A “Target-Rich Environment” with a Time and Capacity Problem
From where we sit, it’s a supply-and-demand calculation. As we move into the summer and the details of the tax reform proposal become clearer and more concrete, we expect sellers to rush deals to the market, with Confidential Information Memorandas clogging the inboxes of financial sponsors and corporate development officers in September and October—all looking to beat the December 31st deadline before the new tax rates likely would take effect.
Such a scenario would quickly overwhelm the engagement capacity of would-be buyers—in particular, strategic buyers who are not accustomed to juggling multiple transactions at once. Those buyers would face a proverbial “target-rich environment,” but with only sufficient ammunition (time and capacity) to pursue one or two opportunities.
Buyers will pick their favorites to pursue and prioritize from there, with slightly less preferable deals left by the wayside. Sellers will face a choice: drop their price expectations to get a deal done by 12/31—or hold and see what the world looks like in 2022 or beyond.
Sell Now—or Forever Hold Your Piece?
For many, that would be a bet on whether Republicans retake control of Congress in 2022—and what the long-term political landscape for reversal of the capital gains rate looks like in 2022 and beyond. For sellers who are late off the mark, December 2021 could literally turn into a game of “sell now…or forever hold your piece (of the business).”
For would-be sellers who are on the fence, June and July are the months to make a move to get to the market on an accelerated schedule with the best chance of closing a transaction prior to a market glut.
And any seller who gets in—even at this point—should think very clearly about what “their number” is for a sale, and at what discount from that number it would still be worthwhile to move ahead.
As an example, think about a seller who believes they own a $100 million enterprise value business, of which $80 million would be taxed as gains in the event of a sale. At the current 20% top rate, a seller would pay $16 million on those gains and realize $84 million from the sale.
Under the Biden Administration’s proposal, the top tax rate could rise to 39.6% as of 1/1/22. That would mean $32 million in taxes on an $80 million gain—and would reduce the seller’s realization to $68 million.
Sellers will be forced to compare that lower realization to—on one hand—the pain of taking, say, a $10 million haircut on the sale price to be able to get the deal done by 12/31.
The other choice would be to hold the business and try to grow it to the point where it could sell for an enterprise value where the post-capital gains on a sale would be closer to the $84 million they originally hoped to realize.
In this case, under a 39.6% top capital gains regime, the capital gains from a sale would have to be nearly $106 million (and thus a sale price near $126 million) to “get back” to where the seller theoretically was at a $100 million enterprise value in a 20% capital gains world.
Finding the Magic Number
Ultimately, this comes back to a frequent topic for us and the business owners we advise on M&A transactions: What is your number?
Too often, we see business owners enter a sell-side process without being clear on the difference between vague desires (“I want to make a bunch of money and retire”) and actual needs (“I need to realize $25 million from this transaction to be able to retire and provide for my family the way I want”) from a transaction.
We encourage owners who think they may want to get to market in 2021 to select an adviser at the earliest possible date and engage in these hard conversations so that they can enter a transaction process with a clear set of decision paths.
At Ascend, we put the highest priority on your objectives, and will assist in helping to identify the various strategic alternatives that make sense for you. We would welcome the opportunity to discuss your specific goals and aspirations.
