"Off the books" revenue and valuations

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June 08, 2021

by a searcher from Northwestern University - Kellogg School of Management in Atlanta, GA, USA

Has anyone had experience with valuations that are based on reported and unreported income? I don't imagine a lender or investor would appreciate the rationale that the valuation seems high because it's based on all revenue, not just the stuff that's reported on taxes. For scale, the unreported income would increase SDE by ~20%. Is this a common practice in business with lower valuations ($1-5M)?

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Reply by an intermediary
from New York University in Menlo Park, CA, USA
Steer clear, if the seller is willing to materially misrepresent to the IRS, they will certainly misrepresent to you.

10%+/- is a considered 'within range' as it is perfectly acceptable to push off revenue and bring forward expenses by a couple of days to alter the taxable income within a specific year. Of course, lots of unreported cash income or excessive personal expenses (home mortgage, vacation homes, luxury cars and boats) is a flashing red light and I'd walk away as a broker.
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Reply by a searcher
from Harvard University in New York, NY, USA
I'm facing this issue now with a seller that wants a valuation reflective of $300+K per year in unreported revenue. The company is attractive so my tentative solution is to offer 5X reported EBITDA and then an earn-out / forgivable seller note, where we pay 20% of revenue above their maximum revenue year in the last 3 years. My argument is if there is all this hidden revenue the revenue should easily eclipse this base number and they will earn another 1.5M over 5 years. Any thoughts on this? Any other solutions that have worked well?
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