By the Smith Barney Division of Citigroup Global Markets Inc.
Courtesy of Lori Frymark, Financial Advisor, CitiSmithBarney
You had a well-defined plan for exiting your business. You knew how, you knew when, and you knew for how much. But, if you’re like most business owners, you might be wondering how changes in the economy and the business environment might affect the timing of your plans to retire or otherwise exit your business.
How the Economy Factors in:
Buy low, sell high. Every owner wants to sell all or part of their business at the top of the market. And certainly, the market for businesses is cyclical, with its health aided by a growing economy, affordable capital for acquisition financing, and optimism and competition among buyers. With the slumping economy at the forefront of today’s news, business owners are now asking, “How will this environment affect the market for my business?” A look at the past, going back 30 years and several business cycles, gives us an idea of what we can expect for business sales when the economy falters.
It is no surprise that, in years of poor economic growth or decline, the number of mergers and acquisitions did in fact drop. And true to form, M&A activity is likely to decline again as the economy softens. But perhaps the more interesting message that history provides is that a new (higher) level of sustained M&A activity is noticeable in the past decade. In fact, 1995 looks to be the line of demarcation, after which M&A activity expanded dramatically and remained relatively high (from a historical perspective), even in weak business environments. Although there will be annual variances, elevated levels of M&A activity appear to be based on accepted business practices that are here to stay.
In addition to economic malaise, business owners are concerned with possible tax rate increases, specifically the capital gains rate. A capital gains tax is charged on the profit realized on the sale of an asset, including a privately owned business. The 2003 Tax Act reduced the maximum capital gains tax rate from 20% to 15% for long-term capital gains (investments owned for at least 12 months) , creating an exceptional tax-saving opportunity for business owners looking to sell, given that the rate had not been below 20% in the past 60 years. The five-percentage point reduction was not a permanent change, however. Originally set to expire in December 2008, President Bush extended the lower rate.
Although the lower rate is now not due to expire until 2010, the change in the White House may raise the issue sooner. With an administration change in January 2009, the capital gains rate debate is expected to surface again. Senator Obama had said he would raise the long-term capital gains rate to 25%-28% for families making more than $250,000; Senator McCain stated he wanted to keep the rate at its current 15% level , but admitted a Democrat-controlled congress could force a rate hike. Either scenario makes today’s capital gains tax rate probably the lowest we’ll see for decades to come.
Personal Factors Take Priority:
The decision to sell a business is not primarily tax or economy driven. While owners sometimes look to maximize value during an attractive M&A cycle or capitalize on a consolidation trend in their industry, most private business sales are motivated by personal factors. These can include a wish to retire, advancing age, declining health, a desire to reduce the personal risk associated with a large concentration of wealth in one asset, or the realization that family members are not interested in taking over the business. While external factors can certainly affect the outcome of a business sale (including the price and terms of the transaction), they usually are not the driving force.
Regardless of your exit motivation, it is never too soon to start preparing for a transition. In fact, savvy business owners begin to prepare for their transitions early – often years in advance of a transaction. Some of the initiatives that owners undertake to get ready for a future transition include setting up family trusts that can help minimize estate and gift taxes on the eventual sale proceeds, compiling proper (preferably audited) financial records on the business, and preparing business plans and detailed documentation about how the business operates.
Planning for a transition can seem overwhelming, but business owners are not expected to do it alone. Tax, legal, investment banking, and financial planning experts can each play a critical role in preparing an owner for an eventual transaction. Such experts can guide you through the planning process, and help identify and implement the most effective strategies to optimize value.
For a more in-depth look at timing your transition, including a detailed list of steps that business owners can take to prepare for a future transaction, contact us and request the Citi Capital Strategies whitepaper entitled Timing Your Business Exit in a Changing Market.
 www.heritage.org “Make the Dividend and Capital Gains Tax Rate Permanent to Keep the Economy Going”, Feb. 2006
 Department of the Treasury, Office of Tax Analysis, “Historical Capital Gains and Taxes”, Nov. 2004 via www.taxpolicycenter.org
 www.fairmark.com “Conferees Finally Agree on Tax Legislation”, May 2006
 The Wall Street Journal Online, 6/19/2008: Your Tax Bill: How McCain, Obama Differ
[Disclosure that must be included if published within the state of California: This article is based, in whole or in part, on information provided by the Wealth Management Department of Citi Smith Barney.]
Smith Barney does not provide tax or legal advice, and it is important to consult with a tax or legal advisor before investing.
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