With the loosening of pandemic restrictions, we have been on the road visiting our clients, prospects and other market participants. Here are our quick takes on the hot button issues business owners are facing.
Potential Increases in Capital Gains Rates
We advise business owners routinely on the economic, operational and emotional aspects of selling their closely held or family business. There are many reasons to sell a business, but after-tax proceeds are generally at the top of the list for desired results.Among several proposed tax increases by the Biden Administration is an increase in the federal capital gains tax rate from 23.8% to 43.4%. Not surprisingly, business owners who were considering selling their business in the next few years are now focused on accomplishing that before these proposed capital gains tax rates go up. This tax proposal could translate to over a 25% negative impact on after-tax proceeds for a business owner—a business that often represents your life’s work. If you’re a business owner considering the sale of your business in the coming years, it is worth contemplating the myriad of risks associated with successfully operating a business for the additional years necessary to generate the sufficient earnings to breakeven if capital gains tax is increased—even if any increased rate is lower than 43.4%.
Although the Biden Administration’s tax proposal provides that the increase in capital gains tax will be retroactive to April 2021, our sources in Washington say that such a retroactive tax increase is highly unlikely. That said, a capital gains tax increase could go into effect beginning in 2022. To take advantage of current capital gains tax rates, business owners who are thinking of selling should start the process now to complete a transaction by the end of 2021. There are alternatives to a control sale of a business if you want to hedge your bets, which we would be happy to discuss with you.
How is the Market?
Another critical consideration for business owners looking to sell is matching their desired timing with the market cycle of valuation levels, interested buyers and earnings. Coming out of the pandemic we are seeing a “Double Rainbow” of high valuations (at or above pre-pandemic levels) and a continuing increase in dry powder among private equity investors looking for quality investment opportunities. The private equity market may not be your desired exit, but it generally serves to set the clearing price for sale transactions. As to earnings, many companies managed through the pandemic with limited earnings loss (even as many benefited), still buyers are being receptive to demonstrable pandemic add-backs.
Is Inflation Transitory and What Will Happen to Interest Rates?
Inflation is getting a lot of attention from business owners and market participants because everything seems to have gone up in price over the last 12 months. It has become harder to source supplies and products, including building materials, computer chips, rental cars, not to mention employees.
There are mixed views as to whether inflation will be a transitory phenomenon, but our consensus is that inflation is mostly pandemic induced and will abate as supply and demand come back into balance. In fact, our clients are noting that lumber prices are already coming back to pre-pandemic levels. Most business owners we talk to are doing everything possible to manage their rapid increase in costs; we also hear of many projects and purchases that don’t make economic sense at current prices being delayed or canceled. We expect this rational behavior, and the course of the steady beat of technological driven efficiency and the reduction in government stimulus payments, to calm inflationary pressures without the need for the Federal Reserve to raise interest rates aggressively.
In these times of political and economic uncertainty as we emerge from the pandemic, and with financial assets including stock markets, private equity purchase multiples and venture capital valuations at, or near, all-time highs, if you’re a business owner contemplating selling your business, it may make sense to do it before market conditions change and capital gains taxes increase—even though you’ll get only a 1.5% return for 10 years by investing the proceeds in a U.S. Treasury bond! Please give us a call if we can help you think through these considerations.