Beating A Hike In Capital Gains

As business owners consider maximization of aggregate net wealth for some-day future retirement – value preservation concerns have reached new highs over the past year – especially for those boomer clients who are nearing an age when they might wish to consider divestiture. If capital gains rates rise from 15% to even 20%, that’s a one third increase in taxes to be paid. If they grow from 15% to perhaps 30%, as some forecasters have predicted, that’s double the tax paid.

Additionally, the market volume of sellers is likely to shift over the next few years, with sellers multiplying several fold, and buyers likely holding steady. Today’s few sellers and numerous buyers create a nice market momentum for those who may be able to sell now.

Owners who may have been just fairly “close” to consideration of exit, a few years ago, have now started to worry that they might have to wait far longer than they intended. Numerous sellers who were close to sale one to two years ago, have waited. They waited because a) their earnings were dropping – and they know you can’t sell a business for maximum price when earnings are off, b) they worried about lack of velocity of corporate buyers, due to lagging performance and thus greater need for caution to keep shareholders comfortable, and c) they heard about lack of credit, and worried about the impact that such tightening might have on buyers in the M&A marketplace.

All of these were legitimate and appropriate concerns, and good reason for delay. However, as the market begins to open up a bit, with perked up earnings streams, and new credit alternatives, the extreme slow-down of the past two years could cause a burst of seller availability, and a far less seller-advantaged supply and demand mix in the marketplace, than any we have experienced in the past 20 years.

John Lewonetti, managing director of Pinnacle Equity Solutions, told Boomer Market Advisor two years ago that the number of retiring business owners is expected to grow from 50,000 to 750,000 by 2009. That increase has been delayed with the present economic environment, but it’s still likely to come. That’s an increase of 15 times, stemming from raw demographic counts of older owners likely to retire. Neil Shroff, managing Director for Orion Capital Group conducted a survey which they reported on in November of 08, which validated this analysis with the finding that almost half of business owners 55 years and older said they want to sell their businesses within the next three years. The Exit Planning Institute says that over the next 15 years, eight million business owners are expected to exit their companies. All of these facts and statistics point to an enormous surge in business sale activity to come, and some likely new market dynamics that may have impact on owners wishing to sell over the next decade. A substantive surge in available sellers on the market, will allow buyers to be more selective, and probably to buy at lower price points.

For owners who may likely wish to sell within the next 5 years, there may be significant advantage to moving earlier instead of later. For those owners operating profitably today, acceleration of potential timeframes for sale, could mean enormous benefit. Capital gains rates are at an all time low. Also, fewer sellers means scant supply of companies in the market, while buyer demand remains strong. Great competition creates great selling prices, and professional seller representatives, poised to move quickly and with manpower and intensity of effort, can mean tremendous success, with as little as a 6 month window for finding and reaching the “right” buyers.

As you think about whether or not you may be “able” to make such fast moves, how do you assess potential?

1. Good earnings histories mean good multiples likely upon sale. Companies generating cash flows in the double digits, as a percentage of revenues, are hot stuff. Last year, companies with even 5% cash flow as a percentage of sales looked quite good. For the manufacturing company, strong pricing might range between 4.5 and 6 x cash flow. For the service company, pricing would typically be a little less – maybe averaging 3.5 to 5 times earnings. Larger companies generally command larger multiples, and smaller ones get more modest multiples. However, for any company, if the competition is tapped effectively, and the company is desirable, all such rules of thumb for pricing may fall quickly by the wayside, in favor of pure market-driven competitive pricing.

2. Companies with both decent earnings histories, and reasonably strong asset base, are today far more easily financed by prospective buyers. In recent times of financial caution, the “belt and suspenders” security of both cash flow capability and the back-up of solid asset base can make a tremendous difference in ready marketability and value.

3. Owners who have been able to develop second tier staff, able to run the company without intense owner oversight and input, are far more valuable in the marketplace. How do you identify these attributes? Are you able to take multiple week vacation trips, leaving your company under staff supervision? Do you have a handful of highly paid executives, with significant leadership roles in the company? Lack of critical owner dependency is a big sign of strong value.

If you think you may wish to consider moving forward in sale, a good M&A firm should be able to give you fairly solid estimates of minimum value likely to be achievable. In seeking help seek a firm with strong seller representation bases, who focus upon the “sell side” of the M&A world. Most of those firms, like ours, are pleased to help, and hope that you will think of them when the time comes to actually move forward in sale. Look for firms with a strong track record of success. (Our firm has closed 95% of the seller reps we have taken on over time. Diligent and established firms can do that, on the sell side of the equation, with pretty high reliability.) Also, firms representing sellers typically work on mostly contingent fees. Thus, your financial risk for the attempted sale should not be huge.

With a bit of luck, and with diligent effort in seeking creative and competitive buyers, the benefit might in fact be anywhere from 25% to 100% more in value achieved. Beat the future increased tax rate if you’re close to ready, by moving in front of the baby boomer market!


Deborah Douglas, Managing Director and Author
DouglasGroup.net

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