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WES S01E14: A CPA’s Take On Buying And Selling Online Businesses

Justin Cooke November 10, 2015

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We get questions about the tax implications of buying online businesses all the time.

“Should this be a stock or asset sale?”

“Can I roll my sale into another purchase in a calendar year to avoid taxes?”

“What part of the sale is personal Vs. capital gains?”

We both have experience in buying/selling websites and online businesses, but when it comes to parsing thousands  of pages of tax code to find your loophole – that’s not really something we can do!

But there are people who CAN do that for you and today we sit down with one of them…

In this episode, we sit down with CPA Mario Lucibello to dig into the ins, outs, and upside downs of buying, selling, and investing in websites and online businesses. This guy’s a pro and we get into quite a bit.

Not the most exciting subject, but I had so many questions I just had to keep hammering him for the full hour. Sit back, relax, and let’s talk accounting when it comes to our industry.

Digging the Web Equity Show? Please leave us a review on iTunes. We’d really appreciate it!

Listen To The Full Interview:

What You’ll Learn From This Episode:

  • Business Structure + Setup
  • Due Diligence With Buying Online Businesses
  • Taxes With Buying/Selling Websites

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 Featured On The Show:

 

Mario:                                   The kid licks the paint on the toy. And how you’re selling the toys to the kids, someone licks the paint and you’ve got a big problem if little Joe dies.

Speaker 2:                           Buying and selling businesses just got a lot easier. Welcome to the Web Equity Show, where thousands of successful entrepreneurs go to learn about buying, growing and selling online businesses. Your hosts Justin Cooke and Ace Chapman share their real life advice, examples and expert interviews to help you build and grow your own online portfolio. Now to your hosts, Justin and Ace.

Justin Cooke:                     Welcome to episode 14 of the Web Equity Show, I’m your host Justin Cooke, and right here with my co-host, Ace Chapman. What’s going on buddy?

Ace Chapman:                   What is absurd, it’s great to be here doing another episode, man.

Justin Cooke:                     Yeah man, episode 14 to keep knocking them out, man. I’m pretty proud of us. A little pat on the back for keeping the show going. Hey, we are talking CPA’s take on buying and selling online businesses. It’s nice enough for us to give advice on taxes since we’re not accountants. We figured, we might as well get someone on here that does know the business. And one of these interesting with taxes, with accounting, when it comes to buying and selling websites is that, there’s plenty of win-win in the industry. But when it comes to taxes, when it comes to tax considerations, it’s a lot less win-win. I mean, there is an advantage on the buy side, and there is an advantage in the sell side. And so, we’re talking to someone today, so, we’re gonna get into that a bit more.

Ace Chapman:                   Yeah, it’s one of these things I find myself constantly, constantly saying, well, I’m not an accountant, but, here’s my opinion. Which, you have to take and go to an accountant and see what they think about. But, I’m sure you get it as much as I do, Justin. It’s just questions after question about tax issues and how people should handle the taxes when they’re buying a deal or selling a deal. And how to structure the deal so that they face the limited liability when it comes to their tax time. So, I thought it was a great idea to get this episode going, we got another one coming up with an attorney, and, which is also one of those things that both of us end up saying like, “I am not an attorney.” So, this will be a good episode for folks with those kind of questions.

Justin Cooke:                     Yeah, I thought it’d be great to get some real professionals from their various industries on here. And I gotta say, I’m putting this out there, man, the CPAs and the attorneys, these guys are deal killers, man, they’re deal killers. But, that is their role. I mean, that is what they’re supposed to do, and so, they can advise you on deals that aren’t great for you, or deals that, at least, don’t look great from an accounting or legal a perspective. And I gotta say, man, taxes, not really the most fun topic. So, if you’re thinking about tune out or skipping this one, I gotta tell you, it’s not that bad. So, the guy we had on, Mario, is a funny dude for an accountant. So, I think, you’re going to enjoy it. I think you’ll find it entertaining, even if the topic is a little out there.

Ace Chapman:                   Yeah, he makes the topic of; I got it as entertaining as it could be. So, you got to know this stuff at the end of the day, and it’s a huge leverage when you go into a deal. And really, you know as much as possible. You know how legal needs to be handled, you know how accounting needs to be handled. And so, when we’re looking at a deal, you can go to a potential seller and say, “Hey, talk to your accountant about this. But, you may want to structure this deal in this way.” So, it’s not the most fun topic, but, I think, he does an amazing job at keeping it entertaining.

Justin Cooke:                     Yeah, man. I brought him on. We’re discussing a couple things. We’re discussing business structures, we’re going to talk about buy and sell considerations on both sides. We’re going to talk about the tax implications that come with buying and selling websites and online businesses, he does a great job of getting into that. Before we do that, buddy, we got some listener love, man. We got a five star iTunes review from Lim Bear. He says, “Awesome, finally, this show is awesome, Justin and Ace are a little practical. Boots on the ground, here’s what really works advice. It’s great to learn from practitioners. This show helps me balance my New York City big law Corporate M&A lawyer background, with a real life deal, some online biz M&A world. Well, while still my paper deals are a little more than other lawyers in the deal, hey, sometimes, I want an officer cert. Now I know what to focus on and what to let go of. Thanks, Justin and Ace, keep on kicking butt.” Well, thanks, Lim Bear, we really appreciate it.

Ace Chapman:                   Yeah, I’ll be excited to hear what he thinks about our attorney episode as well. But, it is really interesting. I mean, we’ve got several M&A attorneys who are fans of the show, the guy who is coming up is, as well. So, it’s great to get feedback from them. And, I talked to people all the time that are curious about private equity. It’s amazing how different this world is from the actual private equity world, it’s its own animal and has its own set of rules. And so, you gotta come at things from a little bit of a different perspective.

Justin Cooke:                     Yeah, it’s heavily cash flow in this business, where private equity is like, “Are we going to absolutely crush and be a billion dollar company or not?” That’s really understood. We got a question, buddy, from a new business buyer, his name is Sean Smith. Let me go ahead and play that, and then, we can respond.

