Back in the day when I was selling IBM midrange systems to manufacturing companies I used to love the pricing announcements that would come out of IBM’s marketing department as the 4th quarter approached. Over many years, IBM’s marketing team had done a great job of training buyers to watch for the Q4 discounts that were quickly followed by next year’s Q1 price increases. Quota carrying, commission-incented sales reps loved the end-of-year action and resulting sales the announcements drove. CIO’s, managers and purchasing agents loved the ability to demonstrate their negotiated and hard-fought discounts and savings. There was a win/win feel that brought each year to an exciting close.
The analogue for business owners and entrepreneurs to the four quarter race for sales reps may well be the four year election cycle. If so, pricing actions are replaced by tax rate changes and, sadly, increased taxes don’t generate the same positive momentum across the business ecosystem that the promise of increased prices do.
The election cycle has come 'round again and buried within Obama’s healthcare act are several key tax increases that have been anticipated in each of the last couple of years. With the Supreme Court’s recent decision it appears that the taxes will indeed take effect on January 1, 2013. Most notable for business owners and entrepreneurs are increases in long-term capital gains, dividends and Medicare taxes. The tax increases are significant and well documented: Capital gains tax rates are slated to increase 59% from the current 15% to 23.8%; and taxes on dividends will increase 189% from the current tax rate of 15% to a maximum of 43.4%. Ouch!
Somewhat surprisingly, there hasn’t been much published yet on the implications of the tax changes, and the potential behavioral impact, to business owners. Entrepreneurs, owners or shareholders that were previously considering selling their businesses in 2013 are accelerating their exit plans into 2012. There’s too much on the table, and owners would be giving away a much greater portion of their hard-earned gains, by waiting. Delaying a full or partial sale of a business from 2012 into 2013 would result in a significant reduction in an owner’s after-tax proceeds, and a significant increase in the IRS’s take. As a simple illustration, a $10,000,000 revenue Software as a Service company, with industry standard performance, in a growth market, and assuming a 2X revenue valuation multiple would net owners or shareholders roughly $17,000,000 after-tax, with $3,000,000 of capital gains tax going to the IRS. That same company, under the same assumptions, divested in 2013 instead of 2012 would net owners or shareholders roughly $15,240,000, or $1,760,000 less, with roughly $4,760,000 going to the IRS. Another way of looking at it is that, assuming all else remains the same, company revenue would have to grow by at least 17% between 2012 and 2013 in order to get the same net (after tax) proceeds in 2013 that a 2012 transaction would generate. I’m certain the IRS has ordered of a supply “Thank You” notes for owners that wait until 2013 to reap the rewards of years of their efforts building successful businesses.
If you’re a business owner, and considering a full or partial exit, planning and timing are critical. Growth projections, sales pipelines and business objectives for the upcoming 18 - 24 months should be vetted carefully and critically. The 17% growth threshold driven by the increasing tax rates might be challenging considering the continuing European Union saga, domestic GDP growth projections of 2%, the continuing high unemployment rates and the risk of further tax increases. If the decision is made to execute a full or partial exit then there’s time available to pull together your accounting and legal team and get a transaction completed before December 31st, 2012. You won’t want to wait though. With tax-driven transaction volume expected to climb over the upcoming quarter, accounting and legal teams are going to become resource constrained, particularly as the end of the year approaches. Otherwise, be sure to watch your mail for the Thank You card coming from the IRS…