February 15, 2021
As an owner, have you been thinking about cashing out due to the low capital gains rate, easy money environment, and high price multiples? Do you want to remain as CEO for several years after the sale? It can be done. Those aspirations are not only realistic but remarkably lucrative in today’s market. Here’s why.
We all know that stock equities are at an all-time high, even as the pandemic winds down. Wealthy investors fear an eventual stock market correction and are searching diligently for other types of alternative investments. Even obscure investments like Bitcoin have doubled in 2021! In prior years, investor money would flow into treasuries and corporate bonds as a low-risk safe haven. But today’s low interest rates are bringing minimal returns. As a consequence, wealth is directed to private equity funds that can deliver high rates of return, many times in the double digits. This has created an environment where PE firms are being pressured to put investor cash to work, resulting in a bidding frenzy for healthy companies in strong industries like yours. That, fundamentally, has created a seller’s market and is what is driving up price acquisition multiples today.
Consider this scenario:
A private equity firm offers to purchase your successful and growing business. They want you to remain with the company post-sale and grow it further with the backing of their additional capital, strategic relationships, and oversight. To incentivize you to do this, the PE firm wants you to keep a portion of equity and be properly compensated for continuing to navigate your company’s growth for the next 3-7 years. If you want to retire earlier, you must train your replacement in the short term and exit when desired.
So, the PE firm purchases 75% of your company with a goal of at least tripling the value of the business. With the higher multiple they receive for a larger company years later, your remaining 25% is targeted to be worth much more than the price you received for the 75% when the company is sold again. You have probably heard of this as “taking a second bite of the apple”.
OK, you get it. So why should you sell your business today? Consider:
- the government’s printing of “free” money will eventually drive-up inflation, which has a discounting effect on business valuation methodology,
- higher minimum wages will increase business costs, thus lowering profits and business valuations, and
- the most significant factor, is that its commonly publicized that tax rates will be increasing, with the capital gains rate of 20% being raised to at least 28%, maybe 36%. At 36% (an 80% increase), waiting to sell your business three years from now would mean you need to get a price increase of 25% just to equal the after-tax cash you would get under current rates.
If you want to take significant cash out of the business and still be able to exit in 1-5 years, this would be an attractive way to structure it.
Written by Steve Zacharias, Managing Partner at Transact Capital. Please contact Transact Capital if you would like to meet or zoom to discuss this topic further. All communication would be held in strict confidence and with absolutely no cost or obligation. 804.612.7102. www.TransactCapital.com.