Sean Smith:                        Hi Justin and Ace, my name is Sean Smith, and I’m in Chicago. First, I want to thank you guys for creating this podcast and creating awesome content that people can learn from you guys about how to acquire businesses. I’m in the midst of potentially acquiring a business with my partner, and it would be our first business. So, it’s really exciting. And we are just trying to figure things out. The question I have for you guys is, what should our first offer be? Because, the owner has the asking price, but we’re wondering what our offer should be. All right, well, thanks so much for listening, and I hope to hear from you guys soon. Bye.

Justin Cooke:                     All right, Sean. Well, first off, thanks so much for calling in, man. Appreciate it. And I also want to congratulate you on your first deal, man. It sounds like it’s going well and you’re getting close to actually making the deal happen. One thing I’ll say before we even talk about making the offer is that, if there’s a third party, let’s say, a broker, an attorney or something on the other side. And they’re getting paid on the deal closing, you can actually play a trick on them and turn them at least into advocates for your case. And the way to do that is to show them and tell them that you have the cash, that you’re ready to move. And then, you can move very quickly on the deal. So, generally, that third party is working on the sell side, they’re working on behalf of the seller. You can actually put them on your team, if you show them that you’re a winner.

Justin Cooke:                     That you’re going to get this deal closed and you can close it really quickly, they’re going to advocate much harder and stronger on your behalf. Because, ultimately, they want to get the deal done. If the deal gets done, they get paid. And if you seem like the best or most likely candidate to get that deal done, they may want to work with you, even if you’re offering less money.

Ace Chapman:                   The other thing to take into consideration when you’re dealing with the broker is, for their seller, like Justin said, their job is to protect the seller and try to get a deal done. And they only have a fiduciary responsibility to the seller. So, if you seem like somebody who’s going to cause a bunch of headaches during the process, they’re not going to want to deal with you. So, just showing them that, “Hey, I have the money, I’m a real guy, I’m really going to close this deal.” That can allow you to make a little bit lower of an offer. When I’m coming in and make an offer, the first thing I’m deciding is, how much do I want this deal? And it’s not just a matter of, oh, do I think it’s a great deal or not? It’s really, what am I going to be able to do with it? So, do I have another deal in my portfolio that can promote each other and both grow? Or, do I see some hidden asset in this business? Where, I’m buying it at two times earnings.

Ace Chapman:                   But, I’m going to be able to double revenue very confidently within the next two months, and basically, turn that into a one multiple deal. Then, that’s gonna affect how I’m making my offer. So, mistake that you don’t want to make is, making an aggressive offer when there’s a lot of low hanging fruit in the deal. And I see this happen all the time, where people just, they get excited, they want to get an amazing deal, and they have all this potential. And then, they end up missing out on the opportunity. So, if it’s just a standard deal, you feel like, “Hey, I want to own it. I’m going to get this return, I’m not going to really be able to do anything special to it.” Then, that means, it’s probably not high up in the priority list, you can go out and do that with any deal. But, if you feel like you’re gonna have a big impact, you want to get closer, a little bit closer to the sales price.

Justin Cooke:                     So, like what you’re saying is, and I think it makes a lot of sense if there’re some strategic opportunity, and you can dig. Look around for strategic opportunity, or even like parallel industry, not even a direct strategic. But let’s say that you don’t have any deals, like you don’t have any other deals or other companies that makes a strategic person for you. One of things I like to do, is mitigate against risk. So, look for the weak spots in the business, and if that requires an earn-out, make it an earn-out. If it requires the seller to stay on for some period of time to recapture their cash, try to set it up a structure in such a way that that happens. And if it looks like a really straightforward deal, and the seller really needs the money for something. If you can find out why they’re selling it, and they need the money for, I don’t know, whatever reason. And then you can quickly, make a quick offer, make it all cash offer. And make it for, 20% less, 30% less, depending on how much cash they need.

Justin Cooke:                     So, try to structure around, both defending against risk in the business. And then, also, trying to meet the needs of the seller, if you can find out what those are. All right, Ace, enough about that, buddy. Let’s talk to CPA Mario, and see what he has to say about buying and selling businesses.

Justin Cooke:                     I’m really excited to have Mario on the Web Equity Show. We’ve been working with Mario as our CPA, helping us to get a bunch of our businesses taken care of. We were working on structure, and he’s working with our lawyer on this. And I thought he’d be a great guy to have on the show to talk taxes. Talk, when buying a site, what are you looking at? When selling a site, what are you looking at? To protect your assets and not pay the tax man all of your money. So, Mario, it’s great to have you on, buddy.

Mario:                                   Justin, nice to chat.

Justin Cooke:                     [inaudible 00:10:14] you’re one of the most interesting and fun accountants. Like usually, your listeners says like, “Oh my god, I don’t know about this guy.” But, you, I think, we’re gonna have some fun here. Let’s talk some business structure and setup, buddy. When setting up your business, a lot of entrepreneurs are like, “Oh my god, I need to go offshore, or, I need to go set up my financial domicile over here, and my corporate structure over there.” And they haven’t even started doing business. So, we generally recommend, do some business first, right? Get some money rolling in, get some cash flowing in. And then, you can go back and fix that. Am I crazy? Does that freak you out? Or you need to be set up from the beginning? Or, does that make sense to you?

Mario:                                   I mean, going offshore, right off the bat, just seems crazy to me. The filing requirements cost a ton of money. And from the U.S. side, if you’re a U.S. person, you’re pretty much getting a little bit of deferral of taxes. So, is deferral good? Sure. But, you might want to wait till you’re netting, maybe, a million bucks a year, until you do something crazy like that. But, a simple setup, sure. Set up an LLC, legally protect yourself, separate yourself from the business. Why not? That’s can cost you a couple a hundred dollars, that’s cheap. You might as well do that.

Justin Cooke:                     So, get something basic setup, get it in the U.S., and maybe, some liability protection. But, don’t spend all of your time as an entrepreneur getting started, worrying about all these crazy structures. Because, like you’re saying, you get to defer your taxes. But, you’re still going to pay your taxes. Deferral isn’t nonpayment, it’s simply, you get to hold on to that cash a bit longer. And hopefully, you could make the money with that cash. So, you can make some more money in the meantime. But, that makes sense for Apple, or Google or something. But, yeah, a young entrepreneur-

Mario:                                   And time and effort involved, why don’t you just make some more sales?

Justin Cooke:                     Yeah, I think that makes a lot of sense.

