A Buyer Is Going to Audit Your Agency. Beat Them to It by a Year.

By Craig S. Cody, CPA, Certified Tax Coach.

Here's the answer up front. If you think you might sell your marketing or PR agency in the next one to three years, the financial cleanup starts at least 12 months before the agency goes to market, not when the banker calls and not when an offer lands. The reason is simple. A buyer doesn't pay for the profit you say you made. They pay for the profit they can prove will still be there after you leave, and they'll spend weeks trying to disprove it. Every problem they find first becomes a lower number, a longer escrow, or a deal that quietly dies. Every problem you find first becomes a decision you get to make.

Over twenty-three years of looking at agency books, and here's the pattern I see. The agencies that get run by the numbers are the ones prepared to sell. Even when they have no plans to sell. Nobody in that group built it for a buyer. They built it so they could run it, and being ready was the byproduct.

This article is about the other group. The owners who have a real reason to sell in the next year or two and haven't started. Here's what a buyer is going to check, why 12 months is the minimum, and what to do with each quarter of it.

Why Does the Cleanup Have to Start a Year Out?

Because the history a buyer reads has already been written by the time you get an offer, and some of it takes a year to fix.

Drew McLellan and the Agency Management Institute teach a full workshop on getting an agency ready to sell, and the operational work they describe, reducing owner dependency and fixing client concentration, runs on a 24 to 36 month horizon. Their page names the problem I want to talk about here in one line: "the mistakes owners make in the 12 months before a sale that cost them real money." That final year is where the financial and tax side either gets done or gets discovered.

Three things in that year can't be rushed:

• A monthly accrual trend takes twelve monthly closes to exist. A buyer wants to see the trailing twelve months on an accrual basis. You can't reconstruct that in a weekend, and what gets rebuilt under time pressure gets discounted.
• A state tax problem has a clock on it. Every state's voluntary disclosure program closes the moment that state contacts you first. Finding exposure with a year of runway means you choose the terms. Finding it in diligence means the buyer does.
• Deal structure has to be modeled before you sign a letter of intent. Once the buyer believes you're committed, your room to restructure the transaction shrinks fast.

Everything else in a sale can be negotiated. Those three run on the calendar.

What Will the Buyer Test First?

Your earnings, and whether they're real. Buyers value an agency on adjusted EBITDA, earnings before interest, taxes, depreciation and amortization, and they build that number themselves. They start with your P&L and then add back what's personal or one-time, subtract what's missing, and apply a multiple to whatever survives.

I wrote the full version of this in Clean Books Sell Agencies. Messy Ones Get Discounted., so I'll keep it to the parts that matter for the calendar. Three tests, in the order a diligence team runs them:

1. Does your EBITDA reconcile? Net income on the tax return, net income in the books, and the "adjusted" number you're quoting need to trace to each other on one schedule. Most agencies I meet have three different profit figures and no bridge between them.
2. Do your add-backs survive a challenge? Your salary isn't an add-back if the buyer has to hire someone to do your job. The correct adjustment is the gap between what you took and what a replacement costs. And the schedule has to cut both ways: underpaid key humans, a hire you've been putting off, and marketing you paused before the sale all reduce normalized EBITDA. A schedule that only goes up isn't credible.
3. Are your books accrual and monthly? Cash-basis books are often right for the tax return and wrong for a sale. Prepaid retainers, annual software paid up front, and contractor costs landing a month after the revenue all distort the monthly picture a buyer is trying to read.

The recurring revenue question sits right behind those three. AMI's workshop page puts it bluntly: "recurring revenue is a wish, not a contract." A client who's billed monthly for five years is dependable. That's not the same as contractually recurring, and a buyer will read the cancellation clause before they read your retention rate. If you want the transferability test in full, the four-point self-audit and whether your agency is worth anything without you cover it.

What State Tax Problems Show Up in Agency Diligence?

The ones you didn't know you had, and in my experience that's the most overlooked risk in an agency deal.

An agency today has clients across the country and humans working remotely in three or four states. Many still file only where the company was formed. That gap can create income and franchise tax, payroll withholding in the wrong state, local business taxes, and in some states sales tax on marketing or digital services. A service business gets no help from the one federal shield people cite, either. Public Law 86-272 protects only the solicitation of orders for tangible personal property. Marketing, advertising, PR and creative work aren't tangible property, so the protection is zero.

