What is the true income of an independent business? This is a question of interest to many parties–including prospective buyers, investors, and lenders–but nobody is more determined to know the answer than the Internal Revenue Service.

What makes the “truth” about a company’s income so elusive? Isn’t this what financial record-keeping is all about? Yes and no. Business owners have been known to go from minor figure-fudging to major-league cheating, in an effort to lower the amount of income necessary to report to the IRS in any given fiscal year. In fact, the IRS estimates that two out of three business owners regularly under-report income.

“Unreported income” is the official phrase for this practice; however, in the trade, the word often heard is “skim.” It sounds light, healthy, and maybe good for you. But is it? Consider an item from a newspaper in a typical Main Street town, bearing the headline “Business Owners Sentenced”:

Two Myrtle Beach business owners were sentenced in federal court in Florence [S.C.] for not declaring money received from poker machines in their bar on their income tax returns, according to a statement by the US Department of Justice.

Roy Gipson of Charlotte and Ann Willis of Myrtle Beach, former operators of Players, a sports bar in the Galleria Shopping Center, were indicted by the federal grand jury in September. They pleaded guilty in October to filing false income tax returns.

(Sun-News, Myrtle Beach, SC)

This is a depressing story, resulting in the sentencing of one of the defendents to three years’ probation, three months in a halfway house, several months of home detention, and a $5,000 fine payable within six months. The second defendent was sentenced to three years’ probation, two month home detention, and 400 hours of community service. All this for a little poker-machine skimming? How was anyone to know? How did anyone find out?

It’s the story behind the story that should really catch the attention of business owners. And especially of potential business sellers, because the unreported income in this case was discovered by IRS agents who went undercover, in “disguise” as typical business buyers.

The undercover agents, acting as any savvy prospective buyer would, wanted a close look at the true worth of the business in order to make an informed “offer.” The sellers were happy to comply, and readily admitted that they were not declaring on their tax forms money received from poker machines that had generated more than $120,000 over a two-year period. Truth, in this instance, did not set its tellers free. Business owners are often tempted to have it both ways–under-report to the government, and then, to sellers, reveal that the news is much better than it looks. The Myrtle Beach bar owners are not the only ones who have been tempted to slant the worth of a business in two different directions at the same time. This practice, although illegal, is not uncommon. And when “everybody does it” becomes the perception, even the most reputable, otherwise law-abiding citizens can get caught in their own trap.

As one Delaware restaurant owner of 20-years’ excellent standing in his community says, “I made more than a decent income which I disclosed on my tax return. However, over and above my regular salary, I also skimmed a geat deal of unreported and untaxed cash for myself and some of my employees. I always thought that most people do it and if I got caught, I could just pay the IRS the taxes due plus some interest and penalties.” Instead, when it came time for the restaurateur to sell his business, he disclosed its true worth to prospective buyers who turned out to be–yet again–undercover IRS agents. The restaurateur says, “Without my knowledge, they tape-recoreded everything I said. You have no idea what it is like to hear your own voice on a tape recording. I never knew the IRS conducted undercover operations.” He adds, “I thought that very few people go to jail for committing tax crimes and those that went to jail were mostly organized crime figures and drug dealers. I now find that sixty percent of all the people committing tax crimes go to jail. They generally serve between one and three years. I am now waiting to be sentenced, but whether or not I go to jail, by the time I’m done paying the taxes, interest and penalites, for every one dollar I skimmed, I will have to pay the IRS three dollars.” (This business owner is presently serving a six-year prison sentence.)

Even if a business owner who skims escapes being caught by such a sting operation, he or she will still face a dilemma when it comes time to sell. Whether or not business owners have made the immediate decision to sell, they should prepare for the future by building the image of a successful business. The picture they have painted for the IRS is not likely to be admired by buyers, who will want to pay only for what is reflected on the books, including what is revealed by the tax return. The seller may think it’s possible to set a fresh scene for the buyer–one based on the theme of potential; however, buyers will be far more impressed by proof of a good track record.