Mario:                                   That makes more sense. I mean, everybody wants to pay as little tax as possible. But, if you’re changing your entire lifestyle to fit taxes, that’s generally not recommended.

Justin Cooke:                     Cool, okay. So, I want to set up my BVI, and I want to have my Singapore Corp and my Hong Kong LLC quite yet, good. So, let’s talk a little bit about housing website or online assets. We have quite a few people listen to the show that may have a couple of websites, a couple of online businesses under their portfolio. What’s the best way on shore, in the U.S., to house those? An S Corp? A C Corp? An LLC? What’s the benefit of each? And what should I be looking at?

Mario:                                   Okay, well, I guess, we’ll start with LLC. I mean, that’s hands down the easiest. If it’s a single owner LLC, your filing requirements are extremely easy. Pretty much just file it on your personal income tax return, and you’re done. Income minus expenses, equals profit. Pay tax on your profit. Now, the S Corp, you could get a little bit of tax savings through, if you’re making enough money, and you don’t have to pay as much in what are called the payroll taxes, the Social Security taxes, the Medicare taxes. So, how that works is, it’s a completely separate entity, it files a completely separate tax return. You have to pay yourself an actual payroll salary, which means, quarterly payroll reporting. And whatever is earned past your normal salary, is a profit distribution. And that profit is not subject to that Social Security and Medicare taxes. So, you will save a little bit of money there. But, you’re required to pay yourself, what they call, a reasonable salary. So, you can’t just pay yourself $10,000 a year, if you’re working 40 hours a week.

Justin Cooke:                     That’s a good question, like reasonable salary, I’ve heard that before. So, is 50,000 a reasonable salary, if you’re getting a hundred thousand dollar distribution? Do you balance the two? How does that work?

Mario:                                   It’s not a matter of, if you balance how much the profit is to what your salary is. It’s more or less, what would it cost to replace you from the business? It’s the standard that, of course, the IRS is. Now, that’s, of course, not an easy question to answer. But, that is the standard. So, you can look on monster.com, and find somebody that could replace you for $10,000 a year. There you go, you have a little bit of backup to say, it only cost $10,000 a year to replace you.

Justin Cooke:                     Okay, so, if it’s reasonable. So, let’s say that, I looked on monster or whatever, and it is like, it costs about $60,000 to replace myself, when I’m paying myself, 45, 50. I’m in the ballpark, I’m close enough.

Mario:                                   Right, exactly.

Justin Cooke:                     And I get to avoid, avoid is probably not the right word, I know. But, to avoid Social Security tax and that kind of thing. Because, I’m getting the K-1 at the end of the year, and take my profits out of the S Corp.

Mario:                                   Right. And then, of course, the final structure is the C Corporation, which generally is not recommended, unless a lot of investors are involved. And here’s why, is the C Corporation, it requires two levels of tax. So, the corporation first gets taxed, and then, when you pass the profits out to yourself, the shareholder, it gets taxed again as a dividend. So, people say, “Well, why ever do this at all?” Well, remember that the corporation pays its own tax. The income doesn’t pass through to the shareholders. So, if you have multiple shareholders, 20, 30, 40 shareholders and they keep coming and going, then, you’re going to want to just have, all right, this entity will pay the tax. And then, the shareholders don’t want to deal with figuring out whose profit is whose? Who owes taxes on what profit? And it just turns into a nightmare when you have too many investors involved.

Justin Cooke:                     Okay, so, it leaves it all up to the individual investors, and the C Corp is like, “Look, hands free, we paid our tax. Now it’s up to you guys, we’re passing it on you.” On the form there, is you’re getting double taxed, right?

Mario:                                   Right, you’re getting double taxed, but, it’s easier in a sense where all they do is pay the tax on the actual dividends they receive, and not the net profit of the entity. The net profit the has already been taxed.

Justin Cooke:                     One of my plans was to leave a lot of the cash in the C corp, right? It’s a piggy bank, does it build up, and then, I can use that or leverage that in other ways?

Mario:                                   Well, sure it could build that. But, again, it’s already been taxed that generally, again, generally, the same rates as the individual rate. And, can you use it for personal reasons? No. Can you use it for business reasons? Yes. Can you use it for the gray area of personal and business reasons? Maybe.

Justin Cooke:                     My special business dinner I had, my business Ferrari. No, that’s not how it works.

Mario:                                   Yeah, the business Ferrari.

Justin Cooke:                     Yeah, that’s not cut. “Hey man, I gotta keep up with the Joneses. I gotta show off the Empire Flippers Ferrari. No, that’s not cut.

Mario:                                   It could be a logo on the side.

Justin Cooke:                     Yeah, I bet. So, that’s not fly end. But, I’m want to keep the profits in the corporation, or if I’m saving up to them and do some explosive growth in the business, the C Corp would work. But really, it’s used for, there’s multiple investors, it’s a huge hassle to figure out, are these hundred investors people in people out? How to pay them out and deal with that [inaudible 00:16:52], we paid, our tax is now on you. Okay, think I got that.

Mario:                                   Really only used in those scenarios when there’s too many investors involved.

Justin Cooke:                     So, I get this question a bit too. If people are wondering, “Look, I have five online businesses and they’re ranging, making anything from $2,000 a month of profit, and the biggest one makes $15,000 a month in profit. How do I decide whether to split those up into separate LLC? Separate S Corps? And when do I do that? And why should I do that?”

Mario:                                   Well, separate S Corps, to me, would sound crazy for something only earning $2,000 a month. Because, there you’re filing five different full tax returns. Separate LLCs is not that bad, because, literally, it’s really just all flowing through to you anyway. So, you’re only filing one thing. It’s still have, of course, five separate filing fees depending in what state you’re in. I mean, if you’re in California, that’s 800 bucks a year minimum fee. And, multiply that times five, that starts getting pricey. To be honest, I mean, the LLC thing is a legal thing. So, it would only, I guess, makes sense if you had one of your sites or one of your products, where you think you have some specific risk or liability. I would think, would really make sense to split these up. I think we made this one example, where the kid licks the paint on the toy. And how you’re selling toys to the kids, someone licks the paint. And you got a big problem if little Joe dies.

Justin Cooke:                     Yeah, they swallowed the little car, and then, all of a sudden, they’re not only suing that one asset, they can then go after all these different assets.

