All indications are that changes to the tax code are coming. These are needed to fund the sharp uptick in government spending and are generally favored by Democrats, who now control the White House as well as both houses of Congress, albeit tenuously in the case of the Senate.

According to an overview of the proposed changes by the American Enterprise Institute, a Washington think tank, President Biden's plan would tax capital gains and dividends as ordinary income for taxpayers who report $1 million or more. This means that capital gains for high income earners will bump up to 39.6%, the highest tax bracket under the proposal. Currently, capital gains are taxed at up to 20%, so this increase would roughly double the current rate.

So let's say you're selling your business for $10 million and are expecting $9 million at close with the remainder going into a seller note. Assuming $8 million in capital gains from the sale and no state capital gains tax, you'd take home $6.4 million under the current tax code and around $4.8 million under the proposed plan.

Here's a cleaner example assuming a $10 million valuation, all of which is capital gains and all of which would be paid at closing. Assuming the tax proposal is implemented, you would need to increase your company's valuation to over $13 million to receive as much from the transaction as you would under the current tax regime.

These changes to the tax code could be implemented retroactively, meaning that they would apply to the 2021 tax year, but the general consensus is that this is unlikely. However, if inquiries to financial advisors are any indication, there is a good chance that there will be changes to the tax code that will take place in 2022 — even if these changes are moderated as the proposals work their way through the legislative process.

Worth thinking about if you are considering the sale of your business.

  • Robert Knauer

By Lindsey Rust

What role do skill and luck play in our failures or successes? Skill, defined as the ability to apply knowledge readily in execution or performance, can be improved through diligent practice, increasing chances of a desired outcome. On the other hand, luck is unpredictable and brought by chance. As described by Michael Mauboussin in what he calls the "paradox of skill," when the outcome of an activity combines skill and luck, as skill improves, luck becomes more important in shaping results.

All outcomes in our lives can be placed on a spectrum from pure luck to pure skill. Thinking of results as the sum of a draw from a distribution of skill and a draw from a distribution of luck, statistical theorem can be used to show that:

Variance(skill) + Variance(luck) = Variance(result)

In many areas, absolute skill has been improving, but the variance of skill has been shrinking. As an example, take the sport of marathon running. Compared to 1932, marathon runners today have access to better nutrition advice, scientifically-based training plans, and coaching, which has resulted in faster average times. This improvement in skill can be seen in Olympic gold medal times, as the gold medal men's marathon time in the 2012 Olympics was 23.5 minutes faster than the gold medal time from 1932. However, the difference between the 1st and 20th place times was 39 minutes in 1932 and only 7 minutes in 2012. As the variance in skill decreases and the variance in luck remains stable, luck is playing a growing role in determining winners and losers.

The same can be seen in the world of investing. As the absolute skill level of most investors grows over time, the relative difference in their skillset becomes narrower. As investors with similar skills compete against each other, luck often triumphs.

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By Deven Desai

You may be thinking: Why should I sell my company when I have grown and built it from the ground up with years or decades of dedication and intense effort? The fact is that if money is the primary object and you have a business that is generating a lot of cash, you'd probably be better off not selling. That said, there are certainly situations and changes in life circumstances that present good reasons to sell your business. Here are a few of them:

  • Retirement — At a certain point in life, you may think about retirement and taking on a relaxing lifestyle. In order to retire comfortably, you might put your company up for sale to earn a large chunk of cash at once that you can use to relocate or fund other retirement activities like travel. In addition, the release of stress and responsibility from running a business would allow you to truly enjoy the rest of your life. Spending time with family and friends or pursuing passions can be even more rewarding than running a business.

  • New Opportunity — As the world is constantly changing and there are so many new problems arising, you may realize that you want to pursue a solution to a different issue. Instead of completely changing your current company, you may decide to sell your current business and start a new one from the ground up. Some entrepreneurs enjoy moving from business to business and the excitement of pursuing different ideas instead of sticking to one company. Building and selling business after business can be quite profitable as well.

  • De-risking — There are high risks that come with running a business because of the ever changing political, economic, and cultural climates. An economic crash or change in industry regulation could seriously impact a business and cause it to go bankrupt in the worst case scenario. Consequently, if you are averse to risk, you may decide to sell your business when it is strong and still growing to exit and earn a solid valuation. You can then invest your profits in mutual funds to further de-risk and watch your money grow over time without the relative uncertainty that comes with running a business.

  • Industry Strength — The industry your business operates in might be attracting a lot of M&A activity with high EBITDA multiples. For example, during the depths of the pandemic, healthcare software and telehealth M&A activity was quite strong because of the focus on more contactless options to receive healthcare. As a result, many businesses within the healthcare software industry had good exit opportunities because they could command high valuations based solely on industry strength. Being in an industry that is booming due to current events and changing cultural/societal trends can influence you to put your business up for sale and try to maximize their profits while the timing is right.

  • Burnout — Running a business can be an extremely draining process, both mentally and physically. You may decide to sell your businesses to relieve yourself of stress, anxiety, fear, and other negative emotions. Stepping outside of an operational role and enjoying the big payout from selling a business allows you to enjoy life and take some time before finding another endeavor to pursue.

For perspective, the below chart shows the reasons why owners of business worth $5 - $50 million have decided to sell. (The information is pre-pandemic).

Everett, Pepperdine University — 2020 Private Capital Markets Report, page 80

While there are many reasons to consider selling a business, you should also be mindful of selling a business too soon or for the wrong reasons. You should also not sell your business too soon to earn some money when you believe in the long term growth potential of your company; in an extreme example, Snapchat’s Evan Spiegel refused a $3 billion dollar from Facebook because he believed in his company, and this paid off when Snapchat later filed for an IPO. In addition, if you enjoy running your business and being your own boss, you should continue to run it.

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