M&A in the New Tax Environment

While the impact of tax reform on the mergers and acquisitions market remains largely to be seen, it is expected to affect a multitude of factors in the sale of a business, from valuations, to negotiations, to how deals are structured.

Doeren Mayhew Capital Advisors recently gathered a panel of experts to weigh in on the topic at our 10th annual M&A Insight discussion. The good news: Sellers are emerging as the likely winners. But the complexities created by the new law make planning for your sale more important than ever.

Read on for emerging trends, expectations and key takeaways.

Changes & Trends as a Result of Tax Reform

  • Businesses will reap the benefit of a permanently lower corporate tax rate of 21 percent beginning in 2018, freeing up cash for owners to reinvest and make the business more attractive to buyers, or to pay down debt.
  • The new environment brings much more to consider when making your original entity selection or restructuring for sale. Gone are the days when an S corporation or partnership was the clear choice for tax purposes. The tax reform package initially appears to equalize the entity types, making structure seen less important, but in reality, it just made the analysis more complicated. Depending on your situation and goals, one may still be a significantly better choice than the other.
  • C corporations are now more attractive to buyers who historically avoided them, meaning a larger universe of targets.
  • The reform package opens up different ways to structure deals, but the uncertainty around the expiration of some provisions (such as interest deductibility in 2021) requires additional foresight to plan the deal.

M&A Market Expectations

  • Overall, sellers are expected to benefit. More cash will be available for deals, and increased deal flow means a more competitive landscape.
  • More free cash flow and the ability to pay debt more quickly means already-elevated multiples should stabilize and even potentially increase over time. Conversely, more cash can also lead to less debt used to structure the deal, reducing what a buyer is willing to pay in those transactions. Additionally, buyers can generate higher returns with leverage.
  • Investors are the anticipated losers in this tax deal, as the interest rate deductibility provision (applying to businesses with $25 million or more in revenue) will have a significant impact on buyers looking to acquire fixed assets by taking on large debt loads.
  • The immediate expensing provision (bonus depreciation) is expected to drive more negotiations around valuations of fixed assets in an asset sale.
  • Inbound deals should increase, as the 21 percent tax rate positions the United States as a preferred location for international businesses. C corporations will become more attractive to foreign investors, as they can now be grown at the 21 percent tax rate, which is now under most countries.
  • While asset deals will become even more attractive due to immediate expensing, stock deals are also expected to increase as C corporations are now more attractive, which historically were not as desired in part because of its legal risks. As such, more diligence is anticipated around these stock deals and the indemnities will be more heavily negotiated.

Key Takeaways

  • Planning is more important than ever. Bringing advisors in early will help you capitalize on the change and make sure you know how it impacts your business now and in the event of a sale.
  • There will be tax savings no matter the entity structure, so owners are encouraged to focus on where to use the new free cash flow to make the business more attractive.
  • The disconnect between what owners often think the business is worth and what a buyer is willing to pay remains. If you have a number in mind, start planning now to reach it.
  • The fundamentals of business value have not changed – businesses still need realistic growth projections and a plan and management in place to attain them.

If you are considering selling your business or growing via acquisition, contact Doeren Mayhew’s investment bankers to assist you in navigating the added tax reform complexities, and leveraging market factors.

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