Mario:                                   Right, right. But, if you’re reviewing pens and pencils, and then getting referral traffic from your review site for pens and pencils. I think, your risk is pretty low.

Justin Cooke:                     Cool, okay. So, I think I got it. We’re either looking at an LLC, or an S Corp. The LLC would probably just be one that would house most of my assets. And the only time I would separate them out, as far as I can see, it is if there’s some liability concern where one could be a problem for the other, that kind of thing. And most of the stuff-

Mario:                                   Or, I guess, the only other thing that would make sense, again, from the tech side, is, if one really gets big enough, and you’re trying to market it to sell, then separation. Then, of course, if you take on a third party partner with another, of course, you’d want to separate that from your own personal stuff.

Justin Cooke:                     Yeah, that makes sense. And another way you could do it, is, if you had them on to the same asset, and you wanted to sell the LLC with the business you probably wouldn’t do. I mean, you could just sell those off to another LLC that you’ve created, and do that right. So, you could sell all the assets, except for one, under that LLC to another LLC. And then, sell that LLC to whoever [inaudible 00:19:24] get and to why, you probably aren’t going to be doing that, anyway. Let’s talk about that. So, due diligence, let’s talk about buying online businesses, selling online businesses, stock versus asset sale. We never do stocks sales, we haven’t done one, they’re always asset sales. Why is that? And who is that better for?

Mario:                                   I mean, as the general rule, the asset sale is better for buyer. Because, the asset sale, you get the stepped up basis in the purchase of the assets. So, that’s typically the reason. And the second is legal liability, I guess. If you’re only buying assets, you’re not buying the former operations of the entity. So, you’re not buying the former liabilities that could have happened of the entity.

Justin Cooke:                     All right, Mario. So, we’ve established that an asset sale is almost always, or you can say, always better on the buy side. So, is it necessarily true that a stock sale is what the seller should prefer? Is that always better for them?

Mario:                                   Not always, from the tax perspective. Sometimes, you can pretty much be in the same place, depending on what the assets are that you’re selling. If all the assets are pretty much web assets, created yourself more or less then, you don’t have any depreciation recaptured you have to deal with. Your full gain will be capital gain to you anyway. But, if you’ve purchased these assets and depreciated them and have to deal with appreciation recapture, then, you might have a partial ordinary income, partial capital gain. So, really, from the sell side, what you’re looking at, is the type of income you’re picking up. “Am I going to be picking up ordinary income? Or capital gain income?” The general rule is that, capital gain income is at a lower rate, so, I would prefer a capital gain income. But, if I have a partial ordinary income sale, as long as it’s not a lot, you’d have to build that into your price.

Justin Cooke:                     So, what part of an asset sale is capital gains versus personal income? How is that determined?

Mario:                                   So, if you have created, for example, if you’ve created everything of, bought the domain, created all the contents. Or, of course, your subcontractor is creating the content, whatever. Then, if you sell the assets, it’s all going to be capital gain to you anyway. Because, that’s what it is, it’s just an intangible asset that you’ve created. Most of your sale is going to be goodwill and your customer list, your email list. However, if you’ve purchased an existing site, say, for $10,000, and you’ve depreciated the site over the years. Say, you’ve depreciated it $5,000, and then, resold it for $20,000. That $5,000 of depreciation that you’ve taken, you’ve taken ordinary deductions for, would get recaptured. So, you’d have $5,000 of ordinary income as part of your sale versus full capital gain.

Justin Cooke:                     Okay. So, it comes down to depreciation of the asset. What happens if I bought it at $100,000 two years ago, and end up selling it at $80,000? What happens to that loss? How do I claim that as a seller?

Mario:                                   So, that would probably be 1231 loss that would be ordinary loss to you. Because, it’s a business loss, and you’d be able to offset that against other income.

Justin Cooke:                     Great, okay. And that’s, on personal income, I’d get a $20,000 basically, subtraction or deduction for my personal income for that year?

Mario:                                   Yes, for the most part.

Justin Cooke:                     Great. Okay, I think I got that. Let’s talk a little bit about accounting due diligence. Now, I don’t want to check, obviously, financials for a website that I’m looking to buy. But, in general, let’s say, for an offline business, what are some quick checks a buyer can do to see if the financial seem up to snuff? To make sure there’s no monkey business going on there?

Mario:                                   Right. So, pretty much, what you’ll always request and due diligence on the financial side is, one, is the financial statement. Second, is your internal books. So, your internal general ledger and trial balance, balance sheet, income statement. And then, of course, the tax return. And then, you want to reconcile the three, and say, “What’s the differences? Why is your tax income lower than your book income? And, how can I get from your trial balance to your actual financial statement?”

Justin Cooke:                     Isn’t that often the case? So, I’ve seen the tax returns and what they’ve got going on in the business. I mean, does that normally happen? I normally haven’t seen that. And it’s always seems to be a little off.

Mario:                                   Yeah, I mean, there’s always going to be a little bit difference. But, you want to know what those reconciling items are. You might have different depreciation methods for book purposes versus expert is.

Justin Cooke:                     That’s actually an itching way to see it like, okay, because, you don’t say that there’s a lot of business then that’s going on. That’s a way to reconcile that, and see what extra income was going to them and how that worked?

Mario:                                   And then, there’s the, they call the normalization process. So, that’s when the owner of the business is paying for his landscaping at his home. And he’s paying for his 12 kids’ cell phone bills, and everything and anything else under the sun that he’s running through his business as a business expense. So, we’re adding that all back to say, “Well, this is what the true profit of the company is.”

Justin Cooke:                     Yeah, it’s tough. As a seller, you need to get clear, a year or two years before you’re selling that business. And not have a lot of that, otherwise, you can end up in some awkward due diligence situations, where, “Yeah, no.” And sometimes, sellers are trying to add that back, and the buyers aren’t having that. They’re like, “I don’t know for sure that you didn’t need that as one of your business expense,” and now you’re arguing over, whether that was needed or not. And so, if you can clean those out, a year or two before you sell. “Three years ago, your landscaping bill,” buyers, you can move that past that. But in the last 12 months, it’s a little more, there’s a bigger question.

Mario:                                   Right. So, really, when you’re on the seller side, you want it to be as clean as possible. So then, it just makes finding that true net income easier for the buyer.