Here are some suggestions to sellers for unveiling hidden profits and putting them where they will do the most good–in front of prospective buyers:

• Think Ahead. Remember that the future is now, and set your mind on long-term instead of short-term benefits. Show maximum profits for each quarter.
• Take a Step Back. If necessary, look back on the previous months’ financial records and work toward showing the truest–and hopefully, the best–profit situation.
• Delve Into the Past. Go even further back and reconstruct records (without showing “skim”) that reveal the legitimate profit situation over a meaningful period of time.
• List Tax-Deductibles. Make a separate list of salaries, and of fringes and perquisites that are tax-deductible and that provide a current benefit to the business.
• And don’t forget–it won’t be only the buyer who will be impressed by true profits. Loan underwriters and potential investors will be more apt to show favor. And the IRS will send its agents-in-disguise to somebody else’s door.

“Your salespeople didn’t listen when I placed my order, and when I wrote a letter to complain, they still didn’t get it right. I guess they don’t read any better than they hear.”

Daniel Langley, the owner of a central Massachusetts mail order company, took this call on a recent Monday morning. It happened to be a holiday, or he might never have got this close to a customer complaint. He was glad he did.

“I needed to be reminded,” he said, “that the problems are always out there. I tend to hear a lot from customer service about the record-breaking order or the customer calling from New Guinea. I realized we haven’t been paying enough attention to the everyday, not-so-happy news.”

Langley is typical of many business owners and managers in that respect. A lot of companies–large and small–do much less than they could in dealing with customer problems and complaints. This is an unfortunate omission, and an unnecessary one: achieving good customer service is neither costly nor complicated. What’s needed is a well-considered plan, coupled with a positive attitude.

The following steps can help any business convert problems into solutions . . . and into good PR as well.

Fight fire with anything but fire.

An unhappy customer calls expecting a fight. If they aren’t downright angry, they are at the very least upset and on the defensive. The salesperson should be careful not to echo the customer’s attitude. Instead, the person answering the complaint should aim for just the opposite tone: a calm expression of interest in listening to the problem, followed as soon as possible by the desire to solve it. This is not always an easy task, and salespeople should be trained to realize that customer complaints are not (in most cases!) personal attacks. Short of a free case of Perrier, employee courtesy is the most effective means of dousing customer fires.

Quick action is the best action.

And in most cases, it may be the only acceptable one. What you do in the first minute or two may well determine whether you will lose the customer–and create a ripple effect of ill will–or gain a “friend” forever. Research shows that the sooner the problem is resolved, the more likely you are to end up with a happy, loyal customer. Proper handling will turn around 95 percent of customer complaints, but the statistics get gloomier in proportion to the time that is allowed to elapse. Wait an hour, and you have a tentative customer; wait a day, you have a disgruntled one; wait longer, and you may have no customer at all.

Place authority where it will do the most good.

It’s one thing to advocate quick action to quell customer complaints. However, if the manager or other superior in a company’s hierarchy is the only one who can “sign off” on problems, delays will be, in most cases, impossible to avoid. If possible, salespeople should have the authority to approve returns and exchanges and solve other problems–up to a predetermined dollar limit.

Approach problems with a can-do attitude.

Obviously, not all complaints can be resolved to the every customer’s satisfaction. However, each problem should be handled with a sincere attempt to make the customer happy. Working within the rules (and financial limits), the salesperson should give the customer the feeling that it is he or she who is important–not the rule book. What should the price tag be on customer contentment? Good business sense says it can’t veer off into extravagance; however, generosity can pay big dividends. The cost of solving one problem may be far less than losing a valuable account, client, or customer.

Measure the quality of your “damage control.”

Many midsized businesses are following the lead of the larger corporation and asking their customers for feedback. If you aren’t already including some form of questionnaire or survey form in your mailings, you might consider trying a simple postcard or product enclosure.

Watch for patterns in customer problems.

Keep a careful record of all customer complaints and determine if there is a particular product or service that generates the majority of problems. If you can detect a pattern, these customer problems will actually have helped you, in the long run, to target company problems of your own. If no pattern emerges, you will be affirmed in treating each case as separate challenge–and, following the steps outlined above, you will have the tools to make quality customer service one of your primary–and attainable–jobs.

How Did We Do?

Here is the follow-up to customer problems Massachusetts one business owner recently implemented. Each customer complaint is tagged in the customer service data base and automatically “personalized” with the customer name and specific problem addressed.

Dear [Customer]:

Our records show you recently [returned/exchanged/had questions concerning] one of our products. To help us continue to offer quality service, please take a moment to answer the questions below:

• When you called [with your question/to advise us of a problem], did you receive a courteous response?
• How much time (approximately) lapsed between your [question, complaint] and our [answer/suggestion as how to resolve it]?
• Did you receive a satisfactory [refund/item in exchange, answer to your question]?

