On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“Tax Relief Act”).  Pursuant to the Tax Relief Act, certain tax cuts that were enacted during the Bush Administration have been extended until December 31, 2012.

The Tax Relief Act extended through 2012 the individual income tax rate schedule, which provides for a maximum tax rate on ordinary income of 35%.  Without passage of the Tax Relief Act, the individual income tax rate schedule that was introduced during the Clinton Administration, with a maximum tax rate of 39.6%, would have taken effect in 2011.  The income tax rate schedule for estates and nongrantor trusts, with a maximum tax rate of 35% on ordinary income, was also extended through 2012 by the Tax Relief Act.

Under the Tax Relief Act, the lower tax rate on long-term capital gains and qualifying dividends has been extended until December 31, 2012.  Except for certain items such as unrecaptured Section 1250 gain on real property (25%) and collectibles (28%), the maximum tax rate on long-term capital gains and qualifying dividends is 15%.  Without the Tax Relief Act, for 2011, the maximum tax rate on long-term capital gains would have increased to 20% and dividends would be taxed as ordinary income. Read more »

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

During stable market conditions, most private company deals are valued between four and six times trailing earnings.  However, the overall supply of companies for sale and demand for acquisitions from financial and strategic buyers plays into the valuation of transactions.  Clearly, the $3.2 trillion (yes, trillion) capital from investors, lenders and corporations will drive demand.

This is good news for company owners who are slowly re-entering the market to sell their companies.  With capital overhang that exceeds two years of historical investment, multiple buyers with substantial resources will be bidding for companies to acquire.

The extra good news is that this kind of supply – demand imbalance creates a “seller’s market” where, at least in the early stages, more money will be competing for the few sellers that come into the market early in 2011.  The historical data of the most recent seven years shows that deal multiples rise as deal flow increases.

To view the complete article, click here.

Posted by John Hammett

Randy Schwimmer, of Churchill Financial, offers good insight into 2011 expectations for middle-market deal flow in his latest news posting. Here are the key points he makes (note in particular his comments about the “value gap” in the sixth paragraph:

Is it too early to be disappointed in 2011 deal flow?

The question occurs to us, even though it’s only mid-January, because primary issuance has been strangely quiescent.

One of our readers – an advisor to a top PE shop, with decades of deal experience – suggests that sellers started working before last November’s election to beat an expected tax deadline. By the time Congress cut the final tax deal on December 16, it was too late to stop some of those transactions, leading to a “one-time surge” in the 4Q.

Of course with [lots of] cash, and few new deals in the offing, investors are all dressed up with no place to go…except the secondary market.

So how long will it take for all this good news to reach the buyout world?

A savvy investment banker friend speculated that the value gap that kept buyers and sellers apart last year may be persisting. Sellers are bullish about earnings prospects for 2011, so are insisting on higher price tags. Buyers, though, remain skeptical of management projections, not wanting to pay up for trends that may not prove out.

If so, what gets PE buyers off the schneid? A nice run-up in equities, says our deal guru. The M&A game is all about building confidence with investors, he says, and 12,000 on the Dow could do the trick.

But there’s been a lot of blood under the bridge. Real confidence may take more time to return than people think. And that assumes no nasty surprises, like a muni bond scare.

Read the full article here.

Posted by John Hammett

All markets go through peaks and troughs and the middle market mergers and acquisition industry is no exception.  What’s on the horizon for 2011? Important developments in the lower middle market likely signal the acceleration of an upward trend in deal flow and more importantly for sellers, a trend in higher valuations.  For a more in depth look at how historical data trends point to increased M&A activity in 2011, check out the executive briefing “Middle Market Pulse” January edition.

Posted by Roy Graham.

My recent Capital Ideas article focused on private equity funds and why they just might be a perfect partner for a private business owner.  After reading a recent quarterly report from Pitchbook, a research company that collects information on Private Equity Firms and deals, the time to either sell or partner up with private equity may just be now. 
 
According to the report, there is roughly $485 billion in unspent capital sitting on the sidelines and this money must be spent before any new significant fundraising will occur.  Positive trends continue in rising valuations, availability of debt financing and economic recovery in general, which likely will translate into increased deal flow into 2011.

posted by David Sinyard

As you may have heard, the Small Business Jobs Act of 2010 (SBJA) was signed into law on September 27, 2010. Included in this recent tax legislation are some provisions that may prove beneficial to certain buyers and sellers of businesses.

The SBJA moved up the gain exclusion from the sale of small business stock to 100%. By comparison, prior to 2009, the exclusion was 50% of the gain. In the early part of 2009, tax legislation was passed which increased the exclusion from gain to 75% for qualifying small business stock acquired during the period from February 17, 2009 to December 31, 2010. Eligibility for the 100% exclusion includes the following requirements:

1. The stock must be held at least five years
2. The aggregate gross assets of the issuing corporation must not exceed $50 million
3. The stock is acquired in an original issuance from the corporation
4. At least 80% of the value of the assets must be used in a qualifying trade or business
5. The stock must be acquired by December 31, 2010

With respect to stockholders that are individuals, the exclusion from gain is capped at 10 times the stockholder’s basis in the stock or $10 million, whichever is greater. Under the SBJA, the excluded amount will not be treated as an alternative minimum tax (AMT) preference item.

For S corporations, one of the provisions included under the SBJA is the reduction of the built-in gains period to five years. Read more »

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 »

You are an accomplished senior level executive with a strong record of success in corporate America but you want more. You understand your industry as well as anyone and you want to capitalize on that knowledge by acquiring a company that you can grow to build wealth. How do you get started? What is the process? Is it doable?

You may want to start by asking yourself if you would want to acquire the company that you are currently working. If the answer is yes and you believe ownership might be receptive, a management buyout may be a great place to start. After all, you already know your own company so you probably know of any skeletons that may be hidden away as well as the kinds of opportunity that exist. Your due diligence should be easier and you’ll have little, if any, learning curve.

Perhaps your company isn’t available, it’s not attractive or you have an alternative strategy and wish to focus on acquiring another company or a buildup of companies. These are all viable options for which there will likely be multiple sources of funding if you are well prepared and understand the process.

There are many investment groups that will fall over each other in their rush for the opportunity to back a strong management team and a good target company. You can reach out directly to private equity groups and try to handle the process yourself but you may find it frustrating as you navigate a myriad of hurdles. 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 »