Justin Cooke:                     Let me ask you this, on the buy side, are there … we talked about some red flags, I think that matching up their tax returns and their business reports and everything like finding all those discrepancies are, and you can look for some red flags there. I think, matching up what they’re claiming they made, and they’re showing, for websites in particular, claiming they made all this money in AdSense, or they made this money from Amazon, or they made this money in product sales. And then, matching that to their actual bank statements is helpful, that you might want to see, make sure that the money coming in, is actually coming in, and the money going out is going out. I think that’s helpful. Are there any signs of a winner for you? Where, you’re like, I know, you and attorneys get accused of being deal busters. But, which is true, that’s why we pay you to protect us from things, right? But, are there any signs? Where you’re like, “I like this, this is a very positive sign or trend.”

Mario:                                   It’s more of the fit to the company that’s doing the acquisition, more than anything. If you’re buying something that you already have expertise in, or if you’re buying with something that you have a current customer list that can use this product or service. And it’s worth much more to buyer who has this customer list than average Joe who doesn’t. So, it’s more or less finding those synergies, where you could make more money with the business than the former seller.

Justin Cooke:                     Is that something you’re going to pay an accountant to look into for you? I mean, it seems intuitive, or, it seems more like the entrepreneur or the company is going to have a better grasp on what a good strategic value is. But, how can I get my accountant involved to actually bust out the numbers and break them down and figure that out for me?

Mario:                                   Well, because, it’s all based on some sort of gross profit. So, you have to make sure that the item that’s being sold is profitable. So, then, it’s saying, “Well, I have a customer list of million customers. And then, if we add this new product line, and if we can sell it to 30% of our current customers, how much more is this worth then to the general public?” Because, we have this customer list already.

Justin Cooke:                     Yeah. And you can also start looking at, “Is there any way for me to get my costs down? I’ve already got a large customer base. And so, I plan on really ramping up this product, let’s say, whatever kind of e-commerce product it is. And, can I improve the margins on that? And yeah, they’re making 30% margins, can I get those to 35 or 40% with my much larger orders? And crush it selling into my current audience.” Right?

Mario:                                   Right. You also have to remember, people hire lawyers and accountants to specifically to say, “Why should I not by this?” That is why we are hired.

Justin Cooke:                     Yeah, I know. Deal busters.

Mario:                                   That’s our job is to be, either, well, deal busters, or, I’d like to say, good, negotiators.

Justin Cooke:                     Okay. It’s totally true, though, and it is true. And what I’ve noticed is like, a lot of times you have to weigh that. They don’t have veto power that give you great counseling, and then, you decide which way you’re going to go, right? I think, there is value in that. So, let’s say, we’re still on the buy side, right? I’m a buyer, and, I’m negotiating the purchase, right? And you’re going to be my good negotiator, and you’re going to help me negotiate this purchase. What kind of concessions can be made in terms of a tax aspect? In terms of a financial aspect? That, don’t give up too much on my part, but maybe really interesting to a seller.

Mario:                                   What can you give up as a buyer and attacks as … I mean, you can always flip flop from asset the stock sale, which, depending on the situation can help. I mean, other than that, on the tech side, it’s really or not much that can be finagled. I mean, you could specifically identify prices of certain assets, that are more favorable for a buyer or a seller.

Justin Cooke:                     Okay, what do you mean? So, let’s say, I say, the domain is worth more or less, how would that help or hurt the seller or a buyer?

Mario:                                   So, again, that would depend on the situation.

Justin Cooke:                     And by the way, let me be clear about what you mean by specify, you’re saying like, we actually break each aspect of the asset down. So, we say, if the domain is worth this much, the email list is worth this much, the inventory is worth this much, right?

Mario:                                   Right. So, let’s say that seller actually wanted to execute a light kind exchange for what he’s selling. He’s going to go and re-buy more assets that are similar in nature. So, if you could match up values to what he needs to purchase, whatever he’s targeting, then, you can be flexible with that and say, “Okay, we’ll adjust our price for domain, we’ll adjust our price for customer list, we’ll adjust start price for content. And then, we’ll lower our price for goodwill.” Because in the end, it really doesn’t matter for us as buyer, but it matters to you as seller.

Justin Cooke:                     Okay, great. So, we can make those adjustments to the specifications, cut the seller break, doesn’t really matter to me, and that’s a good concession you can make that, doesn’t give up much, but gives them some value. So, you can start to then, fight for points you think that are really important. And along those lines, where should a buyer hold their ground? When a seller comes in and says, “I want this, this or this,” where can you stand firm and say, “Nope, I’m not doing that?”

Mario:                                   Obviously, price. Second would be financing options or-

Justin Cooke:                     Non-competes.

Mario:                                   Exactly, non-competes is another good one. Payment for non-competes. Because, payment for non-competes to the seller is ordinary income, versus, of course, what you want is capital gain. So, if you lower your quote value of that non-compete that’s beneficial to seller. So, I mean, there’s just so many factors and it depends on the situation.

Justin Cooke:                     Yeah, so, if I’m attaching an actual value to the non-compete, I can drop the value of that to cut the seller break, because, that’s personal income.

Mario:                                   Right. On every deal, all the assets should be identified and valued. There’s a form required to be filed by both buyer and seller of any business? I think it’s like an 8960, something like that. And both should be filing that when they buy or sell a business, identifying each asset that is sold.

Justin Cooke:                     At what level do this actually comes into play. I mean, it generally doesn’t for an $8,000 AdSense site, but it does in the mid five, low six figure?

Mario:                                   Yeah, I mean, if you’re selling something for 50,000 and up, I think it’s worth filing for.

Justin Cooke:                     Gotcha. All right, let’s switch over to the sell side a bit. Let’s say, for example, Mario, that I came to you and I said, “Look, I’m selling my business, my finances are a mess.” You’re not going to like that, right? I mean, you’ll like it, you’re going to get paid, but, you’re not gonna like it. And that it’s messy, and you’re gonna have to do a ton of digging through and figuring out. What can a seller or do to clean up their financials? Make their financials easier for you to dig through in preparation for a sale?

Mario:                                   You’re gonna have to hire somebody. Because, like you said, you need two full years, at least, to have something clean. You got to have a full bookkeeping system. All of your stuff should be reconciling back to bank accounts, and you should be able to easily prove that. And then, of course, reconcile your actual internal books to your tax return. I mean, most accountants can do this for you annually, anyway. Whether you know it or not, most of them are doing it.

