Time to Sell

Accountants are fond of counseling clients not to let taxes drive their investment decisions.

But with the looming expiration of the Bush tax cuts at the end of 2010, plenty of business owners are worried they'll have to pay much higher capital-gains taxes if they sell their businesses in 2011 or later.

“You can't trust Congress,” says Kerry Dustin, chairman of Naples-based Falls River Group, a mergers-and-acquisition firm that pairs buyers and sellers of companies. “I'm a bit pessimistic of where we're going.”

But Dustin is optimistic about his own business prospects in 2010. “Next year is going to be absolutely terrific,” he says. “Tax-law changes are driving this.”

If Congress doesn't act next year, the Bush-era tax cuts on long-term capital gains for individuals will expire and the rate will rise to 20% on Jan. 1, 2011, up from 15% today. That's a 33% increase in long-term capital gains taxes.

Meanwhile, Congress is busy creating new entitlements, including a massive health-care bill. Businesses and wealthy individuals are concerned Congress will levy additional taxes on the sale of assets to pay for these programs, further driving up the long-term capital-gains tax rate.

There are also generational pressures building. Baby Boomers will seek to sell 8 million privately held companies to fund their retirements over the next 12 to 15 years, according to Exit Planning Institute.

Dustin says the recession has forced sellers to lower their expectations of getting paid high multiples of earnings for their companies while buyers have reduced their anticipated returns because they can't goose returns with as much leverage. The spread between buyers and sellers is narrowing, he says.

For example, good companies will be selling for about six or eight times earnings before interest, taxes, depreciation and amortization (ebitda), compared with eight to 10 times before the recession, Dustin says. Boomers who have managed relatively well through the recession aren't as focused on getting the most money for their business as they were before, Dustin says.

Buyers' expectations of annualized returns are now below 30% compared to the 40% range a few years ago says Dustin, 64.

“The strategic buyers and sellers are out there,” says Dustin, a former managing partner at now-defunct Leventhol & Horwath in Cleveland who formed that accounting firm's mergers and acquisitions team. A strategic buyer might be a competitor who wants to gain market share, for example.

There are also financial buyers such as private equity and hedge funds that have kept cash on the sidelines during the recession but are starting to scout new investments. Family private-equity groups have been among the buyers lately. “There are some very powerful families with multi-billions of dollars,” Dustin says.

Certainly, it's been a dry patch in the last few years for mergers and acquisitions. In 2008, three deals arranged by Falls River Group derailed, two of them victims of the credit crunch and lack of financing.

But the fee-based business of buying and selling companies improved this year. Falls River recently advised Logan's Linens, a Kentucky-based linen and uniform-rental business, in a sale to Thompson Street Capital Partners, a private equity firm in St. Louis, Mo. (Terms weren't disclosed.)

While plenty of businesses are struggling, Dustin says he no longer represents distressed sellers. He prefers instead to focus on selling well-managed “middle market” companies with revenues from $10 million to $250 million. Falls River represents sellers too, but mostly publicly traded companies that are seeking to divest of some of their operations.