In election years, the United States typically experiences increased macroeconomic uncertainty, impacting various sectors including Mergers and Acquisitions (M&A). This uncertainty often leads to a slowdown in M&A transaction volume in the months preceding the election, as sellers hesitate due to uncertainty about the post-election market conditions.
The upcoming 2024 election presents unique considerations compared to previous election cycles. Recent elections have seen a trend of less accurate expert predictions, contributing to a range of perspectives on potential outcomes. Depending on individual views regarding President Biden’s reelection prospects, some business owners may feel compelled to expedite their exit strategies, particularly considering the potential implications of proposed tax changes outlined in President Biden’s March 2024 budget proposal.
What Does This Mean for Business Owners?
For those not interested in reading and deciphering the 2024 budget proposal, the first draft takes aim at capital gains tax rates. This is the tax assigned to investment income, which includes the sale of a business. The budget proposal would increase the capital gains tax rate to the equivalent taxation of investment and wage income. That would mean capital gains for those earning at least $1 million would be taxed at a base rate of 39.6%, up from 20%. When you combine this with the proposed increase to the Medicare tax (which would increase from 3.8% to 5.0%), that equates to a total 44.6% federal rate on the sale of a business (up from 23.8% assuming today’s capital gains and Medicare rate).
In summary, if the budget proposal were to pass and the tax increases were to come to fruition, business owners would be looking at a tax rate that is 21% higher than the current tax rate. For every $1 million of realized capital gains, today’s rate would imply an owned tax of $238,000. Under President Biden’s newly proposed plan, that same $1 million would imply an owed tax of $446,000. That equates to $208,000 more per $1 million of business value simply based on timing your sale (pre or post-tax reform).
The good news is that the buyer community seems to have come roaring back in early 2024. There is ample capital for buyers to spend (private equity reserves and strategics), interest rates have stabilized (and many expect a decrease), the economic outlook isn’t nearly as bleak as it was a year ago, and lenders (both bank and non-bank) seem willing to play ball.
Given these conditions, we are generally advising our clients to accelerate their timelines if they’re at all interested in selling their business in the next one-to-two years. While this contrasts with normal election-year business seller behavior, we view the reward as greater than the risk. It will be difficult for many to “outrun” these tax increases (if successfully implemented) with underlying business valuation increases (e.g. earnings increases) unless a business is in a truly transformative and hyper-growth phase.
