Doug Houser: From Rea & Associate Studio, this is unsuitable, a management and financial services podcast for entrepreneurs, tenured business leaders and others who are ready to look beyond the suit and tie culture for meaningful measurable results. I'm Doug Houser. We all have dreams of retiring someday and if you're a business owner, you probably have some thoughts about how you would like to leave your business.
On previous episodes of unsuitable, we've talked about your different exit planning options, but as you are contemplating which exit planning route is right for you, there are some pretty major considerations that you should be aware of that could ultimately impact the overall value of your business. If you don't address those issues now, you could be throwing up roadblocks before you even get started. Joe Popp, principal and director of State and Local Tax or SALT services at Rea is here to share some SALT related exit planning considerations. Welcome back to unsuitable, Joe.
Joe Popp: Well, thanks, Doug. It's nice to be back.
Doug: I think, for the time being, we are going to refer to you as Pete Schweddy though.
Joe: Okay, well it is the season after all. That's right.
Doug: Well, you are like the Alec Baldwin of unsuitable, because I think you have the most host appearances here on, "Unsuitable." [crosstalk 00:01:34].
Joe: I think that Allen Baldwin holds that record on SNL.
Doug: Okay, well we have fact-checkers over there that are nodding their heads and say, "Yes, yes. This is true."
Joe: I think that's true.
Doug: So favorite Alec Baldwin bit, Pete Schweddy. So there you are.
Joe: That's right.
Doug: We'll repeat it for sake of the podcast, but you know with the reference and if not, you should definitely look. It's quite the treat.
Joe: Yes.
Doug: But anyway, glad to have you here. We talk about state and local tax issues, obviously quite a lot. These things have a way of coming back to bite people in the behind, so to speak.
Joe: Yeah.
Doug: But I think what people don't focus on is from the other side of things, the value that it can create-
Joe: That's true.
Doug: ... in business.
Joe: Let me tell you about this experience I recently had out in the presentation circuit. So I'm replacing a speaker that was talking about the sale of the business and I'm kind of a last-minute change, so I'm walking in. The program still has the old information on it, so everybody is showing up because they're selling their business so I'm like, "Hi, we're talking about SALT, how's it going guys?" which is great. At the very beginning, I've got the slide deck. I've kind of prepared and I knew this was going to kind of come up and I said, "How many people are here because you're selling your business?" And everybody raised their hand. I'm like, "How many people hear about SALT?" No one raised their hand. I'm like, "Okay, good." So this is the audience I like. Flex the fingers, "Okay, here we go."
Joe: So it was actually a really great presentation because I took everything that I normally do, like talking about risk to the business, operational things you could do and all of that and I flipped all of it and I said, "You're a person who's looking to sell your business in two, three, five years, six months right now," and the whole thing, I kind of retooled for that and these are like contractor guys.
Doug: Mm-hmm (affirmative).
Joe: These are guys that are out in the field, a lot of owners there, but a lot of production people and I had every single person looking at me and following along and really engaged and it was because, "Oh, how to do these SALT things..." They do impact in a huge way if you're going to be selling your business. A lot of the people that I talk to that are entrepreneurial, they like taking risks.
Doug: Sure.
Joe: Right?
Doug: Yeah.
Joe: They're out there. I know you work in the construction industry a lot. You know the guys. You aren't going to go and be a construction contractor and have a business like that if you want to play it safe.
Doug: Right.
Joe: Right? So you're already kind of predisposed to take some risks. A lot of times when I'm talking with these, some of the things that are going to save them money right now, they want to do-
Doug: Sure.
Joe: ... the other things that are just, "Well, you have less risk." They're like, "Yeah, okay..."
Doug: "Yeah, that sounds great."
Joe: We'll leave that one for next year maybe. Next summer, let's come back to that calendar invite. But for these guys, if you flip the script a little bit and you talk about these "Things are operational, and if you don't fix them now, it's going to cost you a multiple when you go to sell your business."
