Should I Sell My Business In This Economy?
Before you make a decision, let’s lay out some FACTS…
...Timing is everything!!!
Our typical seller is 55+ years of age, while our typical buyer is 45+ years of age. So, if we take into account our statistical ages of sellers and, more importantly, profiles of buyers, the majority of this turnover in the next ten years is going to stay within the boomer generation. But as the baby boomers continue to age, they will be relying more on Generation X with $55MM people (according to the US Census Bureau) to become the driving force of business acquisitions.
The Bush-era tax cuts have been extended, and this includes keeping the current capital gains rate at 15 percent until the end of 2012. A large portion of the sale price of a small business can fall into the asset category known as good will. In an asset-sale scenario, sellers typically want as much of the sale price as possible to be classified as goodwill because the Internal Revenue Service will tax it at the capital gains rate — which is usually much lower than the seller’s income tax rate.
Unless Congress passes new legislation, on January 1, 2013, the capital gains tax rate will increase to at least 20 percent. Some analysts are predicting that that the new rate will probably be even higher than 20 percent given our growing budget deficit and need for new revenues. Keep in mind that on top of this likely increase, 2013 will also introduce increased Medicare taxes that could add 3.8 percent tax to all investment income. So ultimately, unless Congress moves to change this, the combined tax bite will be closer to 24 percent from the 15 percent of today. That may not sound like much but it represents nearly a 60 percent increase in the capital gains tax rate.
Let’s assume that you are married and that you and your spouse’s Adjusted Gross Income (AGI) is $250,000. Let’s also assume that your business sells for $1 million.
► Scenario One: If you sell your business before the end of 2012, the federal income taxes owed from the sale will be $150,000, allowing you to keep $850,000.
► Scenario Two: OK, now you sell your business after January 1, 2013. Assuming that long-term capital gains rates increase to 20 percent in 2013, you will owe $200,000 in capital gains taxes, an increase in federal taxes of 33 percent. However, since your 2013 AGI remains at $250,000, the $1 million income from the sale of your business will be fully subject to the 3.8 percent Medicare tax, providing an additional $38,000 in federal taxes owed. Selling your business in 2013, instead of 2012, will add a minimum of $88,000 to your federal tax bill, which is an increase of 59 percent over what you would owe under scenario number one.
► Scenario Three: However, what if some analysts are correct and cap gains rates are increased even higher? For example, some believe that the capital gains rates could increase to the 1996 level of 28 percent in 2013. Under this scenario, your total tax bite would increase to $318,000 (31.8% = 28% cap gains tax plus the 3.8% Medicare tax). This would leave you with only $682,000.
To help us visualize this, here are the net after tax proceeds to you under these three scenarios:
Scenario One, sell before Dec. 31, 2012 (15% cap gains tax) = $850,000 net after tax proceeds
Scenario Two, sell after Jan. 1, 2013 (23.8% combined tax rate) = $762,000 net
Scenario Three, sell after Jan. 13, 2013 (31.8% combined tax rate) = $682,000 net
As you can see, delaying the sale of your company past this two-year window could significantly impact the amount of money you retain. In fact, if scenario three turns out to be accurate, delaying the sale of your company would more than double the amount of taxes you would pay ($150,000 vs. $318,000).
With so much uncertainty in the market, sellers considering selling a good to exceptional quality business continue to remain on the sidelines until prevailing conditions improve. On the other side, as predicted, there is a surge of qualified buyers coming into the market place. As most of the United States continue to experience high unemployment rates, there are increasingly more corporate refugees that are educated and experienced individuals with access to 401K’s and other retirement funds that can be used to purchase a business without penalty. Many were laid off and are now focused on controlling their own destiny either by starting their own company or mitigating the risks of a start-up by purchasing an existing established company.
The recession is causing a dip in prices of some business. But, surprisingly small businesses that can make a living for the buyer and pay its debts can look pretty good when compared to the lower investment returns of a previously ‘good’ investment. It stands to reason that as sellers start to outnumber buyers, the corresponding business valuations may drop unless you, the seller, can ensure your business is one of the few in the “exceptional” category. Based on this, we feel the seller sitting on the fence will be better off going to market now before the typical ratio of ‘good’ businesses return to normal, minus normalized unemployment rates removing potential buyers from the market, minus the reduced buyer pool within Generation X that follows.
In the long run, planning for an exit in 3-5 years out will provide the greatest options and the ability to take advantage of the boomer buyers still in the market place with normal to strong valuations.
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