While COVID-19 may have negatively impacted many businesses last year, others are ramping up for growth in a big way. And, according to Hanny Akl, “It just seems like the way to grow these days is through M&A.”
Mergers, acquisitions and transaction activity is booming. Business valuations are high, potential tax changes are coming and businesses that have withstood the pandemic are stronger for it. But if you’re a business owner considering an M&A deal in today’s environment, what do you need to know?
In this episode of The Wrap, Hanny Akl, CPA, CFE, CEPA, CVGA and David LeGrand, CPA join our hosts to give business owners the commentary they need to make informed decisions about what their business is worth, where it stands ahead of tax changes and what the future may hold with a transaction.
After listening to this episode, you’ll:
Commentator: (00:00:00) Hey, I’m Paul Perry. I’m Kim Hartsock. And you’re listening to The Wrap, a Warren Averett podcast for businesses designed to help you access vital business information and trends when you need it. So you can listen, learn, and then get on with your day. Now let’s get down to business.
Paul Perry: (00:00:22) Hey, Kim.
Kim Hartsock: (00:00:23) Hey, Paul.
Paul Perry: (00:00:25) And hello to everybody else that is listening to this podcast. Welcome to The Wrap and right now, Kim and I are going to kick off our new season with a special edition. Our first episode of 2021. This is exciting, Kim.
Kim Hartsock: (00:00:36) It is. And for our new listeners, we typically have these special editions whenever we have a hot topic that is timely and really relevant.
Paul Perry: (00:00:45) Yeah. And we are just super excited about this upcoming season. So a lot of good topics, a lot of good guests coming up in our upcoming episodes, everything from data breaches and security, which, you know, is my favorite, some tax updates, and then just trends that business leaders will not want to miss out on.
Kim Hartsock: (00:01:00) Yeah. Today we’re talking current trends with M&A and tax updates with our friends, Hanny Akl and Dave LeGrand. Welcome guys.
Hanny Akl and Dave LeGrand: (00:01:08) Hey, thanks for having us. I appreciate it. Thanks for having us on here.
Kim Hartsock and Paul Perry: (00:01:12) Glad to have you here.
Hanny Akl: (00:01:13) Yeah, absolutely. This is Hanny. I lead the transaction and advisory practice for our firm. I’m here in Birmingham and we focus on both buy-side and sell-side activity.
Dave LeGrand: (00:01:22) And I’m Dave LeGrand. I am a member in our tax and transaction advisory practices here at the firm. I sit in our Birmingham office and we do a lot of tax work on the M&A side of things.
Paul Perry: (00:01:34) Hey, Kim. Is Hanny our first, like three time, comeback guest? Is he the fourth? Is this number four for you?
Hanny Akl: (00:01:41) No idea. I don’t know. I was trying to think about the times we’ve done it, but I couldn’t remember.
Kim Hartsock: (00:01:49) I think he gets the award for The Wrap’s most frequent guest, for sure. But we’re glad to have you back, Hanny.
Hanny Akl: (00:01:54) Hey, thanks for having me. I, I enjoy doing these with you guys.
Kim Hartsock: (00:01:58) Yeah, and, um, I’m really interested in this topic today. I know many of our listeners are. I was reading, um, last week, this statistic that they interviewed corporate executives and more than 50% of them said they plan to spend more in M&A in 2021 than in years before. And we know that companies have been spending a lot in the most recent years.
Hanny Akl: (00:02:21) Yeah, absolutely. It’s, it’s been quite an interesting time. I think I’ve overused the word fascinating, uh, over the last year, just since the pandemic hit and all the way through today. Uh, but you’re right. I mean, it just seems like the way to grow these days is through M&A. And so even before the pandemic, things were hot as everybody knew. Private equity groups are raising capital and then of course, the pandemic hit. There was a little low right about March and April of 2020. Uh, everybody was trying to just kind of see and hold their breaths. Uh, hopefully this thing would pass by and things would get back to normal.
Uh, unfortunately, it took probably until about Summer of 2020 before things started to pick back up. Now we were always doing M&A deal but they got a little bit smaller from about March to Summer. And then from the summer onward, things just began building steam. And what was interesting about it is that normally an election year creates a pause in the marketplace.