Doug: Right.
Joe: That'll grab somebody. It'll grab their attention. So that was really kind of a really neat sort of situation for me recently to go through that because it kind of just made me look at everything a little different. Even the things that were for the back office tax people, the salespeople flipping the script on that, every single person, therefore, became a person who is adding value to the business all the way down to the sales guys and the guys in the field. It was just a great happening that wouldn't have happened if I hadn't been in that situation where I was replacing somebody.
Doug: So talk to us a little bit about that. If you're a business owner and okay, you've got perhaps you don't know what your risks are, you don't know where you might have nexus, but we've been involved. I know you've personally been involved in some M and A transactions where that's where it comes back home to roost, so to speak. Either the buying or selling party is doing due diligence and they're like, "Whoa, wait a minute. You haven't addressed this."
Joe: That's right.
Doug: Talk about some experiences you've had.
Joe: Yeah. We have a number of these engagements that are going on, we're on both sides of due diligence. So if you're going to buy a business, you can get a pretty nice discount if the other person has had this sort of risk-seeking attitude in the past. You can get a nice discount when you're going to buy a business. Then the same thing, unfortunately, will happen to you if you're going to sell. One of the things that we've talked about is, "Well, how are your reps and warranties going to go when you're in the transaction." So for those of you who aren't familiar with that, a rep and a warranty is a whole section in this sale of your business contract where you go through and you make a representation or you make a statement saying, "This is true for my business: this, this, this, this, this, this."
Joe: And one of the easier ones is we're registered in filing all of the states that we do business. If you're a contractor and you got employees in seven states and you file in one, how are you going to navigate through that rep and warranty? You're not going to be able to. So one of the things that come up in due diligence is there are these pretty easy to find situations that will come up, "Where do you guys have employees? Where do you have sales?" That very quickly leads to this reps and warranties section, which is very difficult to navigate. These days, they do have a what's called reps and warranties insurance. Right?
Doug: Yeah.
Joe: But it doesn't cover you if you know that the thing that you're saying is wrong.
Doug: Right.
Joe: Right. So, unfortunately, the threshold for some of these things is really low, "Where do you do business? Do you have exemption certificate collection processes? Do you file sales tax returns? Do you know if your stuff is taxable?" All of these sort of very easy sort of questions, they come up and due diligence. Some of them come up through the reps and warranty section where you're going through and you're just saying, "Look, these are things that are true for my business." Then some other ones are, even if you don't have a super sophisticated tax person, asking if someone is registered in a state and filing there, that takes a first-year associate [crosstalk 00:08:00] that does tax returns. Who's going to find that?
Doug: Yeah.
Joe: A lot of these things are just things you can't escape. They're going to come up. The couple of clients that we have right now, we're going through this. One of them is selling to a public company.
Doug: Okay.
Joe: So there are some restrictions and things that maybe wouldn't be there normally because you're selling to a public company. In that situation, everybody on the other side knows the game, right?
Doug: Sure.
Joe: They all know exactly what's going on. We're on the other side of it. We know what's going on, so we're talking about it. Then it's less of an adversarial kind of thing and more of a, "Well, how are we going to fix this? We want you to buy an asset that you're comfortable with. How do we get it into a good place for you at a cheaper price than, 'Oh, I don't want to deal with it. You guys just cut me a check and cut me a smaller check.'" Right? So that's kind of what we're working through right now. The bad part about that is if you wait until the very end like that, it costs more than if you just do it earlier.
Doug: Right.
Joe: Some of those issues are just like that.
Doug: At that point, you're committed to the deal, right? And it's tough to go back the other way.
Joe: That's right.
Doug: You got that emotional acceptance already that the deal's going to happen.