Justin Cooke:                     Let me ask you this, a seller ever come to you and say, “Look, I want to sell my business, I want to start getting my financials cleaned up, whatever.” And you’re like, “There’s no way you can sell this business, you’re going to have to wait until we can get past whatever.” Have you had that scenario?

Mario:                                   I’ve never had that scenario. Because, usually, when people approach me, they’re already my clients. And most of my clients, most are pretty organized. So, they have approached me and said, “Well, I’m thinking of selling in the next few years, what should I do to tighten up what I’ve got going on already?” And we do that. We tell them, “Well, why don’t stop paying for the dog’s insurance?”

Justin Cooke:                     That totally makes sense.

Mario:                                   Well, and then, I recommend, “Well, why don’t you make sure that these monthly reconciliations are being done? How about we get a little more detailed in your general ledger, so people know what products and services are being sold, so they can specifically identify what is and is not profitable. And make sure that certain costs, again, are also specifically identified. And let’s just get a little bit more detailed.” And it’s really on what they’re doing, and might take a little bit more time every month, but, just get it done.

Justin Cooke:                     Yeah. So, it makes sense to me that, if I came you, Mario, and said, “Look, two years from now, three years from now, I was looking to sell my business.” Having that consultation so you can help me get prepared. Make sure I’m assigning all my expenses correctly and paying for the things that I really need to my business. And kind of make sense and helping me get prepared for that. That’s something we, I think, again-

Mario:                                   Not paying your dog insurance. At least, specifically, identify it in your chart of accounts, so it’s very clear that these should be added back. If you refuse to stop the deducting your funny business expenses, then at least, at the very least, add something where it’s very easily identifiable.

Justin Cooke:                     You don’t want to be negotiating that at the closing table, where they’re trying to pay you a lot less for your business, and they’re arguing because of some vague reference you have in your books, right?

Mario:                                   Right. Because usually, what people do, is they try to bury that stuff. “I’m going to bury that trip to Italy. Because, why would I make it apparent to the government that I’m trying to cheat the system?”

Justin Cooke:                     Gotcha. So, we often find the decision to sell is often an emotional one. And everyone likes to just think they’re logical and rational, but, it may be that they are getting married, and so, they’re looking for the money to get married. And, it’s not, I mean, that’s a rational decision, kind of rush, though. Though, it’s a rational decision, but, there’s a lot of emotion involved and stuff, like, “Oh my god, am I gonna get enough money to do this? Or, I’m buying my first home or whatever, and I’m gonna sell my business to get this home or whatever.” Do you being a third party, you’re an accountant, you’re a rational actor in this deal, and you’re consultant to the seller. Do you counsel them, in terms of, whether it’s a good time to sell? If this seems like a good market for their business? Or, is that not something you get into?

Mario:                                   Well, what I usually get into is, sell versus Keep. Well, this is what happened if you keep your business. Let’s say, assume the same cash flows for the next five or some other years. And this is what will happen if you sell it, net after tax. Because, a lot of times, what they want to know is, “If I sell my business, how much am I really going to have in my pocket after tax? And then I say, “This is how much you’re going to have in your pocket every year for five years, if you keep your business.” And a lot of times, that is what dictates their price. Because, like you said, it’s an emotional thing. It’s, “Well, if I’m going to sell this, if I’m going to sell my baby. And I’m going to lose this income that I’m earning, then, this is the price I would need after tax.

Justin Cooke:                     Yeah, I mean, they might have that number in their head. Everyone has got that number.

Mario:                                   Exactly.

Justin Cooke:                     “Can I get this? Or, am I paying taxes?” And then, you start realizing what you’re really going to get after fees, after taxes, after everything. You’re like, “Well, not quite there yet.” Right?

Mario:                                   Right. A lot of times, it turns into saying, “Well, that’s not enough after taxes.” And they say, “You know what? Now is not a good time to sell.” And other times they say, “I’m just done. I’m just finished with it, I’ll take anything. I don’t want to deal with this business anymore.”

Justin Cooke:                     Yeah, because you’re just done.

Mario:                                   Then, I try to make sure that they wait for what it’s truly worth.

Justin Cooke:                     Gotcha. So, then, it’s more of like, “Okay, let’s see how we can still maximize value. Keep your cards close and let’s get through this.” Yeah, that’s really interesting. So, you mentioned that thing, the idea that, how much cash in the bank would you have after five years? And so, this is awkward, right? So, if you’re in a growing business, and let’s say, you’ve had year of year growth for the last three or four years. And you start thinking, you start playing that out, and you look at where you’re going to be in five years in terms of cash, assuming everything continues. If that were just the case, on the question or cash, I think most people would not sell their business at all, right?

Mario:                                   Yeah. Usually don’t factor in any growth when we do that calculation.

Justin Cooke:                     Okay, even breaking even. But still, I mean, unless you’re in a part some crazy startup or you’re getting some crazy strategic valuation. I mean, getting five years cash for your business is not common, at least, in the online world. I don’t think of any offline businesses in the six, seven figures are getting that either. Yeah, that’s a tough one.

Mario:                                   Yeah, there’s a lot of times where they said, “Well, that’s just not enough.” But, a lot of times, that just means that they’re really not ready to sell. And then, they would be wasting everybody’s time when it comes down to signing the paperwork. Because, in the end, that’s when they’ll think about it. You want to tell them up front before they start shopping it, and then, wasting everybody’s time and then ultimately not selling it.

Justin Cooke:                     Yeah, it takes a lot to sell. Especially, the bigger the business, there’s just so much more involved. And it almost becomes your full time job, if you’re trying to sell your business and shop it around, it can be quite stressful. And so, in some situations, especially, if it’s like a long drawn out sales process, your business can suffer. And so, I think that’s something you have to consider too, how much of my business will suffer if takes 18 months for me to sell this $3 million business?

Mario:                                   And a lot of times, again, it all goes back to emotion, it’s, what are you going to do once it’s sold? Some people are like, “Well, this is my baby, I still want to come in here.” So, it’s tough for some people.