Thank you!

Are your workers independent contractors or employees? This is a compelling question, especially where the Internal Revenue Service is concerned. Every worker claiming status as a non-employee means payroll taxes and social security contributions that won’t fall into the IRS’s pocket.

Now many states are taking a closer look at the question, too. They are increasingly on the lookout for new sources of state revenue, including workman’s compensation and unemployment insurance, both of which can be bypassed when a business uses independent workers.

What can a business owner/manager do to keep on the right side of both federal and state tax patrols? Here are a few precautionary steps to safeguard the status of workers as independent contractors.

• Encourage (or at least allow) the worker to provide his own assistants, including their hiring, supervision, and compensation.
• Allow workers to establish their own schedule of work days/hours.
• Be sure that workers provide their own equipment and most supplies.
• An alternative may be to use an employee of a temporary service. These services can provide personnel experienced in the job required and, since this worker is actually an employee of the temporary service, all federal and state taxes and fees are handled at that end as well. Although you may pay more for this type of worker, you will avoid concerns about meeting government regulations and restrictions that often come packaged with the independent status. When in doubt, always consult your legal and financial advisors.

1. Place a reasonable price on your business. Since an inflated figure either turns off or slows down potential buyers, rely on your business broker to help you arrive at the best “win-win” price.

2. Carry on “business as usual.” Don’t become so obsessed with the transaction that your attention wavers from day-to-day demands, affecting sales, costs, and profits. Since the selling process could take as long as a year, the buyer needs to keep seeing a healthy business.

3. Engage experts to insure confidentiality. A breach of confidentiality surrounding the sale of a business can change the course of the transaction. Expert intermediaries can channel the process and the parties involved to keep the sale within safely silent bounds.

4. Prepare for the sale well in advance. Be sure your records are complete for at least several years back and do all pertinent legal or accounting “housecleaning”–as well as a literal sprucing-up of the plant or store.

5. Anticipating information the buyer may request. In order to obtain financing, the buyer will need appraisals on all assets as well as information to satisfy environmental regulations (when real estate is concerned).

6. Achieve leverage through buyer competition. This can be tricky; you are wise to let your business broker, as a third party, create a competitive situation with buyers to position you better in the deal.

7. Be flexible. Don’t be the kind of seller who wants all-cash at the closing, or who won’t accept any contingent payments or an asset transaction. Depend on the advice of your intermediaries–their knowledge of financing and tax implications– to keep the deal sweet instead of sour.

8. Negotiate; don’t “dominate.” You’re used to being your own boss, but be prepared to learn that the buyer may be used to having his way, too. With your business broker’s help, decide ahead of time when “to hold” and when “to fold.”

9. Keep time from dragging down the deal. To keep the momentum up, work with your intermediary to be sure that potential buyers stay on a time schedule and that offers move in a timely fashion.

10. Be willing to stay involved. Even if you are feeling burnt-out, realize that the buyer may want you to stay within arm’s reach for a while. Consult with intermediaries to determine how you can best effect a smooth transition.

Answering services, message machines, voice mail, “on hold” music, speaker phones . . . where would a business be without them? Perhaps–in some situations–a lot better off! In the small to midsized business, where every call should count, owners and managers need to ensure that the telephone is an efficient, effective sales tool instead of a handicap. It’s important to remember that the caller’s first impression of your company is from the voice answering the phone. That first minute or less will help form the caller’s lasting opinion of your business, so why not take the opportunity to make that opinion the best possible? Here are a few ideas for improving the way your business says hello.

Call Your Office

Give your office a call–just don’t let them know it’s you. Have someone whose voice your employees won’t recognize place the call, with you standing by waiting to listen. This may sound like cloak-and-dagger tactics, but it’s one that successful managers use to monitor the quality of their telephone service. What to listen for:

• A pleasant salutation (“Good morning, Jones and Jones”), followed by a name, if appropriate, and offer of assistance.
• An unhurried, interested response to queries, or the offer to connect the caller to someone else who can provide information.
• A reasonable on-hold time. And, if the time seems longer than normal, is there an apology for the delay?

