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Why Wealthy Won't Sell Out to Avoid Fiscal Cliff

Congressional Budget Director Elmendorf Testifies During Joint Deficit Reduction Committee Hearing
Andrew Harrer | Bloomberg | Getty Images
Congressional Budget Director Elmendorf Testifies During Joint Deficit Reduction Committee Hearing

Private bankers say the prospect of expiring U.S. tax cuts makes 2012 an opportune time for wealthy families to sell their businesses. But a host of obstacles will likely prevent a flood of deals.

Wealth managers to the rich are telling clients who are considering selling a family business, they'd better act fast. Capital gains taxes will rise to as high as 25 percent from 15 percent if Congress does not extend cuts set to expire December 31. The cuts were enacted under President George W. Bush in 2001.

Some people earning more than $200,000 a year also face a 3.8 percent Medicare surcharge on investment income.

As a further incentive to sell, companies and private-equity buyers have piles of cash and financing for deals is widely available, investment bankers say, driving valuations for some sectors to their highest since 2008.

But owners starting the sales process now may find there is not enough time. Others may choose to keep businesses in the family for personal reasons that outweigh the possibility of a bigger tax bill later.

"The vast majority of companies are deciding they're not going to sell," said Cascadia Capital LLC managing director Christian Schiller, who advises family-owned companies for the Seattle investment bank. "Family companies are driven by a number of legacy issues, and taxes are one of the smallest."

Even so, some wealth advisers, who benefit from sales that generate windfalls of cash to invest, are warning clients about the perils of waiting.

Northern Trust Co, one of largest providers of estate and investment advice to multi-millionaires, says a family selling a $70 million business on December 31 would pay $10.5 million in gains taxes. On January 1, that tax bill could jump to as much as $20.2 million.

"That's real money," said Mary Ann Sisco, head of client solutions at Northern Trust's wealth management division.

OBSTACLES

The biggest obstacle to getting a business sold by the end of the year: time. Examining the books of a business for sale and drumming up cash can take prospective buyers six months.

"Unless you're already on the sales block, you're probably out of luck," said Holly Isdale, a former Lehman Brothers and Bessemer Trust adviser who formed Wealthaven LLC in 2010 to counsel ultra-rich families on estate and tax planning.

Many non-financial issues can also scuttle deals. Parents and grandparents, for example, may become emotionally invested in a company and see their business as a legacy they want to pass on to heirs.

"People say 'I've given my life to this company. How can I put a dollar sign on it?'," said Dennis Jaffe, a professor at Saybrook University in San Francisco.

Jaffe, who also runs a consulting business that advises wealthy families, said many families struggle with cutting ties. In some cases, families inflate their asking price, deterring serious buyers.

There are external factors, too. Choppy markets, continuing weakness in the U.S. economy and other storm clouds may derail deals. Robert W. Baird investment banker Howard Lanser said worries about Europe's debt crisis last month briefly put some deals on hold.

What's more, valuations for smaller companies -- those under $100 million -- or those in more cyclical businesses, have not yet fully recovered. Owners in these cases are more inclined to hold on, bankers said.

Some owners will conclude they will be better off keeping their business as a vehicle for building new wealth as well as generating income.

"There's a back-to-basics movement in wealth management," said Mindy Rosenthal, a managing director of Campden Wealth, a global ultra-rich family networking group. "You're not going to create or re-create your wealth by playing the markets."

Private companies have been more attractive as investments while stocks are volatile and yields are thin, she said.

But, there's "no clear consensus on what families will do," said Bryant Seaman, head of Bessemer Trust's private asset advisory group. "There are also questions about whether the Bush tax cuts will be extended."

On July 9, President Barack Obama proposed maintaining the reduced tax rates one more year for families earning less than $250,000 a year. Tax cuts for wealthy families would expire.

Democrats in the Senate on Wednesday won passage of a bill that renewed tax cuts for most Americans, while letting rates rise for the wealthiest, but the vote was considered symbolic because the legislation is expected to be rejected by the Republican-controlled House of Representatives.

Republicans, who hope to take the White House this November, support extending tax cuts for wealthy taxpayers as well.

Two years ago, just weeks before the Bush tax package was originally set to expire, Obama extended the cuts.

DEAL ACTIVITY

Despite the obstacles, bankers and wealth advisers say families are heeding their warnings about higher taxes. Bankers say they saw a spike in business owners engaging their services in April and May.

But many families are moving slowly. As a result, deals may come at the end of the year,, bankers said, echoing what happened in 2010 when the Bush tax package was first expected to expire.

Excluding sales by private equity firms or divestitures, there were $54 billion of private company deals in the first half of this year, down 3.6 percent from the same period last year, according to research firm Dealogic and Baird. However, the number of these deals rose 17 percent to 3,236 in the first half, the data showed.

Many families may compromise and decide to play it halfway by selling a minority stake of their company to private-equity investment firms. Such partial sales would let families realize gains at low tax rates and, in some cases, continue to operate the business.

Family companies can be attractive to such firms because they tend to have little debt.

"There's tremendous interest from private equity," said Steve Burt, head of the merger advisory business at Duff & Phelps, which specializes in deals up to $500 million. "I'd love to be in the wealth management business at the end of this year: there's going to be a lot of liquidity to manage."

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