The expected increase in capital gains is prompting some business owners, who otherwise might have remained in charge, to consider selling their businesses. And the time has come, as venture capital and private equity funds are scrambling to return to acquisition mode.
For many business owners looking to sell their business, a sale to a private equity or venture capital firm has advantages, according to Verenda Graham, national head of private equity taxation at Top 100 Firm BDO. USA.
“They see private equity as an alternative to selling to individual owners or strategic buyers, or an IPO,” she said. “They might have started out as mom and pop, but they’ve grown to a big size and want to retire. If they don’t have a younger generation to take charge of, it can be difficult to find a strategic buyer who aligns with their goals, and an IPO would be more complex. But a private equity sale involves a fairly short vesting period. This is a very viable option for an exit strategy. “
One of the considerations that preoccupies managers of private equity and venture capital funds, says Graham, is the prospect of higher taxes in the future. “And surprisingly, the potential for an increase in the digital tax on products and services is more for managers of private equity and venture capital funds than a possible increase in capital gains tax, the impact of calculating the interest expense deduction or changes in the deferred interest regulations, ”she said. . Graham cited the BDO Private Capital Pulse Survey – Spring 2021, which included the following key findings:
- Raising the taxation of digital products / services was the number one concern of managers when it comes to potential tax changes, 58.5% are concerned.
- The capital gains tax changes came second, at 50.5%.
- The impact of the interest expense deduction calculator based on EBIT (earnings before interest and taxes) versus EBITDA (earnings before interest, taxes, depreciation and amortization) is the main potential tax change for half (50%) of survey respondents.
- Tax strategy was cited as the top post-M&A challenge over the next 12 months for more than a quarter (26.5%) of PE and VC respondents.
“I think the concern of fund managers is not so much the amount of the tax as it is the uncertainty of how digital taxes work,” Graham said. “Capital gains and accrued interest are real life situations that can be planned and modeled. There is less ambiguity as to where they will land – they will either stay the same or increase. “
“The same goes for the interest shown,” she continued. “Biden has proposed eliminating the special treatment of carried interest, but we know what the impact would be. But digital taxes are worried about how they will be managed globally. With digital taxes on products and services, there is no real way to model based on current propositions. “
While waiting for the OECD to come to an agreement on digital taxation, countries in Europe have put in place their own temporary solutions because they want the revenues that the digital tax will bring, Graham observed.
“A lot of jurisdictions define digital tax in different ways,” she said. “Venture capital and venture capital funds will have to develop ways to arm themselves around something that is less certain than capital gains. They will need to look at factors such as physical presence and economic connection, especially when it comes to tech companies. This is a huge area when it comes to due diligence and its impact on exit strategies. “
The Private Capital Pulse survey interviewed 100 venture capital fund managers and 100 mid-market private equity fund managers in the United States.