Check Out Your Service

Conduct a “test” of your answering service similarly to the above; however, you’ll be listening here for that extra level of care an answering service should take in personalizing its service. Be sure the following standards are met:

• Answering service operator answers with the name of your company, not just a generic “May I help you.”
• Operator should know pertinent facts about your business: times of operation, key names of personnel, etc.
• Check message you give operator against the message that he or she transmits to your company.

If you aren’t satisfied, take the time to educate your answering service about your standards and expectations. If the service can’t–or won’t–comply with your request, engage another organization to do the job.

Tune Up Your Message

When was the last time you listened to your own company’s voice mail message? When you do, turn a careful ear to the following checkpoints:

• Are you satisfied with the voice that represents your company? It should be upbeat, but also well-modulated and pleasingly-pitched. Do a test of several voices and choose the one that sounds best “on tape.”
• If your voice mail system has background music, or if your company has a call sequencer with on-hold music, be sure the sound is welcoming and soothing.

Take High-Tech Down a Peg

Does your company have automated voice mail? Speaker phones? Conference-call capability? All well and good in this era when communication is king. Just keep in mind the advantages of the “live” human voice–when you make a call, business or personal, isn’t this what you prefer to hear? Although the person in your business who answers the phone may well be your lowest-paid employee, remember that this human voice is vital to the image of your company.

Buyers are expected to perform a thorough due diligence on both the business and the seller(s). However, many sellers don’t do an extensive due diligence on the buyer(s). Deals do not always close; many are aborted in the very early stages, and others tank somewhere along the way to what was hoped to be a successful closing. So, what happens that prevents a deal from closing, especially one that began with such positive signs? Obviously, in many cases, the buyer’s due diligence turns up some items that were not revealed by the seller, and others that can’t be resolved.  Some of these items probably had early-sign red flags; other red flags occurred somewhere along the way, and unfortunately, the result was that there were pre-closing red flags.

The Early-Sign Red Flags

Sellers should seriously look at who the buyer is. This may be a corporate buyer who is just looking. On the other hand, some sellers may overlook a strong individual buyer for fear that he or she may be inexperienced in the acquisition process or might be too cautious. In both cases, the seller may want to ask questions such as the following: What companies have you already looked at? How much equity are you willing to commit? What experience do you have in what my firm does?

Some sellers have that sixth sense that allows them to size up a prospective buyer. No one wants to waste time with someone who really isn’t a buyer. The deeper a seller goes into the due diligence process with a potential buyer, the more red flags may appear. If there are too many, if the ones that get raised seem too difficult to resolve, or even if they might be resolved, if that sixth sense says “no” anyway, it is probably time to move on.

Red Flags Along the Way

Once the Offering Memorandum has been given to the potential buyer, the next stage of red flags may occur. For example, if your intermediary informs you that he or she has not heard from the prospect after receiving the memorandum, it could mean that the buyer prospect is not as interested as you might have thought. Also, if the next step involves a junior member of the prospective buyer’s management rather than the CEO or COO, the red flag should go up. If the prospect, corporate or individual, refuses to provide, or delays providing, information showing their financial capability to do the deal, the red flag should be raised. One recommendation is to set up a social event, a dinner or extended lunch between you and the buyer prospect. Visiting at a social event allows the buyer and seller to get to know each other, establish a cultural understanding and build a working relationship. If this meeting goes badly, the red flag should go up, at least half-way.

Red Flags Just Prior to Closing

The Letter of Intent has been drafted and signed. One area that may cause several red flags to go up is if the buyer’s attorney is inexperienced in the deal process, is overly aggressive, or just won’t bend. This is such an important issue that if changes aren’t made, the deal is probably in serious jeopardy of collapsing.  The seller’s attorney may be able to gather some insight on this matter.

Both sides are taking some risks in any buy-sell process, but both sides should take their due diligence efforts seriously. If a deal has arrived at “a just prior to closing” status, it is certainly vital that both sides can resolve their red flag issues. It could be tragic if the deal has gone this far without serious red flags being raised.

The whole purpose of recognizing the red flags is to try to resolve them before the deal “craters”. A positive attitude by both sides is almost always the answer, and this attitude is best accomplished by the use of a professional intermediary who has been there, knows the red flags, and knows how to resolve them.

Sellers have to ask this question and give it serious thought prior to making the decision to sell. In too many instances, sellers get to the proverbial altar and then back down the aisle. In most cases, this happens because the seller’s decision to sell has not been considered carefully enough.