Hanny Akl: (00:03:20) So that plus the pandemic, everybody was thinking, you know, recessions ahead of us are going to occur. And, uh, quite the opposite has been happening here lately. To start the year has been, been quite interesting as well. Because, you know, almost on January 1st, you know, our phones started to ring off the hook. Certainly towards the end of the year, we were working on deals that, you know, people were trying to get ahead of the tax law changes that potentially would occur. And obviously we’ll talk about that a little bit later this call, but, it was interesting that those deals that weren’t going to get done. It was clear that they wouldn’t get done by the end of the year and we moved into, you know, first quarter of 2021. And then, you know, the bottom fell out.
Hanny Akl: (00:04:00) And so everybody is trying to get into some deal activity right now is what it feels like. In all industries, a lot of consolidation seems to be occurring. So it’s, like I said before, quite a fascinating time to be part of an M&A group.
David Legrand: (00:04:17) Yeah, and we’re seeing the same thing on the tax side. I mean, there’s a lot more M&A activity due to the extraordinarily dynamic tax environment that we’re in right now. I mean, so for example, we had 31 years that went by between the big tax package in 1986 and then the tax cuts and jobs acts in 2017. Since then, we’ve had the CARES act last March. We had COVID two last December and we’ve got the American Rescue Plan, that’s going on right now, that just passed the house and is in the Senate. And we’re anticipating a pretty large tax package coming up later in the year that we’re watching very closely. We’re just really in a period of potentially rising tax rates, which will really change the way we structure and plan transactions. So, we’re watching it all closely. And we’re going to go over some of those points today.
Paul Perry: (00:04:57) That’s interesting cause I would have expected the pandemic and coronavirus to slow down the volume and size of transactions. That doesn’t seem to be the case. It seems to be very positive, not negative. And I would imagine that cares act and the PPP funds that were received by companies had something to do with that. Is that correct?
Hanny Akl: (00:05:13) Yeah. Well, there’s a lot of businesses out there that were negatively impacted and certainly our hearts go out to those business owners and families. Political views aside, I do believe that the deals that I’ve participated in and seen, that there definitely has been a positive impact from that those PPP funds. So, you know, it helped buy some time for these business owners to revamp their operations and activities. It certainly allowed them to hold onto employees that they otherwise would have had to let go, just as part of their cashflow minimization efforts. And so definitely, we saw that the PPP funds were a positive impact to these businesses and helped them get through kind of the tough time there that I described.
Kim Hartsock: (00:05:57) So, yeah, not to go way off subject here, but is there any impact on a deal when PPP funds were received by a company?
David Legrand: (00:06:08) Yeah. Sure. So we’ve seen this kind of dealt with in one of two ways. Most often what we see happen is a buyer and seller kind of agreed to escrow the funds that were received in the PPP loan. And then if the loan is forgiven through the SBA process, then the funds are released back to the sellers and if forgiveness is not achieved, for whatever reason, then the funds go back to the buyer. And when we see this take shape in an M&A deal is particularly if we’re on sell side, we really like for the sell side to maintain control of the process. That way, they’re in control of the process because it’s their deal money that they’re playing with. If buy side is in charge of the process post-close, then what we find is they’re obviously less motivated because they’re playing with deal money and they can just treat it as debt if it doesn’t work out. So, that’s the way we usually see this work, you know, nine times out of 10, Every once in a while we’ll be working on a deal and for whatever reason, buy side will be worried about the PR or what the optics might be in play with with getting PPP loans, with everything going on in the press. So they’ll just say: “We don’t want a PPP loan. You can either get it forgiven before we close, or we’re just going to treat this as debt and net it out of your closing wire.” And when we see that happen, what we find is that sell side, if they’re going to concede that deal point, they’ll say, “Okay, well, if I’m going to give you that, then you know, I’d like more in X, Y, and Z” and whatever else they’re negotiating. So we try to use that to leverage and get them something else if they’re going to end up conceding on that point.
Hanny Akl: (00:07:31) I think stressing the point about trying to get forgiveness before doing a deal. Obviously, you can’t time it, right? So, it’s a little bit tougher. But if you can get that forgiveness, it certainly takes one deal point off the table because I mean, a buyer, to some degree, may not be as motivated to get the forgiveness. If they end up putting it in escrow, you know, they’re not as motivated to get that forgiveness as the seller. And so it’s just something to keep in mind, as you think about a transaction going forward.
