard you work the growth will slow.

  • Lack of Funds:

The business press will have us believe that every great business (especially one with growing sales) gets funded. The reality is completely different.

Some businesses, typically Information technology services find it extremely hard to identify tangible competitive advantages, which preclude most of them from favorable equity financing.  On the other hand, a medium sized business is neither a very attractive client for commercial banks given a lack of credible long-term business contracts and an ever-growing need of working capital.

Remember, if you have an IT Services business with a turnover of $10M and you expect to reach $15M in turnover the year after it would be impossible to fund the entire working capital requisite from your accruals alone (that is assuming you have EBIDTA margins north of 20%).

Lets also, not underestimate the need for ever larger balance sheets to attract and retain large clients (the very basis of exponential growth). Almost, every client above a certain size requires a dedicated manager and delivery platform along with certain infrastructure specifications. Whilst, most business are able to demonstrate the ability to execute the contracts on offer, where they most often stumble are on legalities which require them to have corporate governance measures like Executive/Directors/Commercial insurance. A lack of funds not only constraints your ability to grow it also, provides an unfair advantage to your larger peers.

Declining Business Metrics:

This is nothing but a fancy term for saying that you are losing business whether revenue, profitability or, people.

  • Loss of Customer(s):

A business can lose customers for any number of reasons (customer going bust, customer changing product/service roadmap etc.). The important thing to remember is how long before you take the tough decision to let some of your people go. More often than not we have come across businesses with ruined financials (decent revenue, negligible or negative profits) largely because although, they lost customers they refused to cut costs proportionately in the ‘hope’ that another customer would fill the void.

Our advice, understand your sales cycle. No matter how close you think you are to signing that next customer revisit your past experiences with similar set of customers to make an educated guess on when those extra resources can be monetized.

In our experience a loss of more than 15% of revenues takes a minimum of 2 quarters to recover (assuming you are doing everything right and the market conditions are favorable). So take a hard look and decide whether you want to compromise your cash-flows and jeopardize the value of your business because you refuse to reckon with the hard luck that came your way.

  • Recession: Recession

Advising to sell a business during a recession is always a tricky one in the best of times. However, there are scenarios where it should be considered favorably. A downturn does not affect every player equally. Typically, it’s the small and medium businesses that are hit the hardest.

It is absolutely true that you will almost never get great value for your business if you sell it during a recession but at the same time it is also, a misnomer that the value offered would be the lowest you can expect. After all a declining business during a recession is easily palatable for most buyers; what is not is a declining business during the ‘boom times’.

So think hard about whether your business is positioned (cash flow and even on a personal/organizational level) well to not only survive but emerge stronger and larger during a deep recession. After all, if you survive the downturn only to come out as a skeletal clone of your former glory days neither your team nor you as an entrepreneur would realize terrific value for your business.

  • Changing Competitive Landscape:

Most savvy entrepreneurs realize when the macro economic trends in the industry start going against them. It could be evidenced in the form of customer preferences shifting from small niche vendors offering personalized service (something most small and medium businesses excel at) towards managing a smaller base of vendors and thus, necessitating a migration towards larger vendors being able to take on comprehensive delivery roles.

This could be evidenced in other ways as well. Example, most small product companies keep on believing that their niche product knowledge will lead to greater business from a nuanced set of customers. Whereas, the industry itself may have moved towards a more consolidated vendor base.

Recognizing this early would enable you to capitalize on your niche skill set and demand a valuation that is commensurate with your ‘current’ business value. Combining with a larger organization, helping them cross-sell to your customer base is one of the best ways to ensuring not only good valuations but also, a great road-map to future business integration.

Conclusion: In the second part of this article we will explore the role ‘numbers’ play in your decision to sell your business.


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