Changes in federal tax rules significantly increase valuations of companies
By Claude Solnik
BridgeTower Media Newswires
LONG ISLAND, NY — The impact of taxes is always a major factor when it comes to selling a company. After all, who wants to do a deal where Uncle Sam walks away with a big share of the sale price? Owners use trusts and a wide range of strategies to try to keep as much of the price as possible.
But lately, something else is happening: Uncle Sam has done the reverse. Changes in federal tax rules are significantly increasing valuations of companies, rather than just siphoning off part of the sale.
The top federal income tax rate for companies this year plummeted from 35 percent to 21 percent, which means future profits are likely to soar – because taxes will take far less. That makes companies not just more profitable, but more valuable to buyers.
“It’s a good time to sell. If you’re looking to sell the business, the tax rates have come down, so the cash flow has gone up,” said Pasquale Rafanelli, valuation manager at Grassi & Co., in Jericho “The business is worth more today than a couple of months ago.”
Lower corporate tax rates will make running a profitable business more attractive, as well, since owners can keep more, which could lower the motivation to sell. But it also might encourage owners to cash out, if they can get more money for their company.
“It’s a little early to tell whether many people selling now are selling because of the increased value or not,” Rafanelli continued. “But there are definitely people selling because of the increased value in the business.”
Rafanelli believes buyers will pay more for companies going forward, because of the tax rules. But he added that it’s hard to tell how much more and whether higher valuations will always lead to better offers.
”It’s too early to tell. From the valuation standpoint, businesses are worth more today than they were under the old tax regulations,” Rafanelli said. “There are definitely people who want to buy businesses.”
Selling, or handing down, a business is typically among the biggest events in an owner’s business life. Owners typically want to take care of themselves, their family and the company they built. And arriving at a valuation is a complex, sometimes even emotional, process.
“No two businesses are the same,” said Mark Meinberg, partner in charge of EisnerAmper’s Long Island office in Syosset. “The challenge for every business is to retire in ownership and continue to operate.”
Valuing a business is a complex endeavor that involves looking at everything from past and projected profits to liabilities, litigation and even regulation. And it involves breaking out personal expenses owners frequently fold into the business.
Rafanelli, for instance, nearly a year ago was hired to perform a valuation for a manufacturer, analyzing taxes over five years and projections.
“We dug into personal items, discretionary items, added back things like personal auto, personal meals and entertainment, travel,” Rafanelli said. “After we did all that, we looked to see what other companies have transacted. We compared them to the historical projections to make sure there weren’t any anomalies and came up with the value of the business.”
The owners then went out to the market with a report and valuation, mixing income and information from the market. That valuation became a key part of the effort to sell.
“Within three months of it going to market, they were able to sell the business,” Rafanelli said. “They started with a value a little higher than our valuation, which is typically what we see. When they made the sale, the value was within 10 percent of the value we came up with: 10 percent higher.”
Rafanelli said a valuation typically takes four to eight weeks to complete and a sale on average takes a few months, although the process and time vary from industry to industry and company to company. There can be love at first sight – or a long courtship.
“I’ve seen some sell overnight and some take years,” Rafanelli said. “Maybe three to six months on average.”
Valuing a cash business can be complicated. It’s difficult to arrive at a true and total calculation of income. And valuations need to take into account possible impact of litigation and even regulation.
Rafanelli said he had to calculate the possible impact of regulations that hadn’t been, and might never be, passed affecting one firm.
“That’s something we had to take into consideration,” Rafanelli said. “We didn’t know if it would pass, but we couldn’t ignore it. We have to look into and consider outside factors.”
Companies can have different values to different buyers. Someone who owns three businesses in an industry, for instance, might pay more for a fourth, since they can cut its overhead.
“Sometimes businesses have easy niches that can be an easy add-on to a related business,” said Robert Spielman, a partner at Marcum, in Melville. “Then you get better than a low multiple.”
Accountants who do valuations don’t necessarily remain passive after they calculate what the company is worth. After one seller narrowed down five interested parties to a final one, Rafanelli met with that person.
“They brought us in to explain our understanding of the business, the nuances, and help explain to the buyer why the value is what it is, which is what we did,” he said.
Selling to someone in the same industry can simplify things: They’re more familiar with many things impacting the company.
“Because it was somebody in the industry, they were going to run it,” Rafanelli said of one firm. “They had a non-compete agreement with the prior owner.”
While in some cases firms are sold outright, in others, the sale is staggered over various installments. In one deal Rafanelli did, the buyout was divided over three years with half up front and 25 percent each following year.
“There is definitely risk there. In this agreement, they did not build in for that risk. It was an agreed upon price and this person had to pay it no matter what,” Rafanelli said, noting revenue could rise or fall. “I see some agreements where they have an agreed upon price. If the business does lower, or better, there is more or less money total.”
While some sales involve the owners’ exit, many other deals mandate that owners remain involved, to avoid the risk that customers will exit as well. The sale begins a glide path out of the business rather than an abrupt exit.
“We do see them sometimes stay involved,” Rafanelli said. “We see agreements where they say a part of the buyout is based on staying with the company for one or two years. The last thing anybody wants is to buy a business and have the customers say they did business with John Smith. They don’t know you. And they go to someone down the street.”
