| t couple of years have been difficult for business | | | | $1.5 billion, the second highest on record. This indicates |
| owners and financing markets, to say the least. Limited | | | | more private equity groups than expected will have |
| credit, economic uncertainty among businesses and | | | | cash in 2010 and will need to put it to work. With a |
| consumers, and poor financial performance across | | | | return in confidence to the markets and increasing |
| industry sectors contributed to curtailed growth | | | | signs of an economic stabilization, 2010 is likely to see |
| prospects, and have some wondering what their | | | | a number of buyers enter the market with cash on |
| long-term strategy might entail. As we head into 2010, | | | | hand seeking good deals. |
| however, there are many reasons for optimism that | | | | Understand your long-term growth realities. |
| merger and acquisition activity will increase, including | | | | While the economy is expected to undergo further |
| improving economic indicators, cash heavy balance | | | | recovery in 2010, many mid-size firms are simply not |
| sheets of strategic buyers, better than expected fund | | | | going to be able to grow at the same rates |
| raising by private equity groups and increased | | | | experienced in the 2003-2008 period. Given modest |
| confidence in the private and public sectors. For | | | | growth expectations, overall business growth in the |
| potential sellers, 2010 is also an important time to | | | | next three to five years will not be significantly higher |
| consider valuation risks now versus future years due | | | | than its current state in 2010. |
| to the scheduled increase in the capital gains in 2011. | | | | Wyatt Matas & Associates projects the economy will |
| Originally signed into law in 2001, the capital gains tax | | | | grow at an average rate of less than 3.5% for the |
| rate was reduced as part of President Bush’s | | | | next 3-5 year, which will mimic the growth of most |
| Economic Growth and Tax Relief Reconciliation Act. | | | | industries. (There are, of course, exceptions to every |
| Under the reduced rate, long-term capital gains and | | | | rule.) Given this outlook, a company should consider a |
| qualified dividends were taxed at 15% for the lowest | | | | realistic growth projection as part of their calculations |
| two income tax brackets. The lowered rate was set | | | | for keeping their business or selling it now or five years |
| to expire in 2008; however, reduced rate was | | | | from now. This is especially so considering what will |
| extended in 2006 under Bush’s Tax | | | | most likely be a higher capital gains tax rate in 2011 and |
| Reconciliation Act and is scheduled to expire at the | | | | beyond. |
| end of 2010, at which time the rate will revert to the | | | | Think critically about timing. |
| 2003 rates, which were 20%. | | | | Early in 2010, the market will be more favorable to |
| Given the capital gains tax rate increase represents a | | | | sellers, who will have a range of potential buyers to |
| 33.33% higher effective tax rate, there is significant | | | | choose from. Moreover, the capital gains tax rate |
| motivation for owners and shareholders already | | | | increase puts buyers not paying all cash at a |
| considering a potential sale in the near-term to consider | | | | disadvantage, since the increased tax rate will apply to |
| action in 2010. Beyond avoiding a higher tax rate on | | | | deferred payments at the time the payment is made. |
| long-term capital gains, sellers also need to carefully | | | | Deferred payments are likely to continue into 2011 and |
| plan the timing of a potential exit in 2010 in order to | | | | beyond for non-cash buyers. Therefore, sellers are |
| secure the most attractive buyer and preserve | | | | more likely to find buyers with cash in hand earlier in |
| leverage in the negotiations of the purchase | | | | the year. |
| agreement. | | | | In addition to increased choice of buyers, owners are in |
| While owners and shareholders may be hesitant to | | | | a better negotiating position earlier in 2010. As potential |
| pursue an acquisition without greater economic | | | | buyers know that sellers have a range of options and |
| certainty, there are multiple indicators suggesting that | | | | varying deal structures to minimize tax obligations, they |
| 2010 is likely the right time to at least consider a | | | | are more likely to agree to terms favorable to the |
| potential a sale, given favorable terms. The capital | | | | seller. As 2010 progresses, the buyer will be able to |
| gains tax increase serves as motivating factor; it is by | | | | use the impending tax increase as leverage in deal |
| no means the only one. | | | | negotiations, aware the seller has significant motivation |
| The following are key points for understanding the | | | | to close before 2011. In fact, if negotiations are still |
| impact of the capital gains tax rate increase on M&A | | | | ongoing in 4Q10, buyers are likely to try and discount |
| activity in 2010: | | | | the purchase price by 1% to 5% or seek tougher |
| Consider the overall economic picture. | | | | terms in the purchase agreement, knowing the seller |
| There are signs at the corporate level that are | | | | will try and avoid paying the higher tax rate. |
| encouraging to mid-size firms considering being | | | | While not appropriate for all owners, those considering |
| acquired. Over the last three months through January | | | | a sale in the near-term future are likely to experience |
| 2010, deal flow is up 16.8% over the same period a | | | | favorable conditions 2010 as closing before year end |
| year before. Of course, last year was the one of the | | | | avoids paying higher capital gains taxes. Additionally, |
| worst years in our economic history. However, major | | | | early movement will prove advantageous for sellers |
| deals are being completed, which can cause a | | | | by yielding a greater range of potential buyers and a |
| bandwagon effect. In addition to corporate | | | | strong position in deal negotiations. Overall, 2010 is likely |
| confidence, many private equity groups with a strong | | | | to experience a significant revival in M&A activity, |
| track record continue to raise money. In 2009, the | | | | attracting a number of interested buyers to the |
| average fund size raised by private equity groups was | | | | market. |