Tucked away in the Small Business Jobs Act of 2010 enacted by Congress in September, 2010 was a golden gift for owners of businesses who converted from “C” Corp status to “S” Corp status within the past 10 years.

If you are the owner or shareholder of an “S” Corp who switched from “C” Corp status within the past 10 years, you may know something about built-in gains (“BIG”). IRS regulations stipulate if you sell the assets of an “S” Corp within 10 years of converting from a “C” Corp, the BIG is taxed at the highest corporate tax rate, which would be 39% for BIG taxes versus 15% for capital gains, a whopping 24% difference.

Specifically, what is the BIG? According to Christopher F. Beaulieu, CPA:

If a prior C corporation makes an S election, the company needs to measure the fair market value at the effective date of the S election as compared to the tax basis. The amount of unrecognized gain is determined for each asset. The net of unrecognized built-in gains and built-in losses is the company’s unrecognized built-in gain. This amount is reported on page two of Form 1120S (S Corporation Tax Return).

Owners of “S” corps which had converted from “C” within 10 years were faced with two choices when considering a sale of their businesses: a)Sell the stock of the company, which for many closely held, private concerns is not very practical…or desirable for acquirers, or; b)Sell the assets and pay Uncle Sam a fairly hefty sum.

However, thanks to the aforementioned gift from Congress, those with BIG issues have been given a temporary reprieve. The Small Business Jobs Act of 2010 (Section 2014 to be specific)* stipulates the following as it pertains to BIG:

Under the Small Business Jobs Act, if the fifth year of an S Corporation’s recognition period ends before their 2011 taxable year begins, then no tax is imposed on the net recognized built-in gain for the 2011 tax year.

In other words, if you are the owner/shareholder of a “S” corp which switched from a “C” corp between more than five years ago but less than 10 years ago, you are not subject to the confiscatory taxes on the BIG if you sell the assets of your business in 2011.

For example, if, when you switched from “C” to “S” status your CPA determined the BIG was $4,000,000 at the time of the conversion, the BIG tax on the sale of those assets would be $1,560,000. However, if you are able to take advantage of this gift from Congress, and you sell your business in 2011, Federal capital gains taxes on $4 million would be $600,000, a savings of $960,000 (versus taxes on the BIG).

While this may only benefit or pertain to a select few companies around the nation, it isn’t very often Congress hands out gifts to business owners. If you are the owner or shareholder in a business which converted from “C” to “S” more than five years ago, AND you are thinking of exiting your business in the future, you might want to consider stepping up your plans to take advantage of what may be a one-time tax savings for you. Of course, you could always wait for the 10-year clock to run out as well. But, there is no guarantee Federal capital gains tax rates will remain at 15% in the future, either.

*Note: To be fair, unknown to many, in 2009, Congress reduced the hold-period for conversions from 10 years to seven years, for businesses sold in 2009 and 2010. However, the additional reduction to five years, for 2011 only, is an opportunity we may not see again in the future.

Posted by Jim Zipursky

Anyone who saw the movie “Marathon Man” vividly remembers Laurence Olivier torturing Dustin Hoffman while continuing to ask the question, “Is it safe?” Much as Sir Laurence’s character “Szell” kept repeating the question to Hoffman’s “Babe” character, we in the M&A industry today are constantly asked, “Is it safe?” in regards to making acquisitions or divestitures in the current market.

“Is it safe?” As it pertains to acquisitions today, the answer may lie within your own perspective. From a market standpoint, today’s market would seem to favor buyers and acquirers for several reasons:

VALUATIONS

Factors Making It Safe

• Valuations for privately-held businesses are lower today than 18 months ago, although they are higher than they were just six or 12 months ago
• We see purchase price multiples in 2010 down approximately 7% from 2008 and approximately 13% from their peak in 2006/2007
• It took six years from the last trough to peak (2001 to 2007) in valuations; we expect the same cycle for the current M&A market, which means valuations will increase over time, but will not peak for several years

Factors Making It Unsafe

• Valuations for publicly-traded businesses are also lower today than at the peak of the market in 2007/2008. For buyers using their stock as currency, acquisitions today could be costly if their stock is undervalued.
• As mentioned above, valuations for privately-held businesses are also down (relative to recent market peaks). For buyers using their own company as collateral for debt to make acquisitions, lower valuations means less capital available for leverage.

MARKET CONFIDENCE

Factors Making It Safe

• Confidence in the economy seems to be increasing, even if only modestly. Companies, in general, are experiencing year-over-year growth from the trough in 2009. Read more »

Multiple Mania: Part 2 of 2

Previously, (Multiple Mania: Shortcutting Success) we had discussed earnings multiples and their value to the Mergers & Acquisitions process. As previously discussed, we tend to view earnings multiples as shortcuts which, when properly applied, can be useful as sanity checks, but we certainly would never recommend acquiring or selling a privately-held business strictly based upon an earnings or purchase price multiple.

Of course, there are many factors which influence multiples, as we discussed previously. One factor is the prevailing or current economic condition. We all know how bad the economy got in 2008 and 2009. We hope we are on the road to recovery, but there are still some rocks in our path.

Purchase price multiples are post-mortem account; you do not know the number until the transaction is closed. That is one of the problems with reviewing multiples. However, we do know during the period of 2006 to the middle of 2008, purchase price multiples were higher than they had been in the 2003 to 2005 timeframe. Those of us in the M&A business watched as purchase price multiples declined during the latter half of 2008 and the first nine months of 2009. Thankfully, we have seen a recovery in the market and a slight increase in multiples.