Justin Cooke:                     Let’s talk a little bit about deal structures as opposed to just straight buying or selling for cash. So, are there ways to structure a business for a seller that are advantageous? Are we getting paid for their training as opposed to the asset? I think, training is personal income versus capital gains, is that right?

Mario:                                   You’re right, exactly. Training will be purely personal income. The one benefit of it, though, is, you can play with the tax years it gets captured. So, it’s, okay, you’re on as a consultant for a year or two years. You sell in November for a million bucks. So, you’re in a huge high income tax bracket. But, your payments on your consulting doesn’t start until January. And now, you have low income. So, although it’s ordinary income, you’re still not at too high of a tax rate, and it’s kind of a win for everybody.

Justin Cooke:                     Okay, and you can move the dates around to be advantageous on the seller side.

Mario:                                   Right. You can play with dates, which helps sometimes. Other times, sometimes it doesn’t if you have other sources of income.

Justin Cooke:                     Is there any difference? Let’s say that I’m telling a business for 1.2 million, and, I’d be doing $600,000 earn out, right? Is there any difference on whether it’s tied to the success of the business versus just a straight loan? Is that attacks in any different way? Is there any strategic advantage there?

Mario:                                   I mean, it’s so dependent on what the earn-out is. It would depend on if you actually constructively received it, is pretty much what the IRS standards are more or less. Where it’s like, what are the odds that you even receive that extra $600,000? So, it might not be income until you actually receive it. But, if the restrictions aren’t that difficult, it might be income the day you sell it. That gets confusing.

Justin Cooke:                     To say I’m completely confused it’s not surprising.

Mario:                                   That gets confusing. So, like I said, it depends on the restrictions of the earn-out payment. So, if the earn-out payment is very, very likely. Then, it’s possible you actually have to include that earn-out in your gain that you’re recognizing in the year you sold.

Justin Cooke:                     Okay. So, let’s say that I’ve got a lien, it’s a flat payment, they have to make these payments, it’s very likely they will. Because, they’re personally liable for those payments or something, it’s much more likely that I’d claim it. If it’s tied to some kind of profit or some kind of goalposts that the business has to hit, that’s not a guarantee.

Mario:                                   Right. And then, you could always play with probably installment sale on it as well, depending on how it’s setup. So, where you do partial income part gain in, or part gain part return, I guess, of what your basis is, in the year you sell it, in the year to collect. So, that one gets tricky.

Justin Cooke:                     All right, man, let’s move on. Still, not sure I totally understand that, but I’m gonna get some other questions. Let’s talk about, just tax in general, buying and selling websites in particular. If I’ve never owned a website before, and I’m buying one for the first time, how should I account for it on my taxes? How does that work? Is it an accounting for always ordinary income? I’m sorry, if I’m buying it, how do I account for it? Do I get to write it off?

Mario:                                   Right. So. if you buy an asset, which is to full more or less at the business. You’re buying, not just domain name, you’re buying a domain. You’re buying content that’s on the site, you’re buying, probably an email list of customers, and the goodwill. Now, all of those assets, for the most part, are what are considered section 197 intangible assets. Those assets, when you buy them, should be depreciated over 15 years. You can’t immediately deduct to that purchase.

Justin Cooke:                     How can I shorten that depreciation time?

Mario:                                   Not easy. There’s not a lot written in any guidance on purchase of web assets. There’s some stuff out there where, if you’re purchasing like sales copy, that could possibly be immediately deductible.

Justin Cooke:                     That might be a stretch. There is some sales copy on the site, and it definitely does its job, it’s been split tested. But, how much value of the asset is really in that sales copy? That’s Yeah.

Mario:                                   And then, the second thing is that, a domain … so, generally, if you buy a domain, not as part of a purchase of an entire site. If I buy a domain that I’m going to start, it’s three years depreciable property, for the most part. But, because it’s purchased along with the assets of the business, it’s typically 15 year property. But, if you can somehow separate out the part that is the goodwill portion of that domain versus the actual value of the domain, you might be able to pull off a three year period on that domain. So, I guess, here’s a good-

Justin Cooke:                     No, no, no, I think I got him right. Let me see if I’ll give you a scenario, you tell me if I’m right. So, I’m buying a business, I’m paying 1.2 million for it. But, there’s a ton of value in the brand. And associated with the brand, are a bunch of other domains that are included in the sale. And if we can tie the brand value to those domains, not the whole thing, but, a portion of that, then I can depreciate that over three years.

Mario:                                   Not exactly. Because, most of that sounds like it would be goodwill, because, they’re tied to each other. So, here’s the example more or less is, if I’m buying a site called drugs.com, that has inherent value. Because, if you were just buying and selling domain names, drugs.com would be great domain name, right? But, for example, google.com is worth nothing. Except for the value, the actual goodwill value that Google has built up.

Justin Cooke:                     Oh my God, that’s crazy talk, man. Yeah, now I hear you. I hear you because Google made the brand. Yeah, like Amazon, if there is no Amazon, that’s nothing, right? But, drugs is a commonly used word, and you could argue that.

Mario:                                   That has an inherent value. And again, this is all super gray area. There’s nothing written in guidance. This is all … I had to do one research one time for a big purchase. And I said, “These are options, they’re not good ones. But, at least, there’s some people talking about it.”

Justin Cooke:                     Someone could kind of argue that, possibly, maybe.

Mario:                                   Right, exactly. You could argue that that domain has inherent value outside of its brand.

Justin Cooke:                     So, basically, let’s say, we’re talking about doing some deal like this. And you’re like, “Dude, it’s gray area, it’s kind of a sketch.” It probably would be good idea to bring the lawyer in that I would have to fight or defend for and say, “Hey, man, can you help me with this?” Is this something you think that would hold, right? And you guys can help us figure it out.

Mario:                                   And then you have to value each. And then, who’s going to give you a valuation? I mean, depending on the dollar amounts you would actually want to get a valuation opinion on what the value of the inherent value of the domain is versus the goodwill value of the domain. So, I mean, you’re talking of a lot of money involved just to get accelerated depreciation. Now, another option, just doing the lifetime exchanges. And I think I talked about this on the last show, and I wasn’t sure but I did actually talk with a lifetime expert, I think just yesterday or the day before. So, what you can do is, if you’re selling your site, you can actually just go and repurchase another site and not capture any gain. You cannot capture some of the gain on the sale. So, if you were to buy a site that has similar things to it. So, it has a domain, not a similar domain, but just the domain. It has content and it has a customer list, email list. Then, those are similar assets, and you could defer the gain on that sale.