Joe: Yes. The momentum on that, we've talked some time about that where once you've made that decision to sell when you have a buyer, you have this momentum going like, "Okay, I'm going to retire now. I've got this. I'm selling this thing. It's good. I told the family." And then someone says, "You're going to get $5 million less because you have these SALT issues," and you're like, "Well, I still want to be done. So maybe I can find a way to square that with myself." But often, we get engaged and you'll end up paying something that's not $5 million-
Doug: Yeah.
Joe: ... to get things kind of fixed.
Doug: Yeah. But to talk about, again as a multiple of EBITDA because that's what typically you're looking at any type of transaction, whether it's internal or external.
Joe: That's right.
Doug: The multiplier gets big really quick.
Joe: You know, and that's a good point because I was just talking with our valuation BV expert, Mary Beth about this the other day and we're talking about EBIDTA and if you haven't heard that on the podcast before, here's the tea, so go and look that up, right? It's a very important term to know, but it's earnings before a couple of different things. Then you multiply it by some hopefully, high multiplier, right? If you're selling and that's the value of your business. So it's earnings before and then taxes is one of the things in there.
Doug: Yeah.
Joe: So you might look at that and you're like, "Well, this guy Joe Popp is telling me about sales tax problems in my business. But I have one up on Joe because I know EBITDA is earnings before taxes. So it's not going to matter because they're going to value this, this high. And then, yeah, I'm going to have issues, but it's going to be fine. Right? So I got this, I got this." It's true, taxes are not transactional taxes. We're talking about EBITDA and the multiplier.
Doug: Yeah.
Joe: So income taxes, yes.
Doug: Yes.
Joe: But sales tax, no.
Doug: Not so much.
Joe: A company that we recently talked to has got about $6 million in sales tax exposure-
Doug: Ouch.
Joe: ... because they have never charged on their purchases and they've never charged on their sales.
Doug: Oh, wow. [crosstalk 00:11:29]
Joe: Right, either end. So there's one of those that they didn't do the correct thing. They should have been paying tax. For them, it's, well, what if your EBITDA's times 10?
Doug: Right.
Joe: Let's say you got a great situation. Well, that's $60 million ding.
Doug: Yeah.
Joe: Not $6 million now. What if you were to go out and I were to sell you... If you spend $3 million, you're going to fix this. So you go and you spend it and maybe you spend it a couple of years before.
Doug: Right.
Joe: Right? Well, what's your savings? It could be $60 million minus three. It's $57, that's pretty good.
Doug: Still pretty good ROI there.
Joe: Yeah, that's a pretty good return. But that's if you have the time to correct that before you get to those calculations.
Doug: Yeah.
Joe: Because once you get to those calculations, yeah, you're going to hit the three, but it's three times 10; it's 30 million.
Doug: Yeah.
Joe: You know? So that's something that does come up very often is the timing and whether or not they're doing stuff on the front end or if they're waiting all the way to the end, they're already in contract, they're trying to get in contract and then these things come up.
Doug: So pre due diligence then, what should I be concerned about if I'm a business owner? Do I look at my vendor relationships? Where do I start?
Joe: That's a great question. What I tell people is the due diligence questions are pretty easy and high level. Are you registered in all of the states you do business in, right? That's one of the reps. Ask your accountant, ask your internal person that deals with that kind of stuff because as the business owner, you got lots of stuff going on. You're probably not aware of that.
Doug: Mm-hmm (affirmative).
Joe: It's not a, "you," issue. That's a CFO, that's a controller, that's some of the financial people, maybe you've outsourced that to your accountant and you could just say, "Hey, where are we registered? Is it every place we do business? It's not? Okay, I got a problem." Right? That's easy. "Our stuff, when we sell it, is there sales tax on it? Is it taxable? Do we know? The customers that we have, why aren't we charging them tax if we know that this thing is taxable?" Oh, because it's exempt? They're exempt? Do we have some kind of proof?" So these are some questions just to ask high level, pretty easy questions. You'll know if you have a problem. The problem is the answer to the question. So you kind of have a path, "Then we need to register in those places"
Doug: Right.
