An Eye on the Taxman
Market watchers anticipate the planned 2010 hike in the capital gains tax could keep deal flow steady among family-owned businesses, even if the credit markets and economy continue to suffer
April 9, 2008
In early April, Morgan Construction sold itself to a division of Siemens VAI Metals Technologies after more than 120 years of being almost entirely family-run. Morgan's president Philip Morgan, the fifth consecutive first-born son to helm the business and descendant of founder Charles Hill Morgan, no doubt had a hand in the process, although he was not the only blood relative involved. Of the roughly 180 shareholders who reaped returns on the $160 million deal — counting $30 million in debt assumed by Siemens VAI — about 170 share the Morgan DNA.
This kind of collective family thinking helped catapult what started as a small construction supplies company in suburban Boston into what is now a worldwide enterprise. Back when such a move was considered a gamble, Morgan began ramping up development in China in the late 1990s. The budding company would later venture into the U.K., Brazil and India.
That same foresight might have impelled the company to sell now, even against the headwinds of a looming recession and ongoing weakness in the credit markets. The thinking behind the sale, while not implicit, surely took into consideration impending changes to the tax code in 2010, when the rate on long-term capital gains escalates to 20 percent. The current 15% tax rate had been set to expire this year, but was extended by two years when President George W. Bush signed the Tax Reconciliation Act in 2006. There's an outside chance that a last minute reprieve could come yet again, although few family-owned businesses necessarily want to take that risk if they're considering a possible sale.
“My sense is [that the capital gains tax rate was] something considered by the Morgan family,” says Paul Sperry, co-founder of Sperry, Mitchell & Co., a New York investment bank that specializes in leading privately held, and often family-run, companies through the M&A process. Sperry adds that he doesn't feel the capital gains tax was a deciding factor necessarily, but he believes it made a difference.
Some family-owned companies are even taking a shorter-term view. Amid a presidential election that's picking up steam, Brad Schwartzberg, a partner at New York law firm Davis & Gilbert, notes that some potential sellers are bracing for the event of a Democratic sweep come November, a prospect these sellers believe could launch the long-term capital gains tax rate beyond the 20% currently being targeted.
“People are looking closer to November” Sperry adds. “There will be a different tax matrix in 2009,” he says, emphasizing that should a Democrat win the presidential election, a tax hike could be among the first areas a new administration would look at. With eager sellers facing these prospects, Sperry notes "a fair number" of family-run businesses have approached his firm regarding a possible sale.
Davis & Gilbert's Schwartzberg adds that the view of an impending tax hike has even altered deal structures. He cites that sellers may shy away from earnout provisions. Alternately, buyers may pay more upfront as a way to soften the impact.
The gain represents the difference between the basis versus the net, or in other words, the initial cost versus the final purchase price, meaning companies that have been family-controlled for a number of years will likely be most affected.
In the case of Morgan, Sperry notes that given the company's century-long run in family hands, "the shareholder basis was clearly very low" — implying that the family likely saved millions by pursuing a sale now as opposed to waiting, even if the company experienced an incremental increase in valuation, which is also no sure bet in today's market.
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