Paul Perry: (00:07:54) So, Hanny, I imagine that’s got to play differently with your valuations. What are you guys seeing right now as it relates to valuations with these deals?
Hanny Akl: (00:08:03) Right. Quite an interesting time, as I said before. When a demand is high and supply is low, which is pretty much what we’re seeing in the marketplace, there’s just not enough. deal volume out there for the amount of capital that needs to be deployed. So the valuations are obviously going up. Uh, we would have thought, you know, record highs in the year before. Uh, but we’re still seeing some very, very high price deals coming across our desk. And so what does that mean if you’re a seller? Uh, it’s, it’s very, very attractive. If you’re a buyer, people are still competing at these higher prices and figuring out how to make these deals work. So it has been an interesting time to see these valuations go up. And then as a seller, I mean, if you made it through the recession, this is kind of mindset that we’re hearing and seeing. If you made it through the pandemic and I know we’re still kind of in the middle of it, but if you made it through and your business was positively impacted, you’re feeling like your pandemic resistant at this point, or recession resistant. So, you know, if you thought you were a five or six times business before the pandemic, now you’re thinking you’re a seven, eight, or nine times business. And because there’s so much demand for deal flow, prices go up in an auction situation. So, to answer your question, in short, valuations are much higher today than they were.
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Kim Hartsock: (00:09:50) Yeah, it’s definitely fascinating to watch. And it just seems like there’s so much capital that was raised by these private equity groups before the pandemic that have to deploy the capital or give it back, which we know they don’t want to do. They’re just competing, and prices are going up. So, you know, more and more businesses are coming to the market and trying to get ahead of these tax laws that we’re trying to talk about because we know they’re coming. Plus, you have interest rates that are so low. Yeah, it definitely seems like it’s just the perfect storm.
Paul Perry: (00:10:24) So, Dave, I understand you did a discussion for the M&A South conference this week. Uh, I’m sure it was very interesting discussion for PE firms. But if I’m a business owner, what did y’all talk about and what do I need to know?
Dave LeGrand: (00:10:33) Yeah. So I think if you’re a business owner right now, you really have to keep a close eye on this tax package, as it develops, because I think it could be very, very significant. I mean, first off, the notion of taking capital gains up to ordinary rates. So you’d be going from 20% to 39.6%. Uh, this tax law change would be very, very dramatic and it’d be a real earthquake and kind of how M&A gets taxed, particularly on the sell side. So, you know, to put that in perspective right now, we’re at 20%. If we went up to 39%, you’re talking about doubling the capital gains rate. So it’d be really, really significant. And a lot of the structuring and planning that we do on sell side right now has a lot to do with looking at purchase price, allocations, and other structures, so that we can try to move dollars from ordinary gain to capital gain. We’re playing with that rate arbitrage of about 17%. It’s at 37% for ordinary and 20% for capital gains rate. So if that whole notion goes away and rates are basically the same and that rate arbitrage evaporates, we really will have lost one of our tools in our tool belts in respects to planning. So we’ll be thinking about how we do things a little bit differently if this law were to come to pass. You know, one upside here for sell side might be that Section 1202: Qualified Small Business Stock Structures or Opportunities Zone Planning may become much, much more powerful if capital gain rates really, really go up. Those are a couple of areas in the tax law that will enable taxpayers to either defer, or even completely exclude, some capital gains from their taxable income. So that could become a lot more powerful in a post-tax law change environment that we may be looking at with these higher rates. So, we’re watching that very closely. The second thing that I would point out is the idea that this the corporate tax rate may go from 21% back up to 28%. It was at 34%, it went down to 21%. Now we may be going back up. And if that were to become law, we would see corporate structures post-close would be less efficient to operate from a tax perspective. The other thing we would see, if we’re on buy side, if we’re structuring our transaction in an asset sale context to try to achieve tax amortizable goodwill and achieve that “step up”, as we call it in M&A tax. In a higher rate environment, those deductions and that balance sheet that’s more favorable to the buy-side would be a lot more valuable in a higher rate tax environment. So that would be another area that we would look at if this were to become law later this year.
