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Effects of Capital Gains Tax and Interest Rates on Owner’s Net
TIMING… WHEN SELLING A COMPANY, it's not how high the sell price as how much the owner "pockets". There are a number of important considerations facing business owners who are considering transitioning in today’s markets. Two of the most important and clearly quantifiable are the proposed increases in capital gains tax rates and interest rates. But just how significant are these?
Capital Gains Tax Rates
Many think that capital gains taxes are likely to increase soon. Federal capital gains taxes were reduced from 28% then to 20% and at last to 15%. Given the current climate in theWhite House, it is quite possible, some say quite likely, that the capital gains tax will increase. That means your company will need to sell for a lot more to net the same amount.
Interest Rates Will Rise
Buyers tend to pay more when the cost of money is low. Lower interest rates make growth by acquisition a more attractive option than organic growth. Quite simply – the lower the cost of money (interest rates), the more a buyer can pay for your company.
Let’s look at the impact on your business’ “value” if capital gains rates go to 30% from their current level of 15% as well as interest rate increases of 2%, 4% and 6%.
% Decline in Business Value Resulting from Capital Gains Tax and Interest Rate Increases
Many business owners have suffered earnings declines related to the current recession and believe that a wait-and-see strategy is best. However, many economists are predicting a bath tub-shaped recovery, which means we are likely to see very little real growth for several years once the recession is over. Let’s look at what kind of earnings growth would be required to simply offset the loss in value from capital gains and interest rates.
% Increase in Annual Earnings to Offset Decrease in Business Value from Capital Gains and Interest Rate Increases
Value is typically defined as Business Enterprise Value—the amount that an expert values a company— or Market Value—what the open market will pay for a company. For purposes of illustrating the effects of an increase in capital gains tax and interest rates, we’re defining value as the combination of the decrease in sales proceeds received by an owner due to an increase in capital gains tax along with the decrease in purchasing power of the buying market from an increase in interest rates.