So what drives multiples? Read more »

In addition to teaching a “How to Value a Business” continuing education course each year, I am also asked to speak to various groups of CEOs, entrepreneurs and business owners on the same subject.  Regardless of the audience, invariably, someone will ask, “Jim, this valuation stuff is all well and good, but what is a simple multiple of earnings or formula to use to value a business?”

Face it, we all love shortcuts. We learn at an early age the benefits of shortcuts: whether we cut through our neighbor’s yard on our walk to school, clean our room by stuffing our messes into our closets, or even feed our unwanted vegetables to our dog (surreptitiously under the table, of course) so we can get the dessert our mothers’ promised if we clean our plates, who can resist a good shortcut?

Today, I still use the shortcuts my high school mathematics teacher taught us to check our addition and how to quickly multiply by 25. I doubt any of us can get through the day without utilizing at least one shortcut we learned as kids. For business buyers and sellers, multiples are simply shortcuts to the valuation and/or negotiation process.

When applied properly, multiples can be used effectively as sanity or temperature checks/gauges. However, I personally would not want to buy or sell a business based strictly upon a multiple. There are always so many variables to consider when acquiring or selling a business; basing such an important decision on a simple multiple does not make sense. Take a look at the following, admittedly simple, example as a way of illustrating my point. Read more »

While working on a recent transaction where we represented a seller who was looking to complete a Management Buyout sponsored by private equity groups, one of the potential equity sponsors told us,  “We will only invest in this transaction if there is another investor group who invests along side us.”  “Is that to minimize your risk,” I asked.  “No, it is our requirement to have a co-investor because it validates our investment philosophy.”

In other words, like sheep who flock together, this investor group was satisfied with an investment so long as someone else came to the same conclusion.  “But what if you like the opportunity but do not find a co-investor,” I inquired of the group.  “Then we walk away from the opportunity,” I was told.

This group, and many others with same investment criteria, are not willing to trust their own instincts but need validation from others.  Ultimately, this is a sheep mentality… following others at all costs.

Eagles, on the other hand, hunt and soar alone.  They find their prey and seize the moment.  Eagles have the courage and temerity to make their own decisions based on their own standards and criteria and seize the moment regardless of what others around them are doing. Read more »

Singing In the Rain

No doubt, for the past 18 months, the current economic crisis has hung over our heads like a summer storm over the Great Plains.  We are certain it will pass, but its rains and winds can produce lasting damage for all in its path.  In times such as these, we can either seek the comfort and security of shelter, or, more aggressively, we can learn to sing and dance in the rain.

Recently, I was invited to attend a recent summit of CEOs of mid-market companies.  I heard many CEOs who literally shouted: “Now is not the time to seek acquisitions because we do not know if we have hit bottom yet,” “Banks are not lending like they once did,” “How can we consider an acquisition now when we have our own business challenges?”  These were common themes and common statements during presentations, around the lunch table, and at the bar during cocktail hour.

However, a few of CEOs, those who I will call the “enlightened elite” embraced an alternative approach, exclaiming for all who would listen: “There has never been a better time than now to make acquisitions. Read more »

Not Just For Big Companies

Recently, I was asked to speak to a group of CEOs of mid-sized companies regarding EBITDA and its importance to them as business owners. Several questions from the group centered on what I will loosely call “tax avoidance” and “tax deferral” practices commonly employed by owners of privately held companies. The questions focused upon the impact of these practices on the value of a business. The common theme from the audience was, “buyers understand owners do not want to pay taxes and they are willing to adjust for these practices.”

I reminded the group that buyers, or anyone who is reviewing the performance of their companies, will only be able to evaluate what they can see. If you are writing off inventory, expensing personal items, or employing any of the myriad other “tax avoidance” practices, you do a nice job of lowering your tax burden, but you may not be able to get a return on this “investment” when you look to “withdraw” these funds. All of these practices impact your cash flow positively for you, but not necessarily for those evaluating your company. Read more »

As Investment Bankers, we are often asked, “What kills most deals?” This is an especially critical concern in uncertain economic times like those we are in now. Unequivocally, our answer, regardless of the economic situation, is always the same, “Time is not your friend in deals; it is the ultimate deal killer.”

When we reflect upon our deals that did not get done, or those that died between Letter of Intent and Closing, regardless of the specific reason, time killed all of these deals in some why or another.

Once a seller of a business makes his/her decision to sell the business, time does not move fast enough. Sellers imagine the worst: customers or employees learning of the sale; declining revenues; problems with the business; all these events happening the longer a deal takes to get done. Some of these fears are justified, others are not. Read more »

Recently, Fortune Small Business magazine conducted a survey of owners of privately-held, small & mid-sized businesses in the USA. Two questions were asked:

• How critical to your business’ survival is succession planning?
• Have you done anything about formalizing a succession plan?

The results were extremely interesting. More than 95% of the respondents said a succession plan was critical to the long-term survival of their business, but a staggering 85% had not done anything to formalize their succession plans.

This survey reinforces information we learned first-hand several years ago when Read more »

Case Study

Situation: In 1991 Carol and Jim Townsend acquired a small employment agency and entered the world of entrepreneurs. Quickly, they moved into providing temporary employees and eventually built their business into a regional powerhouse. Their company, Sunrise Enterprises, based in Dubuque, Iowa had 13 offices in a three-state area and billed over 2 million hours of work per year.

Solution: Based on a referral from their CPA, Carol and Jim retained CFA to sell their business to a buyer who would continue to develop Sunrise. Ultimately, CFA found a complementary, strategic buyer who would not only acquire the business, but would, in turn, sell part of the company to Sunrise’s key executive. The sellers got the value they wanted for the business and achieved their retirement goal.