Here's why this belongs in a sale article and not just a compliance one. A buyer won't inherit an unknown liability. In diligence they'll ask for employee locations, client locations by state, payroll filings, and every state return you've filed. If your filings don't match your footprint, one of three things happens: a purchase price reduction, a chunk of your proceeds held in escrow, or a special indemnity that leaves you on the hook after closing.

Put a number on it. You don't want $150,000 going into escrow at closing because the buyer thinks you had filing responsibilities in states you never filed in. Read that sentence again and notice the word "thinks." The buyer doesn't have to prove the liability. Doubt is enough to hold the money, and the money sits there until the doubt is resolved on their timeline, not yours.

Twelve months out, you have a fourth option. Almost every state runs a voluntary disclosure program: you come forward, file a capped lookback period, usually three to five years, pay the tax and interest, and the penalties come off. The Multistate Tax Commission runs a version that covers several states in one process. The catch is the one I named above. Eligibility ends the moment the state contacts you first, and a buyer's diligence request isn't the state, but it's close. Once a problem is in the data room, the buyer prices it. Before it's in the data room, you fix it.

I've written up the two halves of this separately: how your client list becomes a tax map and what a remote hire does to your state filings. For the sale, the exercise is one page: every state where you have a person, a client, or an office, next to every state where you actually file.

Which Tax Elections Have to Be Decided Before the Letter of Intent?

The ones that change how much of the price you keep, and almost all of them lock once the LOI is signed.

A $10 million offer isn't one number. It's a different number after tax depending on whether the deal is a stock sale, an asset sale, or a stock sale with an election that makes it taxed like an asset sale. Buyers usually want asset treatment, because they get to write up what they bought. Sellers usually want stock treatment, because it's one layer of capital gain. The middle ground for an S corporation is a Section 338(h)(10) or Section 336(e) election, and both come with rules that surprise owners who hear about them late.

Take the 338(h)(10). The IRS instructions for Form 8023 say the election "must be made by all of the shareholders of the target, including shareholders who do not sell target stock." Every shareholder. So if you have a minority partner who isn't selling, or an ex-partner who still holds a sliver, that's a conversation to have a year out, not a week before closing. The form itself is due by the 15th day of the ninth month after the acquisition date, which sounds like plenty of time until you realize the consent has to be in hand at signing, not at filing.

That's one election. The list you should be modeling in the year before a sale includes:

• Stock sale versus asset sale, and the 338(h)(10) or 336(e) middle path
• How the purchase price gets allocated across assets, including goodwill and personal goodwill
• Installment treatment if part of the price is a seller note
• Whether your stock qualifies for the Section 1202 exclusion, which most S corporations don't
• Your state of residence and how each state sources the gain
• Pre-closing retirement and charitable planning that only works if the plan exists before the deal

Not every one applies to every agency. The point is that you need the after-tax number under each structure before you negotiate the headline number, because once the buyer believes you're committed, your ability to change the shape of the deal drops to almost nothing.

Model the cash you'll actually keep after federal tax, state tax, transaction costs, the working capital adjustment, escrow, and any rollover equity. That's the number you're selling for. The one in the LOI isn't.

What Does the 12-Month Calendar Actually Look Like?

Four quarters, each doing a job the next one depends on.

Months 12 to 10: find everything. Reconcile the three profit numbers to one schedule. List every proposed add-back with the support behind it. Build the state footprint page. Pull every client contract and read the term and cancellation clauses. Run a first after-tax model under stock and asset treatment. The goal isn't to fix anything yet. It's to know what can still be fixed and what will have to be disclosed and explained.

Months 9 to 7: fix what has a clock. File voluntary disclosures where the exposure justifies it, and register prospectively where it doesn't. Get the accrual monthly close running so you'll have a real trend by the time you go to market. Separate personal spending from the P&L going forward. Start the shareholder conversations any election will need.

Months 6 to 4: build the evidence. Assemble the normalized EBITDA schedule, the client-by-client revenue analysis with contract dates and gross margin, the state tax matrix, and the tax structure models. Open the data room and start filling it, because a room built in a week looks like a room built in a week.

Months 3 to 1: run your own diligence. Sit on the buyer's side of the table and try to break your own numbers. Does every add-back trace to the general ledger? Do the payroll reports agree with the books? Do the tax returns agree with the financials? Can your second in command explain the unusual months without you in the room? Every question you can't answer cleanly now is one the buyer will answer for you, at a discount.

