Marshall Rowe, president and chief investment officer of Harvest Capital in Concord, agrees. There has never been a better tax climate for selling a business than right now, he says, as the current capital gains tax rate expires at the end of 2012. The capital gains tax is paid on profit that comes from selling an asset that was purchased at a lower price. This frequently happens from the sale of stock in a company. Currently, the tax rate on qualified dividends and long-term capital gains is zero. At the end of 2010, that was going to change, but the rate was extended two years as part of the extension of the George W. Bush-era tax cuts.
However, after 2012, the rate is expected to jump to about 20 percent. Although there's an election in the interim, chances are the tax will increase, Rowe says.
From a tax standpoint, the next 19 months are optimal [to sell], Rowe says. Taxes are likely never to be lower than they are right now, if you know you are going to realize a gain. In 2012 there's likely to be a rush to try to complete transactions under the current tax laws because certainly privately held businesses-on a cost basis-are always low, always a lot of capital gains. So benefiting from the current tax structure is going to be a high priority.
There are Buyers
While the recovery may be slow, there are people shopping for businesses, says Steven Burke, a director at McLane, Graf, Raulerson & Middleton law firm in Manchester. People are definitely still looking for a bargain, but there is more money out there than there's been for at least two years, he says. We've seen a lot more transactions at the end of last year and the beginning of this year than we've seen in the last few years. It really has picked up. I mean it's not moving the way it was a few years ago, but people are feeling more confident in the success of the businesses that they are purchasing. And I think that's made the business climate much more robust for these transactions.
Cohen of Devine Millimet attributes the increase in sales to the fact that private equity buyers are sitting on a pile of investor cash. The money has to be spent in a certain amount of time, Cohen says, and that time in running out. If the money isn't spent on a business, the buyer has to return the money to the investors. And, Cohen says, no one wants to do that.
Because many of them haven't done as many deals or purchased the number of companies that they wanted to, they are looking at either returning the money to investors, which they know will mean they'll never see the money again, or deploying the money by buying a company, Cohen says. Those private equities are usually called financial buyers-they are creating somewhat of a frothy market right now.
Selling Stock vs. Assets
Though the tax climate is ripe for selling, business brokers, financial planners and lawyers caution sellers not to make big moves based solely on tax timing. While the change in the capital gains tax is weighing on the minds of investors and business owners, it is relatively uncommon for a business owner to sell the common stock of his or her business, which would result in capital gains, as buyers are wary of the unknown liabilities that come with such transactions, says George T. O'Brien, managing director of G.T. O'Brien Inc., a business brokerage firm in Manchester. He says most transactions are asset sales. A careful evaluation and assignment of the purchase price to the assets of the seller can minimize capital gains and ordinary income gains that flow through to the seller (on a federal level) should the company be a pass-through entity, such as an S Corporation.
But a C corporation will not pass through the nature of the gains to the shareholder. This means the company will have to pay its own taxes on the gains at standard corporate rates, and then when the shareholder liquidates the company, the shareholder will potentially have to pay a gains tax, in effect resulting in significantly more taxes overall, O'Brien says.
Before a business owner considers going to market, Cohen suggests doing a Monte Carlo analysis. They should compare whether they would be better off selling stock or selling assets, he says. They (should) look at what the taxes are and how they can reduce taxes by allocating the purchase price even in an asset sale. It's important to run the numbers is the moral of the story.
Rowe also says to optimize the benefits of a low capital gains tax, it's beneficial to consider also taking advantage of the low estate tax. Currently, the lifetime gifting exemption under estate tax provisions is $5 million. So if you can gift some of your interest in a business, while the exemption is $5 million you can both capitalize on the lower tax rates and the higher gifting capability, he says. Minority shareholders who own less than 50 percent of a business also enjoy added benefits.
Because you are a minority shareholder, there's a discount to your value. So some of the transactions that will occur, and the gifting that will occur, will be designed to reduce ownership down below that 50 percent level, Rowe says. So you get the added benefit on the tax rate when you sell it, as well as the minority discount in the value of the transition, for example, to another family member.
To explain, share percentages are not pro-rated. For example, if a business is worth $10 million and one person owns 60 percent of the business and his or her shares are worth $6 million, another individual's shares, although 25 percent of the entire shares are not necessarily worth 25 percent (or $2.5 million).
The Economic Ripple
How will shifting
ownership of businesses affect NH's economy? New owners bring a fresh view to
operating expenses, often looking for ways to save expenses which can mean
cutbacks and layoffs. Layoffs lead to more people in the labor market for other
companies looking to grow and hire,
Cohen says.
Burke says new business owners come out of the gate thinking
long-term and focused on operations. It usually means that the business
expands or almost tries harder, Burke says. It can involve layoffs certainly,
but it also involves focusing on the parts of the business that really do well
and long-
term expansion.
Current Issue - May 2024