…An appreciable difference when tax ramifications are considered!

As the number of people getting vaccinated for Covid-19 continues to grow, business owners across the Commonwealth of Virginia are looking forward to getting back to normal. Encouraged by the warmer spring weather, we’re spending more time preparing for what comes after the pandemic.

During normal times, April finds most business owners and their CPAs in the middle of preparing for another rite of spring: Taxes. This year, the due dates for both Virginia state and federal taxes have been pushed back to May 17, to allow additional time for recovery. If we can tolerate the pollen and don’t mind wearing masks a bit longer, hope is in the air.

But there’s more than pollen and hope in the air this year. There’s also talk of pending changes to the tax laws. The costs associated with the economic stimulus and plans for future spending on infrastructure have many financial and economic forecasters predicting higher taxes. For small and mid-sized business owners considering selling their companies, a change in the way capital gains are taxed can have considerable impact on their bottom line.

 

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Consider the (fictional) Bloom’s Floral Shop.

Janet Bloom’s floral shop has been growing nicely for nearly thirty years. She started with a loan from her parents, expanded market share and added capacity by acquiring four locations, and has assembled a team of twenty loyal employees. Her company is a success!

Having put in long hours to build the business, Janet is looking forward to a relaxing and successful retirement. But she is unsure whether she’s ready to “pull the trigger” on selling just yet, or to stick with it for another couple of years, to get peak value from the business sale. Her trusted accountant has the books in good order and has recommended Janet meet with the team at Rich-Biz Brokers & Advisors, LLC, to consider her options.

Rich-Biz Brokers performs an evaluation that determines a current fair market value of $3 million for the business and presents Janet with a matrix of different scenarios factoring in various potential business growth rates versus changes in the capital gains tax.

EXERCISE 1
Assumptions:

• Bloom’s Floral Shop is sold in 2021 for $3,000,000.
• The book value of the company’s underlying tangible assets is $1,000,000.

• 20% Tax Scenario – Capital gains are taxed at the current rate of 20%. $2,000,000 capital gain taxed at 20% = $400,000 capital gains taxes paid, resulting in $2,600,000 sales price after taxes.
• 28% Tax Scenario – Capital gains tax rate rises by 8% from 20% to 28%. $2,000,000 capital gain taxed at 28% = $560,000 capital gains taxes paid, resulting in $2,440,000 sales price after taxes.
• 36% Tax Scenario – Capital gains tax rate rises by 16% from 20% to 36%. $2,000,000 capital gain taxed at 36% = $720,000 capital gains taxes paid, resulting in $2,280,000 sales price after taxes.

 

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EXERCISE 2
Assumptions:

• Bloom’s Floral Shop is sold in 2023 rather than in 2021.
• The capital gains tax rate increases from 20% to 28% beginning in 2022.
• The book value of the company’s underlying tangible assets remains $1,000,000.
• The discount rate is 4% per year.

• • Scenario 1 – No growth: Business value remains constant at $3,000,000.
    • Sales price is $3,000,000.
    • Net sales price $2,440,000 ($1,440,000 + $1,000,000).
    • Net present value = $2,248,704.
    • LOSS in net present value vs. selling in 2021 = ($351,296).

 

• • Scenario 2 – Moderate growth: Business value grows 4% per year.
    • Sales price is $3,244,800.
    • Net sales price $2,616,256 ($1,616,256 + $1,000,000).
    • Net present value = $2,411,111.
    • LOSS in net present value vs. selling in 2021 = ($188,858).

 

• • Scenario 3 – Exceptional growth: Business value grows 8% per year.
    • Sales price is $3,499,200.
    • Net sales price $2,799,424 ($1,799,424 + $1,000,000).
    • Net present value = $2,579,949.
    • LOSS in net present value vs. selling in 2021= ($20,051).

 

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Even when a business is healthy and growing, owners might be better off selling sooner rather than later when the tax rate is rising!

Bloom’s Floral Shop’s growth in intrinsic enterprise value would have to increase 8% per year for 2 years in order to equate to slightly less after-tax sales value of the business in 2021 with the assumptions herein described. If the value of the business increases anything below 8% per year for 2 years, or stays the same, Janet Bloom would receive a much lower after tax net present value for the sale of her business by waiting to sell in late 2023.

It’s difficult to predict the future. But it is prudent to weigh your options as soon as possible in light of emerging trends.

Not only is it important that Janet Bloom evaluate the numbers based upon certain known and assumed projections, but she should also evaluate whether this is the right time personally for her to sell. There are many personal and professional issues that are important in the owner’s decision on the right time to sell. We will address these business owner issues in a later Rich-Biz Newsletter.

Rich-Biz Brokers & Advisors, LLC, provides business owners and prospective owners with the valuable counsel they’ll need to make informed decisions regarding the sale of their companies. Our team brings together more than 100 years of combined executive experience providing proven, affordable transition solutions to small and mid-size businesses.

It pays to know who’s in the know. If you’re considering buying or selling a business, the experts at Rich-Biz Brokers & Advisors, LLC can be an invaluable resource to aid your decision-making process.

Just give us a call or drop an email. We’ll respond promptly!

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