Looming tax changes could accelerate M&A
President-elect Joe Biden has made it clear that corporate tax rates, and taxes on high net worth individuals, will increase under his administration. Just how many of those plans will come to fruition, and how quickly, is unknown.
As I’m writing this, we don’t know the results of the January 5th runoff election in Georgia, so we don’t know whether the Democrats will have control of the Senate. If the Republicans retain control, Biden’s most ambitious tax plans will be dampened.
That said, there’s still room for executive orders, bipartisan compromises, and more modest tax increases ahead. Even if the Democrats win, it seems likely the administration’s first and immediate priority will be on COVID recovery. That could give us a year of breathing room before new taxes go into effect.
Right now, investment firms and business owners are looking at the possibilities and examining their exit strategies under different tax and political outcomes.
Critically, Biden has proposed raising long-term capital gains tax and taxes on dividends to 39.6% on income above $1 million a year. That’s nearly double the current rate of 20%. If the Democrats gain control of the Senate, these measures are likely to move forward.
Let’s look at a fictional business generating $20 million in revenue and growing at 5% every year. Let’s assume a consistent 20% EBITDA margin and 6x EBITDA multiple at sale. To simplify calculations, we’ll assume a basis of $0 and no transaction costs.
In 2021, the business has EBITDA of $4 million. At a 6x multiple, that’s an enterprise value of $24 million. At a 20% capital gains tax rate, the tax liability would be $4.8 million for net proceeds of $19.2 million.
Now let’s say the owners decide to grow the business and sell in 2023. With a 5% annual growth rate, revenue is now $22,050,000 and the EBITDA is $4,410,000. At a 6x multiple, that’s an enterprise value of nearly $26.5 million. At a 39.6% capital gains tax rate, the tax liability would be nearly $10.5 million, for net proceeds of $16 million – a significant loss.
These are simplified calculations and other factors come into play. But under our basic scenario, an owner projecting 5% annual growth would need to run the business for an additional five years to reach a breakeven point after increased capital gains.
Recognize the average business takes about nine months to sell. If you’re a business owner and you were thinking about exiting in the next couple of years, start talking to your advisors now.
Begin with an M&A advisor to get a valuation and see if it even makes sense to take your business to market. Then talk to your CPA and run the tax scenarios to understand the best- and worst-case possibilities ahead.
By Scott Bushkie
With more than 20 years in the Mergers and Acquisitions (M&A) industry, Scott is a recognized leader in the field, providing exit strategies, business valuations, and M&A advisory services to business owners in the lower middle market. He has successfully executed sales to domestic and international buyers, private equity firms, family offices, and strategic buyers.
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