Will You Be Giving Thanks on November 22, 2012?

Historically, the capital gains tax rate has fluctuated greatly. In May of 2003 it dropped from 28% to 20% or the equivalent of a 40% drop. Further, in May of 2007 it dropped from 20% to 15%; a 33% decrease but with a “sunset clause” to return to 20% on December 31, 2010. After the November 2010 mid-term elections, the reduction from 20% to 15% due to expire on December 31, 2010 was extended to December 31, 2012.

The merger and acquisition (“M&A”) industry involves experts and professionals from many functional disciplines. Each one of these professionals plays a unique and necessary role in the closing of a transaction. Transactions are typically brought forth to market by investment bankers, transactional attorneys prepare and negotiate the documents to reflect the terms delineated in the Letter of Intent (“LOI”), CPA’s advise business owners on the tax consequences of the transaction and asset allocation of the purchase price, lending institutions fund part of the purchase price, and financial planners assist owners in post closing investment advice.

The M&A industry is like most other industries in that it has certain resources and “band width”. Although most of the process is the same with each transaction, every transaction is different and there are no economies of scale. In fact, every transaction is custom and requires the same amount of professional resources regardless of size or sector. Therefore, the band width of the M&A industry is limited, inflexible in terms of economies of scale, and inelastic to volume.

What happens if there’s a sudden dramatic spike in M&A volume prior to a deadline? Answer- transactions most probably will not be closed by that deadline.

Further, if interest rates increase, prices paid for privately-held companies decrease. On Wednesday March 16, 2011 The Reserve Bank of India quietly announced an increase of 25 basis points to its key lending rate. THEN, on April 7, 2011 the European Central Bank raised interest rates by 25 basis points as well.

Could this be a harbinger of things to come? If so, will it cause a spike in M&A activity by sellers that want to exit at higher transaction values prior to further interest rate hikes?

In 2010, the first wave of baby boomers turned 62 years old. In the coming years, the number of baby boomers will increase exponentially. These baby boomers, nearing retirement, will want to sell their companies and the supply of privately-held companies on the market will increase and values will decrease. The first wave of baby boomer owned companies are hitting the market necessitating that the others take similar action or risk losing value.

The Perfect Storm…

• Economic reality will replace political expediency and capital gains taxes will increase on December 31, 2012 from 15% to 20% plus the 3.8% health care surcharge; or an increase of 55%.
• Interest rates increase reducing purchase prices that create a rush to sell privately-held companies.
• Baby boomer companies will enter the market at an increased rate and stress the M&A markets band width and adversely affect values.

These factors will cause owners of privately-held companies to enter the market and cash out sooner rather than later…consider:

• It takes 6 to 18 months to sell and close a transaction for a privately-held company.
• Owners will want to close a transaction prior to December 31, 2012 to avoid the increase in capital gains taxes, interest rate increases, and softening of prices due to increased supply from baby boomers.
• Yet…the M&A industry band width of professional resources needed to close transactions will be overcrowded and closing times will be delayed.

Therefore…if you don’t close a transaction by Thanksgiving 2012, chances are you will not at all in 2012 and will face the economic consequences.

Want a Happy Thanksgiving 2012? Start the process to sell your company right now.