Looming Tax Hike Motivates Owners to Sell

The looming increase in the capital-gains tax rate next year is fueling sales of some privately-held businesses. Many business owners are looking to close deals before next year, when the tax on investment income is scheduled to rise from 15% to at least 23.8% on most capital gains.

By JOHN D. MCKINNON
Updated November 1, 2012, 5:38 p.m. ET
Wall Street Journal

A looming increase in the capital-gains tax rate next year is fueling sales of some privately-held businesses.

Many business owners—mostly founders who could gain a lot from a sale—are looking to close deals before next year, when the maximum tax on investment income is scheduled to rise from 15% currently to at least 23.8% on most capital gains, at least for higher-income households. Many sellers intend to convert their equity into retirement funds or just start anew.

"It just made more sense for me to take my chips off the table and go do something else," said Bert Wolf, 60 years old, who has an agreement to sell his compressed-gas business, Acetylene Oxygen Co. of Harlingen, Tex., before year-end.

Mr. Wolf added that if he waited until after the tax increase to sell, he would have to expand the business at the current rate "for at least 3 or 4 more years to achieve the same after-tax sales dollar." He is profiting on the sale of his business to Praxair Inc., PX +2.15% a public company.

"There's a kind of a panic on to get things done," said Beatrice Mitchell, co-founder of Sperry, Mitchell & Co. Inc., a New York investment bank that is advising Mr. Wolf on the sale.

To be sure, the weak economy has been difficult for many small-business owners across the board. The median selling price for U.S. small businesses in the quarter ended Sept. 30 was $174,000 down 8.2% from four years earlier, according to BizBuySell.com, an online small-business marketplace. The firm's findings are based on sales, reported voluntarily by business brokers and mostly of less than $1 million, in 70 major markets.

In the three quarters so far this year, 3,536 small businesses exchanged hands, down 34% from the first three quarters of 2008, when sales of small businesses were at a record high, it found.

Yet, some companies' bottom lines are in better shape now than during the recession. That has improved their valuations. Investment bankers say they believe sales of companies whose asking prices are $10 million to $250 million have been boosted for the past two years by pending increases in the capital-gains rates.

The top tax rate will go up at year-end by at least 3.8 percentage points because of a provision in President Barack Obama's health-care overhaul law. But that will be added onto a top rate that will depend on negotiations between Mr. Obama and Congress after the November election, when they are expected to seek a deal on numerous tax and spending measures.

Mr. Obama and Congress agreed in late 2010 to extend the current 15% capital-gains tax rate through this year. Absent further action, the top capital gains tax rate will rise to 20% on Jan. 1. After adding the extra charge from the health-care law for higher-income households, the maximum tax on investment income would be 23.8%. When combined with the scheduled expiration of some other tax breaks for high earners, the maximum tax on investment income would be as high as 25%.

Many Republican lawmakers want to extend the 15% rate. If they prevail, the maximum tax likely would rise to at least 18.8% because of the health-care charge.

Mr. Obama proposes to let the top capital gains tax rate rise to 20% on income above $250,000 for couples, but hold it to 15% on income below that threshold.

Republican presidential candidate Mitt Romney has said that if elected, he would seek to eliminate taxes on all investment income, including capital gains, for taxpayers with incomes below $200,000. He proposes to maintain the 15% maximum rate on income above that level. He also plans to repeal parts of the health-care law, including the investment-tax increase.

Leonard Ramirez and his wife built up their Houston-based oil drilling supply business, Drilling & Production Resources Inc., over 25 years. They sold it last year to PGI International, a manufacturer of precision parts and systems, partly to avoid the possible capital-gains increase, according to Mr. Ramirez.

The owners of IM Solutions LLC, a Dallas-based online marketing company that serves the legal industry, figured the expected tax increases in 2013 would eat up about 8.8% of the proceeds from selling their business, said company president John Emerick. That 8.8% chunk could be up to $1 million or more of his share, he said.

"It was pretty clear to us that it made more sense for us to pull the trigger early," Mr. Emerick said. "For me—I'm 49—I'm thinking I might not earn that much for the rest of my life. The earnings for the rest of my life would be equivalent to the tax I'd be paying by waiting until 2013." The owners sold the business to LeadingResponse LLC in a deal financed by Huron Capital Partners, a private-equity group, closing on the sale in July.

Generally, there are more sellers than buyers of small businesses. Investment bankers and brokers say both are being motivated by taxes to some degree. Sellers are looking at the scheduled increase in capital gains rates, and buyers are being discouraged by the overall uncertainty over tax policy.

When Congress last raised capital gains tax rates in 1986, lifting the top rate to 28% from 20%, the change triggered a wave of asset sales, including securities and companies, in the months before it took effect.

The top rate had been scheduled to rise to 20% from 15% at the end of 2010, before the White House and Congress agreed in December 2010 to extend the lower rate for two years. In the fourth quarter of 2010, there were 928 sales of companies priced between $10 million and $250 million, for instance, compared with 660 sales of companies in that range in the third quarter, and with 548 sales of companies in that range a year earlier, according to data from S&P Capital IQ.

Sales of companies in this range have stayed reasonably strong, averaging 728 per quarter since the start of 2011, according to S&P Capital IQ data. But such sales have slipped a bit this year compared with 2011, largely because of broader uncertainty about the economy as well as tax policy, investment advisers say.

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