With the final passage of the Tax Cuts and Jobs Act, there may be a flurry of M&A activity thanks to higher wages and greater opportunities for corporate investment.
One of the most significant changes in the act included a shift in the corporate tax rate from 35% to a flat 21%, as well as an end to the corporate alternative minimum tax. Some businesses are already using the extra money as compensation incentives for staff, but many will seek to invest in M&A activity.
Drawing upon what we know about this act, we can make a number of predictions about the world of M&A in 2018. The act offers an immediate deduction for 100% of the cost of tangible assets such as machinery, land, and property through 2022. Equally important is the fact that the Act offers the deduction even for new property acquired from another taxpayer. Businesses hoping to reduce their tax burden can capitalize on these provisions, using the extra cash to invest in middle-market companies. We predict that manufacturing, pharma, and construction will be big winners.
To benefit from the increased depreciation provision, the sale must be structured as an asset acquisition. Though sellers typically prefer this structure, it’s not always advantageous for corporate sellers. So middle-market buyers must think carefully about how to make deals more attractive given the additional depreciation benefits on the buy-side.
Corporate tax reductions may not mean as much for transactions with significant intangible value. That’s because intangible amortization (often over 15 years) affects cash flow less. Acquirers may still prefer the legal protections of an asset acquisition, but may not stand to reap as many cash benefits.
Meanwhile, buyers must consider the impact of tax changes for pass-through entities. The act offers deductions to many pass-throughs, including a deduction of up to 20% of their income. Certain pass-throughs that qualify as specified service trades or businesses, including health, law, and consulting, won’t qualify when taxable income exceeds $207,500. Non-qualifying businesses may face challenges and may need to evaluate their tax profile before moving forward.
A one-time repatriation tax of 15.5% on earnings held in cash and 8% on other earnings may also affect M&A. This money can be reinvested over several years, presenting a significant middle-market opportunity.
Taxes aren’t the only factor weighing on M&A. Expectations are also key. Deloitte’s fifth M&A Trends Report asserts that 68% of US executives and 76% of executives at PE firms say deals will increase in the next 12 months.
It’s important to consider, however, that most deals are in technology and finance. Healthcare, telecommunication, and other industries may grow, but expert predictions vary from industry to industry.
The 13th Annual M&A Outlook by Dykema also predicts strong deal volume and anticipates significant increases.
Many economists point to the bull market as a sign of a pending decline in 2019 and 2020. So businesses hoping for optimal deal structures should proceed quickly and intelligently in 2018 and 2019. It’s time to begin immediately preparing an exit strategy. Though it’s impossible to forecast the future, a growing market will not grow forever. Excessive optimism can ultimately undermine a company’s chances of selling under favorable conditions. You may have only a two-year window to sell your business.
About Kratos Capital
Trying to manage a transaction on your own is a fool’s errand. The expertise of an advisory firm can help you better understand the other side’s motivation, and then challenge this knowledge into the best possible deal. As you navigate the process, partner with an M&A advisory team that boasts expertise in your industry. Kratos Capital can help.