Justin Cooke:                     That sounds so great, because, I mean, all terms are gray area. Because, I mean, all online businesses are the same, they all have that. You could argue that. Does that have to be an e-commerce to e-commerce sale? Or could it be e-commerce to lead gen? As long as they’re both making money online, have a customer list.

Mario:                                   I guess, the only difference would be that the inventory would not be like-kind. So, yeah, you could always exchange like-kind assets for like-kind of assets. So, like you said, if you’re specifically identifying the dollar amounts in your buy and you sell, and then, you defer the portion of those gains, you’re still going to have gain on your goodwill, but you won’t have gain on the sale-

Justin Cooke:                     The other line items.

Mario:                                   Right. So, you sell your customer list for 20,000, and then you buy a new customer list for 20,000. Then, even if you have zero basis in your first customer list, you’re not gonna have to recognize that $20,000 gain.

Justin Cooke:                     Gotcha, Okay. Now, you’ll have to recognize or you’ll have to pay the piper on the goodwill, but now that you’ve made line items or itemized each of the deals in this business, at least, a portion of the business, that’s not goodwill. As long as you’ve rolled it into something else is like-kind, you’re not gonna have to pay tax on that.

Mario:                                   Right.

Justin Cooke:                     That’s sneaky, I like that.

Mario:                                   Which I thought was very, very interesting. Now, of course, there’s a ton of other rules around it. You can’t be flipping sites every three months.

Justin Cooke:                     Oh, don’t tell me that, Mario. Don’t tell that, now, you were good, man. We were good, and now you’re going there. So, everything you want to be too much. I mean, what if you did it every six months, every nine months? Like where multiple times in a year wouldn’t work?

Mario:                                   The general rule, well, if you have multiple sites, then maybe. But, the problem with doing this with multiple sites, is actually, the sale of your site. They might consider that to the inventory to whoever is buying and selling sites. So, you don’t want to be in the business of buying and selling sites, you want to be in the business of running the sites.

Justin Cooke:                     Gotcha. Okay. Yeah, I know, there are some people out there that have large inventories of sites. I’d say, hundreds of profitable sites, and that’s like inventory for them. Now, why is inventory a problem? Or, why is having, say, 500 sites and you’re constantly buying and selling, and why is that necessarily a problem?

Mario:                                   Because, you want to be seeing this site being an investment, instead of a cost of goods sold asset. You know what I mean? For example, if I’m in the business of buying and selling chairs, every time I buy and sell a chair, I have ordinary income. That’s not an investment to me, that’s just me buying inventory and reselling it, right?

Justin Cooke:                     Yeah. So, if you’re just pumping them out, yeah.

Mario:                                   Exactly. I’m in the business of buying and selling chairs, now. If I were, instead, in the business of managing a chair company, that buys and sells chairs. And then, I’ve built up a customer list toward my chair company. And now, a year later or two years later, I sell all my customers, I sell all the significant assets that’s, sell this chair business. Then, I’m selling a business you know, I’m selling my investment.

Justin Cooke:                     How would that be determined? I mean, if you have 10 businesses, if you have 15 businesses, where’s the line there?

Mario:                                   Yeah, there is none.

Justin Cooke:                     Everyone will ask me, when I say we’re in the wild west here, with this buying and selling of online businesses. And then, I talked to guys like you, you’re like, “Yeah, here you’re in the wild west, man.”

Mario:                                   Yeah, there is no bright line test to it. I mean, it’s kind of like, I liken it a lot to real estate. If you own a whole bunch of rental properties, you’re fine. But if you’re a builder, and you actually are buying a rental property, fixing it, and then, reselling it, that’s what you’re in business of doing. And if you keep doing that again and again and again, then, the sale of those houses are not capital gain, that’s ordinary income.

Justin Cooke:                     Gotcha, okay. So, what’s interesting about this, I think, a thing I’m going to take from this is, if you’re selling your site and you’re buying another. And you have it line items out to where the goodwill you’re going to pay on, but the rest you’re not. And so, the more you can get in the rest, the better. As long as is it’s a like-kind. So, that’s valuable.

Mario:                                   Talk to your advisor, it’s something that could be worthwhile, depending on the dollar amounts. And there, a lot of stuff has to happen. Money has to get held in escrow by certain certified escrow agents. I mean, a lot of stuff has to actually happen correctly to accomplish it.

Justin Cooke:                     Yeah, to claim that, okay.

Mario:                                   Right. But, it could be very advantageous if you’re deferring a gain of a million bucks.

Justin Cooke:                     But you have to buy same year, same calendar year.

Mario:                                   There’re certain guidelines of how long it is. Honestly, I don’t remember how long the time. You have to specifically identify, I think, I want to say like six months. So, identify a few different purchases, and then, close a few months after that. I honestly don’t remember the timelines.

Justin Cooke:                     No worries, Mario. Well, I’ve taken up a bit of your time here, man. This has been super helpful. And you don’t mind my digging questions or my maybe curious questions because all of this stuff is really interesting to me. I’m sure listeners are fascinated as well. And by the way, I’ve loved working with you, if anyone is looking to work with you potentially, where can they get a hold of you, man?

Mario:                                   They can always get me by email, It’s mario@greenhausriordan.com. That’s a lot of stuff, I’ll probably just post it in show notes or something.

Justin Cooke:                     Yeah, but, I’ll put it in the show notes, I’ll link to your site. I’ll put a link to our other interview that we did over on the Empire Flippers podcast as well. People want to hear more from you, buddy. But, thanks so much for coming on. I think, Ace is gonna get a ton of value out of this, I’m gonna tell him. He needs to start working with you, man. You guys can do some good business together, I’m sure.

Mario:                                   [inaudible 00:50:44] tell him to call me.

Justin Cooke:                     I’ll do that, man. All right, thanks. Thanks for coming on.

Mario:                                   No problem, anytime.

Speaker 2:                           Thanks for listening to the Web Equity Show. Now is your chance to be a part of the action, go to www.webequityshow.com/gift, and send us your business acquisition or exit question, and have it answered on the show.

 

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