Many people, including M&A peers of mine are sending around analysis that suggests a heavy tax bill for sellers under a Biden administration, that looks something like the following:

While this analysis suggests an initial sticker shock when comparing the potential before and after (potentially 2x cap gains tax and needing 33% higher valuation to achieve the same after tax proceeds), a few things to consider:

  • While Biden states his plan is to raise capital gains tax rates to a max of 39% for those with earnings >$1mm, I question the reality of these levels as the rate has NEVER been this high over the last 100 years as seen below, especially considering he’s more of a centrist than radical left type like a Bernie

  • Further, as it relates to strategic planning, such as the most optimal time to sell your company to bypass this potential hike, please consider the most likely timing of the tax increase to take effect. If the bill passes in 2021, it will likely not be in effect until 2022. This timing/sequencing was similar to the Clinton, Bush and Trump administrations. This means you have all of 2021 to complete a sale of your business to realize the existing tax treatment
  • The worst case scenario is this tax hike would take effect the day the bill is passed, as early as Q1 2021, which suggests you want to sell before Biden takes office, which is challenging for those not already in a sale process. More practically and realistically plan for a sale in advance of Q2 2021

Much Bigger Factors than Biden Tax Hike

  • While clearly no one is excited about the possibility of paying 2x the cap gains taxes on a sale, the more important factors to consider and hope for, are as follows:
    • Continued macro/micro-economic rebound, including more stimulus in the near term
    • Continued record breaking capital raising of private equity funds, which sustains if not increases the investment/acquisition activity, driving demand, and thus increasing valuations
      • ~$1.5 trillion of dry powder that these funds need to deploy in a finite period of time
    • 2020 M&A activity lull to create pent up demand into Q4 2020 and 2021, correlated to Covid-19 getting fully under control
    • Low interest rate environment and lending for acquisitions to continue to loosen inline with the economic recovery. Expect to see a full rebound to pre-Covid-19 levels
    • Public market valuations continue to break records, trickling down the private markets
      • Public SaaS companies are trading at ~20x+ ARR (annual recurring revenue), with the outliers (Zoom & Snowflake) at 50-100x
      • Private market investors and acquirers understand they can comfortably pay 10x+ for a private SaaS provider (that’s of scale with strong financial performance) knowing the strong potential for a value pop in the public markets, or the ability to sell to a larger private equity acquirer or strategic, where such buyer can then take the company public to receive their pop

Takeaways

  • The Biden proposed maximum capital gains tax increase is concerning, yet should not be the end all be all as a key driver while strategic planning
  • We feel it’s unlikely that this level of tax will be instated, as the highest its ever been in the last 100 years was 35%, especially considering Biden is more left center than extreme left (and would require a blue wave)
  • The more impactful drivers to sustain the level of M&A and financing activity as well as valuation froth is tied to the record levels of private equity and VC capital raised, the $1.5 trillion of dry powder needing to be deployed within a finite period of time, and the pent up demand for activity once Covid-19 subsides
  • Further banks are continuing to lend, in a low interest rate environment. The loosening of the leverage multiples enables acquisitions and valuations. The more leverage and the lower the cost (rate), the higher the valuation a buyer can afford
  • Business owners seeking to exit in 2021, should begin to prepare, and lay the groundwork for a sale next year

For those seeking to exit in the coming years, with a sale-ready business (based on size of revenue, profitability and growth), we are entering a unique and arguably unprecedented time-frame to realize a favorable valuation, while taking advantage of existing low capital gains tax rates. We are happy to learn more about your opportunity and provide candid feedback, as well as strategic insights. Feel free to reach out to us to discuss.

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