Kim Hartsock: (00:12:54) What if I’m an investor? I mean, is there something different that you’d think about?
Dave LeGrand: (00:13:00) If you’re an investor, the biggest thing would be watching those capital gains rates to see if they’re going to really go up as much as we think that they might. Based on the literature in the tax community that we’re seeing, the campaign websites from last year’s election, everything that’s out there is pointing towards this potentially really being in this package. So we’re watching that very closely. The other thing I would point out is carried interest and this is an area of the tax law that’s kind of under constant threat with various mediums and with the legislative branch. But it’s basically the idea that if certain metrics are met in a private equity or a real estate context, that these pieces of income that’s allocated to selected owners and typically a partnership context, can be taxed at the current preferential capital gains rates instead of being an ordinary rates. And there’s, there’s an idea out there that this could go away as well with this new package that could be taking shape later in the year.
Paul Perry: (00:13:52) All right. I heard you say something, Dave, and I want to be very clear. So right now, if the holding period is met, which is what you’re talking about, preferential capital gains treatment is available?
Dave LeGrand: (00:14:02) That’s right under current law. If a three-year hold is met, then these promotes, or these carried interests, can be taxed at preferential capital gains rates. So, there’s an idea out there that could be in this package that could take that benefit away.
Paul Perry: (00:14:21) Dave, is there an example that you can walk through for our listeners to try and wrap their heads around?
Dave LeGrand: (00:14:23) Yeah. Sure. So, uh, for example, say you have a $10 million able to accompany and you’re going to trade at a 10 X multiple. So you’re talking about a hundred million dollar enterprise value. Let’s say you’ve got an asset sale, that’s all good will and it’s all capital gain, and you got 15 million of basis. So. you’re talking about an $85 million gain that you’re going to tax at today’s tax rates at 20%. You’re talking about $17 million of tax. If you go up to 39.6% for that rate, then you’re talking about $34 million of tax. So your after-tax net cash take-home money in that particular scenario would go from $83 million down to $66 million. So you’re down about 17 million bucks if these rates go up this much. And again, all this is to say, this is the federal tax – we’re not talking about any applicable state taxes or net working capital adjustments or any of those things. This is just to to drive home the point of what this capital gains rate tax hike could possibly mean to your take-home money. We did some math to try to see how this would impact the negotiations and the economics as people are structuring these deals if these proposed rules were to become tax law. We came up with a multiple about 12.75, so you’d have to sell for 127 and a half million instead of a hundred to get the same net take-home pay. So if you’re talking about a 27% or 28% increase in your enterprise value to get to the same place to give you an idea of how tax inefficient this would be as compared to today.
Kim Hartsock: (00:15:53) That’s, that’s really an incredible job. So when will we know that these changes will be effective and what they finally are?
Dave LeGrand: (00:16:01) Yeah. So we’re watching this package, it’s probably going to develop later in the year, maybe summer or fall. There’s a couple of different ways we think it could go. And again, nobody’s seen a bill yet, so we really want to see what happens when they start arguing in ways and means, and in the Senate Finance Committee. But what, where we really think this could go is one of three ways. Number one, it could be retroactive to January 1st, 2021, so applicable to 2021 tax years and forward. Number two, they could split the year and they could say this is going to be effective at the date of the enactment. If they, if they pass a law and it’s signed into law at some point before December 31st. The third possibility is they could make it effective January 1st, 2022.
So it’d be effective for tax years 2022 and forward.
Paul Perry: (00:16:41) So how does a business owner protect themselves? I mean like what, what type of tax planning is going to be necessary based on all of this discussion with the potential change?
Hanny Akl: (00:16:53) Yeah, it’s a good question, Paul. I guess from our perspective, if you were considering an exit in the next two or three or even four years, it makes a lot of sense to think about that now just given the points that Dave was just making,
Dave LeGrand: (00:17:10) I was saying it’s really, if you’re thinking about in a couple of years, taking a good look at 21 and getting signed up with an advisor soon and starting to kind of think through what it would look like would be a good idea to see if you can stay ahead of some of this. It really could alter the economics of your deal as we indicated in that earlier example. I think if you’re on buy-side, the potential for higher rates could really make your opening tax basis balance sheet on your newly acquired entity more valuable. If you have these additional deductions that we can try to structure and plan for. So I think that’s something else to keep in mind. Um, and so we really like to just kind of run models for clients, you know. What if we structured it this way or that way, or allocated our purchase price this way or that way to see if we can get the best answer for everybody as we kind of structure and plan things with clients as we move on.