Who This Is For, and Who It Isn't

This is for you if you own a marketing, advertising or PR agency, a sale is a real possibility in the next one to three years, and you couldn't hand a buyer twelve months of accrual financials, a supported add-back schedule, a state filing map, and an after-tax model tomorrow.

It isn't a reason to stop doing tax planning. Nothing here says pay more tax so the P&L looks prettier. Every legitimate strategy stays. It just gets documented so a buyer reads it as an add-back instead of a question.

And it won't rescue an agency that runs on you. If two clients carry the revenue, or every relationship lives in your phone, a clean data room gets you paid fairly for what you built. It doesn't change what you built. That's the 24 to 36 month work AMI teaches, and it's a different article.

The Worst Time to Learn Something About Your Own Agency

Is after the offer. At that point every discovery belongs to the buyer, and it all runs one direction. An unsupported add-back is a lower EBITDA. An unfiled state return is an escrow. A weak contract is a lower multiple. Messy books make the buyer wonder what else you haven't noticed.

Start a year out and every one of those turns back into a choice. And if you get to month twelve and decide not to sell after all, you own an agency with accrual books, a clean state map, and a tax structure you understand. That's not wasted work. That's the agency the run-by-the-numbers owners were already operating, and it's the one that flourishes whether or not anyone ever writes you a check for it.

The buyer is going to review your numbers. Don't let them be the first.

Frequently Asked Questions

How far in advance should I prepare my agency for sale?

Start the financial and tax cleanup at least 12 months before going to market, and the operational work on owner dependency and client concentration two to three years out. Twelve months is the minimum because an accrual monthly trend, a state voluntary disclosure, and a deal structure model all need lead time and can't be compressed into the weeks between an offer and closing.

What is adjusted EBITDA and why does a buyer calculate their own?

Adjusted EBITDA is earnings before interest, taxes, depreciation and amortization, corrected for items that won't continue under new ownership. A buyer rebuilds it from your general ledger rather than accepting yours because they're paying a multiple of that number, so every unsupported add-back they refuse leaves the purchase price multiplied.

Can I add back my own salary when selling my agency?

Only the portion above what it would cost the buyer to replace what you actually do. If you're the agency's lead salesperson or strategist, the buyer will subtract the cost of hiring a replacement from any add-back you claim. A credible add-back schedule also includes downward adjustments like underpaid staff and deferred hires.

Does Public Law 86-272 protect my agency from other states' income taxes?

No. Public Law 86-272 protects only the solicitation of orders for tangible personal property. Marketing, advertising, PR and creative services aren't tangible property, so an agency with clients or remote employees in other states gets no protection from it and needs to review its state filing footprint directly.

What is a state voluntary disclosure agreement and when should I use one?

A voluntary disclosure agreement lets a business that finds unfiled state returns come forward, file a capped lookback period of usually three to five years, and pay tax and interest with penalties waived. Use it before a sale, because eligibility ends once the state contacts you first, and once a buyer finds the exposure in diligence they'll price it as an escrow or indemnity instead.

What is a Section 338(h)(10) election in an agency sale?

A Section 338(h)(10) election lets a qualifying stock sale of an S corporation be taxed as if the assets were sold, which buyers often want for the write-up. Per the IRS instructions for Form 8023, every shareholder of the target must make the election, including those not selling, and the form is due by the 15th day of the ninth month after the acquisition date. Model its after-tax effect before signing a letter of intent.

Let's Talk

Here's a one-hour exercise for this week. On one page, list every state where you have an employee, a contractor, a client, or an office. Next to it, list every state where you filed a return last year. The gap between those two columns is the first thing a buyer's tax team will find, and finding it yourself is the whole point of the year.

If you'd like a longer read on the tax side of running an agency you might one day sell, I wrote a book for marketing and PR agency owners. You can request a free copy at the link below. And if you're closer than a year out and want a second set of eyes on the numbers before a buyer sees them, let's talk.

https://www.craigcodyandcompany.com/free-book

Craig S. Cody is a CPA, Certified Tax Coach, and retired NYPD Lieutenant. His firm works with more than 70 marketing and advertising agency owners every month, helping them keep more of what they make through proactive tax planning.

This article is general education, not advice for your specific situation. Confirm your own facts with your advisor before acting.