How could tax reform impact the M&A market?
When it comes to the Biden Administration’s impending tax reform, the timing and ultimate details remain uncertain. One thing that we can expect is that tax changes will likely be substantial and far reaching. Of significant concern is the proposed increase in the capital gains tax rate. For high income earners1, the proposal would effectively double the capital gains rate from 20% to 39.6%.
This pending reform has significantly disrupted the deal market. There were 178% more insurance brokerage deals closed in Q4 2020 than in Q1 of 2021. The decision to close in 2020 versus 2021 by many was a hedge against the unlikely scenario that an increase later in 2021 could be effective retroactive to Jan. 1, 2021. Deal activity remains extremely high as the House and Senate work on proposals for the reconciliation bill that could be enacted this fall.
Could the effective date of an increase in the capital gains tax rate occur this year?
According to BakerHostetler, “The effective dates of the newly enacted provisions generally are expected to be Jan. 1, 2022, but certain provisions may have proposed effective dates tied to committee action or the date of enactment (for example, capital gains tax rate increases may be proposed to apply to sales occurring after the date of committee action in early October or the date of enactment of the legislation later in the fall).” As the likelihood of an increase gains clarity so will the impact on the insurance brokerage market.
How could tax reform impact the insurance brokerage market?
Expect more deals in 2021 than any other year on record. The 33% increase in the capital gains rate that occurred on 1/1/2013 caused a 122% increase in deals during 2012 versus the prior year. The proposed increase to almost double capital gains, coupled with very high valuations, has caused a substantial number of firms to come to market to evaluate a sale in this calendar year.
Best in class organic growth will no longer be optional. If your firm grows 15% a year, it will double in size in five years. If capital gains double, is your firm prepared to grow annually at double-digit rates for the next five years to have the same after-tax value that your business has today? Your firm will need to be running to stand still. If valuations decline at the same time, it may become a sprint at a rate more than 15% a year just to maintain value.
Expect buyer capacity problems as early as July. The tax change on 1/1/2013 caused many buyers to stop meeting with new potential partners as early as September of 2012. Capacity was redirected to make good on promises made to close deals under LOI by year end 2012. The capacity bottleneck could come as early as July this year, given the potential effective date of a capital gains rate increase the fall of this year combined with the sheer volume of potential sellers coming to market that want to be at the front of the queue.
While the final details and timing of tax reform remain uncertain, significant change seems inevitable. Given the substantial impact a tax change could have on deal activity, after-tax net worth, and the need to grow, now is the time to finalize your five-year strategic plan.
Five years from now looking back to today, will you be forever grateful that you planned ahead or wonder why you didn’t? Will you be proud of your decision or indecision or will you have regrets? Will you be glad you sold or glad you didn’t? With substantial change afoot, taking the time to evaluate your long-term goals and making a commitment to growth, achieving internal perpetuation or aligning with a third party has never been more important.
If you have questions about Today’s ViewPoint or would like to learn more about the potential impact of tax reform on value, please email or call John Wepler, Chairman & CEO, at 440.392.6572.
1Defined as taxpayers with adjusted gross income of more than $1 million.
Marsh, Berry & Co., Inc. and MarshBerry Capital, Inc. do not provide tax or legal advice. Tax and legal professionals should be consulted separately before making any decisions that may have tax or legal ramifications. Any references to tax implications in this presentation should not be interpreted as the provision of tax advice.
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