Kim Hartsock: (00:17:53) Yeah. I mean, I think it’s always a pretty good practice to keep it on your market evaluation, but especially in this current environment. So really the best way to do that is to ask the market what you’re worth. Right?
Hanny Akl: (00:18:09) Yeah, absolutely. We always advocate that and obviously you can call any CPA that does valuations and try to get a formal evaluation. You know, in our minds you could just as easily go to an investment banker or a private equity group that are focused on your space in particular. So they’re specialized in your area. They know all the nuances of what your business interacts with. And so just kind of poking around and asking some questions, you could get a pretty quick and dirty range as far as what your business is worth or many of those groups will give you a true value for your business. Uh, and you can choose if you want to transact or not. It doesn’t mean you’re for sale. It absolutely doesn’t mean that, it’s obviously very confidential. Everybody understands confidentiality and the M&A world. And so like we said, it’s just good practice to think about what your value is. And then once you get that number, you can then run the models that Dave was just alluding to and see what kind of tax impact you’re going to have in the current law or the future law. As far as what we’re thinking, it’s going to look like.
Paul Perry: (00:19:11) So you’ve given us some best practices. What else should a business owner do exactly at this point, if they’re contemplating moving forward with M&A transaction on either side?
Hanny Akl: (00:19:25) I know it sounds cliché, but from my perspective, I think it’s about surrounding yourself with the right team and the right advisors. And so in this case we do M&A transactions day in and day out and we can be helpful. Obviously, you know, bringing in an attorney as well, that does transactions would be helpful too. Uh, like we said, there’s bankers and other things, so rounding out the team. So from my perspective, I would say building your team and starting to ask these questions and poking around what makes sense to do is certainly the best next step.
Dave LeGrand: (00:19:55) I think on the tax side, you know, running some models to look at different structures and different ways that you could transact and how you could sell your business, whether it’s an asset sale or equity sale, or how the purchase price allocation would flow… It’s always a good idea to get a general idea of what your net after tax cash might be if you did elect to transact.
Kim Hartsock: (00:20:11) Well, this has been great. Lots of great information that we’ve discussed and Hanny, since you’ve been here so many times that here on The Wrap, we like to wrap it up in sixty seconds or less. So what are some of the key takeaways you want to leave listeners with today?
Hanny Akl: (00:20:25) From my perspective, the number one thing I’d love for a business owner to take away is to figure out what the value of your business is. I think, you know, get to that number and get to a good number. I think there’s a lot of ways to get some valuations for your business. But I think the best way is to ask the market. From that perspective, you need to be asking investment bankers or private equity groups or folks that are doing M&A in your industry. I think that’s the best way to kind of get to that number and then running those models.
So that’s what I would leave you guys with.
Dave LeGrand: (00:21:03) And I think on the tax side, the key pieces of the potential legislation that we’re watching are those capital gains rates. Uh, the corporate rates, the potential to change the way carried interests are taxed., and then obviously the effective date of the package as it comes through Congress. Again, our firm’s going to be watching this very, very closely. We’re going to have lots of content out through various mediums. It, it may be articles or webinars or podcasts or LinkedIn posts, but we’re going to be watching this very closely as this legislation takes shape.
Kim Hartsock: (00:21:32) Thank you guys for being here today. This has been really great, and we always love hearing from you and thanks so much for sharing your time with us today.
Hanny Akl and Dave LeGrand: (00:21:39) Thank you guys for having us. We enjoyed it. We appreciate it. Thanks again.
Commentator: (00:21:42) And that’s a wrap. If you’re enjoying the podcast, please leave a review on your streaming platform to check out more episodes, subscribe to the podcast here, or make a suggestion of other topics you want to hear.
Visit us at warrenaverett.com/thewrap .
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