Joe: "We need to start doing this. We need to start collecting tax." so they're pretty easy. If you ever go to your accountant for year end tax planning, just ask a simple question like, "Can you give me a due diligence list? Just a couple quick things that people ask?" They should be able to give that to you. It's going to be generic, not necessarily specific to your business, but it's not going to cost you anything, really. Go through that list with someone internally. Can you meet all those things? If you can't, there you go. Then maybe re-engage the accountant, talk to your lawyer, whoever is your good trusted business advisor and just go through that list.
Doug: Yeah. Well, and it's about we've been through this with a couple of clients about instilling those processes and procedures within their business, kind of building those habits within what they do. Really, that goes all throughout the organization. You're talking about salespeople or you're talking about people who are out in the field perhaps, all the way obviously to the top and just understanding that.
Joe: Absolutely. As an example, if you are out in the construction industry and many states, just about all states have some kind of rule that covers when a particular something becomes a real property project. So if you can see kind of behind me, we have this TV screen, right? And behind the TV screen is a wall. Well, that wall, most people would say, is real property. It's drywall. It's got wall coverings on it. That's real property. So at some point in that chain, there was drywall, which was definitely tangible and moved around and then it's real property. That is the most complicated set of rules across the country in terms of who's supposed to pay the tax and when.
Joe: So when you're doing job costing or you're doing a proposal... So you're the guy and you're like, "That's a tax thing. That's the back office people" [crosstalk 00:15:48] But are you able to quote appropriately based on, "This should be our subtotal. This should be our sales tax or tax. I want to make sure I'm not screwing it up, and then the customer's like, 'You changed the price on me. That's not fair. You didn't tell me there was going to be tax'" So these are some of the things that bleed all the way down to even people that are taking stuff out of stock. Is there something that you need to be keeping track of if you're pulling a wire out of stock? What's that job that it's going to do? You have to communicate that back to your back office person.
Doug: Right.
Joe: Everybody, all the way from the owner who should really care-
Doug: Yeah.
Joe: ... all the way down to the folks that are doing sales, everybody has a piece of this.
Doug: Right. And again, I think the best practices we've seen if you get that sort of culture of thought instilled in your business, at least you're raising the issue and so you can deal with it.
Joe: Yeah. Not everybody is going to be a sales tax nerd like me.
Doug: Sure.
Joe: That's fine. I get that. They're missing out on life. But what are you going to do? For those folks, it's really about, "Can you translate that to something that's very impactful? Sometimes what we'll do is we'll do these flashcards that we'll give to the folks that are proposing and will say, "Well, if this is the project, make sure that you include sales tax. If this is the project, the tax actually goes into the price, but then it's not going to be a line item." That's all they need.
Doug: Right.
Joe: They don't need to know the why's and all of that.
Doug: Right.
Joe: You just have to give them a tool that'll work.
Doug: Yeah. Give me the process and I'll implement it and [crosstalk 00:17:27].
Joe: Yeah, just give me something that's at my level that I can deal with. If I'm taken wire out of stock, it's for a nonprofit job. I mark it on this page of the clipboard. If it's for a taxable job, I'm mark it on this page of the clipboard.
Doug: Right.
Joe: Easy stuff.
Doug: Yeah.
Joe: But it's remarkable the level of controls that you can add to the business like you said-
Doug: Mm-hmm (affirmative).
Joe: ... that people just have no interest in doing. It's just, "Ah, it's too difficult. So I'm just going to pay that $3 million on the back end when I want to sell the business."
Doug: "I'll take that risk and..." Yeah, that's what they think at the time. [crosstalk 00:18:04] Sounds okay. Now talk to me maybe a little bit about attachment. I know that's a big issue, particularly when it comes to construction projects and then the rules are different obviously in different states.
Joe: Yeah.
Doug: Ohio is a bit unique I think in that regard, correct?
