Business Owners

U.S. business owners: Want to sell your company by year-end?

Oct 19, 2021

Here’s what you need to know right now.

Steve Faulkner, Head of Private Business Advisory

Andrew Oshman, Executive Director, Private Business Advisory

 

We’ve seen this before: U.S. business owners who are interested in selling their companies make a mad dash to complete their deals before potential tax increases that might reduce the after-tax proceeds from the sale of their companies.

It’s happening right now and heating up 2021’s already hot mergers and acquisitions marketplace. But it also happened in 2012 before President Bush’s tax hikes were set to expire in 2013, and previously in 1986, right before the 1986 Tax Reform Act increased the capital gains rate on January 1, 1987.1

The phenomenon is fascinating to any of us who are market observers and investors. But if you are one of those business owners hoping to close a deal before this December 31, there is much you should know right now.

Here are some insights that may prove helpful depending on how far along your deal is—and no matter when it actually closes.     

A traditional broad sale process takes six to nine months from start to finish. Even a more condensed process takes four to five months in a normal environment. And word to the wise, sellers who prioritize speed over other factors often do so at the expense of negotiating favorable terms or finding an outlier valuation. 

Still, there is good news for you. Go directly to “Prospects are bright,” below. 

As for those of you who are already pursing a sale, be advised: If the proposed Build Back Better Act (BBB Act) is passed as currently written, the top capital gains rate would increase from 20% to 25% (plus the 3.8% Medicare surcharge where applicable)—effective as of September 13, 2021.

Source: U.S. Department of the Treasury Office of Tax Analysis
Line chart shows the long-term capital gains realized from 1980 through 2014. It shows an increase in the long-term capital gains rate causes an increase in realized long-term gains before the tax rate changes as sellers look to realize gains at lower tax rate. It also shows a meaningful decrease in long-term capital gains realizations in the year the tax hikes went into effect.

Obviously, a September 2021 effective date would render moot any rush to complete deals before year-end so as to avoid a hike in the capital gains tax. But that has not slowed sellers’ drive to wrap up this year. After all, the BBB Act’s proposal could change significantly before enacted—if it’s adopted at all.

So maintain the deal momentum you’ve created. Delays rarely inure to the benefit of the sellers, and waiting until the tax impact is known would not likely give you sufficient time to close by year-end. 

However, this uncertainty around taxes is just one challenge. Some additional headwinds you may face as you try to close your deal before December 31, 2021, include:

  • Shortage of available advisors—Deal professionals are resource-constrained now, just as they were during the last rush of deals in 2012. If you don’t have your deal team in place, you may have difficulty assembling a team of experienced advisors, may need to pay higher fees to convince advisors to take on another deal this late in the year, and may face potential delays in your process.
  • Slow buyers—Some of your most logical buyers/investors may not be able to move quickly enough to close by year-end due to their slow internal processes. Others, including those who have expressed interest in your company before, may be focusing their efforts on other deals.
  • Negotiating tactics—Looming tax increases may create an asymmetry in deal negotiations, potentially giving buyers additional leverage to retrade the price. Of course, the leverage pendulum always shifts from the seller to the buyer when a Letter of Intent is signed and the buyer is granted exclusivity. But now, some buyers may try to use your rush to their advantage. They could seek to renegotiate your purchase price to claw back proceeds or to move some cash to a performance-based earn-out (which may be taxed at the long-term capital gains rate in the year the earn-out is paid.2

Business owners who sell their companies in 2022 or 2023 may find an equally favorable environment. The supply-demand imbalance could even tip in favor of business owners, as the abundance of capital is likely to be chasing fewer deals. 

Competition for deals is one of the main drivers of higher valuations. The primary drivers for today’s hot M&A activity should still be in place next year: Corporate cash on balance sheets and uninvested private equity capital should remain at, or near, record highs. Interest rates should remain low. Leverage levels should remain aggressive. 

The supply of deals may not be quite as strong in the coming years—if history is any clue. After 2012’s rush, 2013 was a year of low deal activity, as sellers accelerated their timing to close in a lower-tax environment.3

Source: PitchBook 2020 Annual North American M&A Report
Bar chart shows the quarterly deal volume from 2010 through 2020. It shows a spike in deal volume in the fourth quarter of 2012 before the long-term capital gains rate increased on January 1, 2013. The spike was followed by a decline that troughed in the second quarter of 2013 to a level that has only been eclipsed once since then—during the height of the pandemic in the second quarter of 2020.

All this is to say: You might be able to overcome any increase in taxes by getting more for your business.   

There are a number of ways to minimize or offset an increase in taxes through increased financial performance, a higher multiple, or both. Companies that are growing rapidly, took longer to smooth out a pandemic-inspired disruption, or needed more time to demonstrate improved margins through headcount reductions and efficiency improvements, likely would sell at a higher EBITDA4 in the near future–especially if these companies have time to conduct a more traditional broad auction process.

Also, whenever you sell your company, it’s important to keep in mind that taxes are only one piece of the puzzle—they are not the entire puzzle. Your focus should be on maximizing your after-tax proceeds rather than paying less in taxes, and on understanding how potential tax increases affect your goals. This can be accomplished if you have a holistic, goals-based plan that can be updated to reflect changes in taxes and deal terms as needed. 

Many business owners are selling for the first time, so the transaction process is new to them. It is not new to us—and experience can be extremely helpful during such a critical time.

Your J.P. Morgan team can help you and your professional advisors understand the scope of your opportunities, and help you evaluate potential options for your company and your personal finances.

 

1 The years with the two highest annual percentage increases in long-term capital gains realized from 1980 to 2014 were in 1986 (91.7% increase over 1985) and in 2012 (62.2% increase over 2011).

2 This assumes that a capital gains increase would be effective on January 1, 2022, but no assurances can be given in this regard. The legislative process is ongoing, and it is possible that—if tax reform is enacted—a capital gains increase may have a different effective date, and possibly a retroactive effective date.

3 Deal volume in Q4 2012 was the highest deal volume since the Great Recession up to that point. Many business owners pulled their deals forward to close by year-end, resulting in a precipitous decline that troughed in Q2 2013. The only time deal volumes dipped below Q2 2013 was during the height of the pandemic in Q2 2020.

4 Earnings before interest, taxes, depreciation and amortization.

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