What to Consider When Planning to Sell a Distribution Business This Year

While 2021 seems rife for a sell-off of businesses to distributors and other entities, sellers might want to take a hard look at the tax implications this year, according to a panel during last month’s M&A Summit virtual conference.

 Speaking during the investor panel, “Is Your Business an Attractive Target?,” Brent Grover, M&A adviser for Brent Grover & Co., said he was advising his clients to review the proposed tax changes under the Biden administration, as well as changes in state taxes. Motivators for selling all or part of a business included the need for more money to grow profits, succession plans and changes to the capital tax gain rate, according to Grover.

Grover said sellers were worried about capital gains rates, which are currently around 20%, elevating to 39.6%, although 28% was more likely.

“But in addition to that, something that’s new and different is state income taxes, particularly for people in New York, California or other states,” Grover said. “The things they have in common is, of course, they’re wealthy states, but with outrageous income tax rates of 13% to 16%. [That] would be the tax paid by a seller in state income taxes, which is not deductible under current law from federal income tax. Consequently, the effective tax rate for those sellers could be 50% or more.

“And one more thing, and that is the estate taxes. Currently, there’s a more or less $22 million exemption for a married couple who own a business that is very likely to become $11 million or less between now and 2025.”

The end result in Grover’s example is that a wholesale distribution business that changes hands could be subject to a tax of 40% when it changes hands from one generation to another.

In another M&A Summit session, CPA Jeff Pease, president of Pease and Associates, outlined some of the potential tax changes that were currently on the drawing board, which included an increase in top individual tax rates from 37% to 39.6% and the elimination of the income cap on Social Security taxes.

Longer-Term Holds

Jim Miller, founder and partner for Supply Chain Equity Partners, said there’s a bifurcation taking place this year between the companies that are looking to exit being pulled forward at a faster rate versus those that don’t get out before the current tax window closes.

“I think there are going to be longer-term holds because of the difficulties in running the buy and build program long term,” Miller said.

Prospective sellers are faced with a balancing act this year when it comes to the probability of taxes going up, according to Jason Wilcox, the managing director and founder of Wilcox Investment Bankers.

“Based on how much you think they may go up, you may be willing to do a deal today for a little bit lower valuation because you may end up better off even if the multiple is a little bit smaller today,” Wilcox said. “So that’s part of the thought process on trying to figure out when to go to market, not to mention all the other basic things you think about. But, yeah, taxes could be a really big thing.”

Raymond James’ Gareth Hughes said during the panel that the need for estate planning was even more important this year in the face of the tax changes. Business owners need to have their revised estate plans completed before the tax changes occur.

“One of the things that we would advise our clients pretty early on is to make sure they’re speaking to tax advisers and getting estate planning in place because it’s pretty complex,” said Hughes, who is the director of investment banking at Raymond James. “There are cutoff points by which any tax planning done after that point effectively doesn’t apply. You really need to get in front of it early with the changes that are coming.”

Over the past several months, Irving Place Capital Partner Devraj Roy said his company has seen an uptick in activity from families and private business owners that are almost entirely tax driven, even though a business may not be at the right point in its lifecycle to change hands.

“We are seeing taxes being the primary motivator to come to the table with the understanding that the owners may not get full value for the business, given where it sits today,” Roy said. “But on an after-tax basis, they will get more today versus waiting to get a higher multiple down the road because of the tax dynamic. I would say there’s much more interest in tax-driven transactions.”