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Wednesday, October 28, 2020

If Biden wins, small business owners are more likely to sell companies

If you believe the polls, a Biden victory in November’s elections seems probable. If he’s elected and if he has a majority in both the House and Senate, small business owners can expect to see tax legislation in the next two years that will have an impact on their operations. I’m also expecting to see a significant increase in the number of existing business owners who decide it’s time to sell their companies. The reasons will be driven by a few significant factors.

The first will be capital gains. Joe Biden has proposed increasing the capital gains tax rate from the existing 20 percent level up to individual rates as high as 39.6 percent once someone is earning more than $1 million per year. Selling a company triggers a capital gain for a business owner and obviously the higher rate, the less taken home after the transaction, so selling sooner rather than later would be the right move for many. 

But higher taxes on capital gains aren’t the only tax increases business owners will see. Besides an increase in individual rates, the candidate also wants to impose the 12.4 percent Social Security payroll tax for wages above $400,000 (it’s currently $137,700), raise the corporate income tax rate from 21 percent to 28 percent and phase out the “small business tax deduction” on pass-through earnings (otherwise known as the qualified business income deduction or Section 199A) for filers with taxable income above $400,000.

None of these future increase would be appealing to people currently running businesses and would create more reasons to get out while tax rates are still lower.

Mr. Biden also wants to change the rules concerning the “step-up” basis for assets purchased in an acquisition. Current tax law says that if you buy a company the new “costs” of the assets are “stepped up” to the price you just paid (or inherited). Therefore, down the road and when a business is sold the gain will be calculated using the “stepped up” cost level.

This removes a significant benefit for a buyer of a business. Why? If, under a Biden administration, this benefit is taken away then current owners of a business will have to pay much more in taxes because they’ll be using an historical cost to calculate their gain, which of course would be higher at that time. Better to get the transaction down soon, before these new rules take effect.

There will also be higher estate taxes. Democrats want to lower the approximate $11.5 million exclusion of the 40 percent estate tax rate to about half the current levels. This, along with the “step-up” rules described above (which would tax heirs on the unrealized gain of a business handed down) will provide a reduced incentive to pass down a business from one generation to another, depending on how it’s structured and would likely encourage business owners to sell their companies sooner rather than later, pocket the cash and then figure out another way to move their cash to the next generation.

I’m an accountant, so taxes are my thing. But there are plenty of other non-tax related reasons that are independent of the election that will also likely drive small business owners to sell their companies over the next few years. 

The pandemic, for example, has reduced the profitability of some small firms to a level that would make their acquisition price more attractive. According to a new report from BizBuySell, an online business marketplace, 59 percent of buyers would consider buying a closed business due to the pandemic, and 81 percent would consider a business that has remained open but has been negatively impacted.

Twenty-eight percent are actively searching for a depressed business to hold until conditions improve. Meanwhile, 68 percent of owners experiencing a decline expect their fortunes to rebound within the next year. All of this should create an interesting environment for negotiations.

The pandemic has also created many real estate opportunities. The researchers at BizBuySell believe that buyers have a rare opportunity to secure prime locations without having to pay for the historical cash flow the existing business would normally generate. “The pandemic will result in thousands of fully built out restaurants not reopening which will present opportunities for many new restaurant operators,” Steve Zimmerman, a business broker specializing in the restaurant industry says. “A major advantage, they’ll have immediate access to the use of hundreds of thousands of dollars in built out equipment and leasehold improvements.”

The age of business owners continues to creep up and many — particularly after the stresses of the pandemic — are looking to get out while the getting’s good. Current interest rates, which are historically low, will help them attract buyers seeking financing. Inflation rates are also low, and investors with extra cash who are frustrated with low savings rates and do now want to take a gamble on the stock market may find it more under their control to buy and run an existing business.

A growing number of millennials, hungering for more flexibility and opportunities than their corporate bosses can provide, are looking to try their own thing. A not-insignificant number of clients I know who have navigated the pandemic successfully and have some extra cash lying around are looking to buy up the businesses of their competitors who were not as fortunate.

I know it’s tempting to think that a Biden victory will cause “socialism” or bring down society as we know it. But that’s not going to happen, of course. What will happen is that a Washington run by his party will create a costlier environment for many small businesses and — given the demographics and inevitable tax increases they will enact — will also likely create a very active market of smart small business owners selling their companies in the next few years. According to the BizBuySell report, entrepreneurs are “pivoting, adapting, and seeking opportunity amidst the disruption brought on by the pandemic” and as a result, acquisitions are already steadily bouncing back from April lows. 

“We’ve barely scratched the surface of baby boomer supply and as the pandemic continues,” says one broker. “Any increase in uncertainty will propel these owners into the market.”

• Gene Marks is a CPA and owner of The Marks Group, a technology and financial management consulting firm that specializes in small- and medium-sized companies.


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