Joe: Yeah. The states are fairly uniform in one of two categories. Think about it like the drywall that we have behind us. So first there's this idea of, is the thing attached? So is that television attached? It is, but you can easily move it without damaging it. So it's not really attached. It's like a picture. It's just hanging on the wall. But the drywall, you can't move that without knocking it out, knocking the studs behind it out, all of that. So the very first thing that states look at is, is it actually physically attached? Right? Then in a lot of states, you're done. That's it. It's attached, that means this is the tax structure right here. Ohio is an attachment plus state. We have to be special.
Doug: Of course.
Joe: There are lots of special states across the country. So they say, "Well, attachment is nice, but then you need something more. We need to look at one other fact; how you use it to determine whether or not it's attached for purposes of who's supposed to pay the tax on it." Right? So the cases, and I'm sure I've mentioned this super briefly at some point on here before, think of a rollercoaster.
Doug: Mm-hmm (affirmative).
Joe: One of the landmark cases in Ohio is on a roller coaster. So if you look at the roller coaster, is it attached? You hope so.
Doug: Better be.
Joe: Right? You hope it is. At least it's attached enough you're not going to kill you, someone else. So it's attached. Okay, fine. It's in the ground. We have these big concrete steel structures that are attached. It is attached, right? Ohio considers that roller coaster the exact same as the television. It's hanging on the wall behind me just hanging on a nail, exact same tax treatment. You're like, "But those are different." They are, but not for tax purposes. Right? That's that whole attachment versus non-attachment thing is in attachment states, it's attached and you know when you see it. Great, then you know what the tax treatment is. In these attachment plus dates, man, construction contractors have got a time of it because you need to look at the next piece. How's it being used? Is it a business fixture or not? That's kind of the term for that. It's quite complicated for folks that are used to going out executing on jobs and they're not sales tax nerds.
Doug: Right.
Joe: Let me tell you.
Doug: Well, and not to scare people, but that's why I'd call Joe or Pete today, Pete Schweddy-
Joe: That's right.
Doug: ... that's why I'd call him and have you come in and do an assessment and understand, "Okay, these are my risks. This is where that lies." It doesn't take a ton of effort to go through that assessment.
Joe: No, no. Like most due diligence problems, you're going to find it in 15 minutes or less.
Doug: Yeah.
Joe: Very easy. You find the right person to answer your question, simple question, "Hey, guys. Do we know when we're doing a job for a nonprofit or a school district? Do we have a form that someone fills out?" "No, we don't." "Okay, well that's a problem," right? You found it in like five minutes.
Doug: Right.
Joe: It's super easy. Fixing it is troublesome. That's the thing that takes a long time, but the initial diagnosis to see if you have a problem, super easy.
Doug: Yeah. So it's well worth the effort to investigate if I'm any business owner. I don't know why you wouldn't want to know where your risks lie, that's for sure.
Joe: Right.
Doug: Well, that's great. Good stuff, Joe.
Joe: Sure.
Doug: I appreciate you coming on and always something to think about particularly, as we are at this point in the cycle where there are a lot of business transitions, a lot of liquidity events going on. It's something that needs to be dealt with before you get into the due diligence phase.
Joe: Absolutely.
Doug: Lesson for the day. We appreciate you being on. Thanks again. If you want more business tips and insight or to hear previous episodes of unsuitable, visit our podcast page at www.reacpa.com/podcast. Thanks for listening to this week's show. You can subscribe to unsuitable on iTunes or wherever you like to get your podcasts including YouTube. I'm Doug Houser. Join us next week for another unsuitable interview from an industry professional.
Disclaimer: The views expressed on unsuitable on Rea Radio are our own and do not necessarily reflect the views of Rea & Associates. The podcast is for informational and educational purposes only and is not intended to replace the professional advice you would receive elsewhere. Consult with a trusted advisor about your unique situation so they can expertly guide you to the best solution for your specific circumstance.
