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JANUARY 01, 2023

A Window of Opportunity

With potential changes to tax laws looming and a mergers and acquisitions market that’s on fire, it’s an important time for business owners to consider the strategic options for their business – fundamentally, should you continue to focus on growing your business, or should you consider selling it?

 A panel of BMO experts recently discussed the current situation and the strategic options business owners can consider. 

  • Kyle Crowe, Managing Director of Middle-Market Mergers & Acquisitions, BMO Capital Markets
  • Bob Harrod, Director of Corporate Advisory, BMO U.S. Bank
  • Jayne Hartley, Regional Director of Wealth Planning, BMO Wealth Management


Following is a summary of their conversation.

Potential Tax Changes
President Joe Biden’s American Jobs Plan and American Families Plan have laid out the administration’s proposals for changes to the corporate and personal income taxes, respectively. Legislation has yet to be drafted, but Hartley outlined the three key changes we currently know about proposed corporate tax reform:

•    Raising the corporate tax rate on C-corporations to 28% from the current 21% rate
•    A 15% minimum tax for companies with more than $2 billion in net income
•    A 21% minimum tax on foreign profits

On the personal income tax side, there are implications for business owners in terms of capital gains, wealth transfer and real estate investments, including:

  • Raising the tax rate on $400,000 in taxable income to 39.6% from the current 37%
  • Raising the tax rate on income from capital gains and qualified dividends, as well as private equity and hedge fund carried interests, to 39.6% from the current 20% 
  • Repealing Section 1031 of the Internal Revenue Code on tax-deferred investment real estate swaps
  • Repealing the stepped-up basis on inherited assets 

We don’t know what those changes will look like in their final form, and with a divided Congress, negotiations are likely to be intense. But Hartley noted that a bill could pass using the budget reconciliation process, which allows legislation to pass through the Senate with only 50 votes—including the Vice President’s tiebreaker—instead of the usual 60. That’s why she’s advising clients to prepare now.

"One thing we know for sure, tax changes are coming,” Hartley said. “What we've been waiting for is some legislation that's going to tell us exactly what they're proposing. The big question that everyone is asking is what's going to be the effective date. It is something we’re all concerned about, and it's all the more reason to act now.”

A Red-Hot M&A Market
Many experts expect any tax law changes to become effective on Jan. 1, 2022. That’s why business owners considering a sale or acquisition may want to act quickly. Another factor that could accelerate your timeline is the fact that the M&A market is particularly strong. 

Crowe pointed out that after slowing down in the early stages of the pandemic, M&A deal volume in the second half of 2020 returned to a sizzling pace. That momentum has continued into 2021. What’s driving this frenzy of activity?

"One is pent-up demand,” Crowe said. “A lot of deals in 2020 were put on hold because of the pandemic, so they came back to markets in Q1 in earnest. We also have a new group of sellers who I don't think were planning on selling their business anytime soon. But having worked through a pandemic and not wanting to go through it again, I think we're seeing some of those owners come to market today as well. I think 2021 will be on track for maybe the biggest year in history.” 

Crowe said, “strategic buyers have been the primary driver of acquisitions, representing 82% of all acquirers so far in 2021 . They’re holding record levels of cash, stocks for publicly traded companies are at or near all-time highs, and they're getting pressure from their growing shareholder base to grow the business rapidly.” 

Crowe expects deal activity to remain strong for the foreseeable future. Interest rates are expected to remain low in the near term, and the U.S. GDP is expected to rise around 6% year over year. But the most significant macroeconomic factors have been consumer and business confidence levels. 

“Confidence and market stability are probably two of the most important factors for a strong M&A market,” Crowe said. “The key is the buyers have an optimistic view of the next few months or next few years.” 

Crowe said all of those elements have resulted in high purchase price multiples. The median purchase price multiples we saw in 2020 was 10.3 times EBITDA, the highest level since 2016.  That’s not a surprise given the availability of capital and a supply-demand imbalance between buyers and sellers. It’s what Crowe called “a perfect storm for buyers,” and it’s a trend he believes can continue at least in the near term. 

“It's tough to be a buyer out there,” Crowe said. “You have to know where the market is and what you have to pay for a business. You have to lean on your advisers to make sure that you're making the right decision, both strategically and financially, and hopefully not paying a crazy multiple.”


Weighing Your Options
Given the current market conditions and the possible future tax implications, making key strategic decisions before the end of the year could be imperative for many business owners. Harrod outlined the options facing business owners: stay the course and continue to invest in growth; take some chips off the table during a more favorable tax environment; or monetize the business. “The good news is that in this environment, all these can be very viable options,” Harrod said. 

He added that the decision should be informed by multiple considerations, including: 

What are your priorities and objectives as the owner? 

  • Are you active in the business, or more passive? 
  • What’s your retirement timeline?
  • What are your personal near-term liquidity needs, and how do the financial aspects of the business affect those needs? 
  • Are there suitable acquisition targets available? If so, do you have the capabilities to execute and integrate an acquisition? 
  • If you’re interested in selling, what kinds of multiples are being paid for similar companies? 
  • What is your industry’s outlook? Has it peaked, or is there more runway for growth? 

"From a growth perspective, you have multiple options,” Harrod said. “You can grow organically, which may be a little slower and take a little longer than an acquisition, but you control it and you don't have to worry about potentially overpaying for an acquisition, or potentially damaging your culture by bringing in a business that isn't a good fit, or integrating the business poorly. Acquisitions can get you where you want to go faster, especially if you're looking to diversify.” 

Another option is dividend recapitalization, in which a business assumes new debt and distributes the proceeds to shareholders in the form of a dividend. As Harrod noted, given the potential changes to the tax code, implementing this strategy today could help shareholders realize some level of liquidity in a more favorable tax environment.

"As you consider your options, we encourage business owners to evaluate this with an investor mentality,” Harrod said. “That means thinking about the financial returns that can be generated for your business like any other asset you might invest in.”


Time Crunch
Whatever decision you land on, proactive planning is essential. Crowe pointed out that a typical M&A process take about six months from start to finish. That means to complete a transaction before the end of the year, the process needs to get started by July 1. 

“The issue we have right now is the markets are getting busier and busier with more and more deals coming to market every day,” Crowe said. "And we’re all seeing a tightening of service provider capacity, whether it's lawyers, accountants, investment bankers, insurance providers. We saw this in 2012 when the capital gains rate was going to up in 2013, and there were a number of sellers at the table and they couldn't get the financing in place at the last minute because the banks were so backed up with closing, and some slipped into the next year. So, if you're considering it, get your advisers involved immediately.”

"The overall market environment now is one we may never see again,” Harrod said. “As a business owner, now is the time to critically and proactively evaluate all of your strategic options.”