There are the obvious event-driven reasons such as failing health, partnership, marital issues or because the business is going downhill. In cases such as these, business owners generally don’t have a lot of options. Selling the company is the easiest and most obvious one.

In too many other cases, the owner claims retirement, “burn-out,” or some other reason, none of which is necessarily a permanent state of things. Take the example of the owner of a company who is also the founder, and after a lot of hard work and probably years of financial hardship on his part, the company is now quite successful. It is, as they say, the owner’s “baby.” The first question that needs to be asked is: Do I really want to sell? The second question is: If so, why? And the third is:  What am I going to do after the company is sold? These questions involve not only business decisions, but important emotional issues as well.

Attempts to formulate answers should not be made until the owner has discussed these questions with family and personal professional advisors. There are books on exit strategies and consulting firms that deal with these issues. A professional business intermediary is also someone that has experience in this area and can provide a good idea of current pricing issues and market conditions.

In many cases, the sale of a small company is “event” driven. That is, the reason for sale is health, divorce, partnership issues, even decline in business. A challenging reason is one in which the owners want to retire and live happily ever after. Here is the problem:

The owners have a very prosperous distribution business. They, unfortunately, are the embodiment of a value-enhanced business (see “12 Ways to Increase the Value of Your Company,” under Selling a Business). They each draw about $250,000 annually from the business, plus cars and other benefits. If the company sold for $2 million, after debt, taxes and closing expenses, the net proceeds would be, let’s say, $1 million. Sounds good until you realize that this sum represents only 2 years income for each (and that doesn’t include the cars, health insurance, etc.) – then what? Unfortunately, many owners of smaller companies claim they want to retire when the reality is that they just want to slow down, or eliminate the day-to-day responsibilities of running the business.

Those who want to retire, but don’t think they can afford to, may want to reconsider their decision. Perhaps they can’t afford not to sell.  These owners may have already retired, at least mentally. The owner loses focus, decides not to invest the capital necessary to continue to grow the business and ultimately loses sales and profits or loses a key manager or salesperson, etc. This lack of enthusiasm will no doubt impact their business, lowering its value to a buyer when selling becomes inevitable. In the meantime, following their decision not to sell, they could lose a major customer, a major competitor might begin to eat away at sales — and profits — or a new competitor may move into the market. All circumstances that will reduce value!

Perhaps the owners will not have the “luxury” of changing their minds and deciding not to sell. If they are eventually forced to sell the firm because it is declining, they most likely won’t receive anywhere near the $2 million they might have earlier. The time to sell is when the business is at a high point. Using the services of a professional intermediary can bring the highest price possible.   If you are thinking of selling but hesitating because “the time isn’t right,” take the step that can make all the difference. Seek expert advice, which is as close as your nearest business intermediary’s office.

A buyer was interested in a building products manufacturer that did $70 million a year in sales.  Although the business was profitable, it seemed that their margins were lower than they should have been for this industry. The buyer asked the seller how they priced their products.  As the seller was explaining his pricing strategies, he happened to mention that a price increase of 1.5 percent would not really impact sales. He failed to see that the price increase of 1.5 percent on $70 million in sales would bring $1 million in profit. A smart buyer would realize how to get an additional $1 million in bottom-line profit simply by increasing prices by 1.5 percent.

A recent book titled The Art of Pricing by Rafi Mohammed went immediately to the business best-seller list, and no wonder. The author stated: “One of the biggest fallacies in business is that a product’s price should be based on its costs.”

Here are some of the author’s suggestions:

• Restaurants: Keep the entrees priced attractively, but expect to make up the profit shortfall on drinks, desserts and extras.  McDonald’s profit on hamburgers is marginal, but it has substantial profits on French fries and soft drinks.

• Television Advertising: Sell 75-85% guaranteed slots six months in advance, then sell the balance of advertising to the spot-market with little advance notice at premiums of 50%.

• Financial Printing: Price the printing of IPO prospectuses at near break-even, and then charge exorbitant fees for last minute changes.

• Investment Banks: Quote a relatively modest accomplishment fee as a percentage of total consideration, but insert a rather substantial minimum fee.

Another notable quote from Rafi Mohammed is: “Companies should develop a culture of producing profits. Through better pricing, companies can increase profits and generate growth.  In many ways, smart pricing is like hidden profits.”

This takes us back to our first premise: Small pricing increases can greatly increase profits.