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Writer's picture: Robert KnauerRobert Knauer

Chair Powell answers reporters' questions at the FOMC press conference on May 3, 2023. Federal Reserve Photo, Public Domain.


In his memo "Sea Change," Howard Marks argues that the investment world may be experiencing the third major sea change of the last 50 years. Reflecting on his long investment career, he cites the first sea change occurred in the early 1970s when the Bretton Woods system collapsed and the world moved to a floating exchange rate regime. The second sea change occurred in the early 1980s, when the Federal Reserve under Paul Volcker raised interest rates sharply to combat inflation.


Marks argues that the current sea change is being caused by a number of factors, including the spike in inflation, the war in Ukraine, and the Federal Reserve's response to these events. These factors have led to a reversal of the market conditions that prevailed after the Global Financial Crisis and for much of the last four decades.


In the past two decades, investors have enjoyed a period of low inflation, low interest rates, and strong economic growth. This has created an environment in which asset prices have risen sharply and borrowers have been able to access cheap and easy capital. However, Marks argues that this environment is coming to an end.


The Federal Reserve is raising interest rates in an effort to combat inflation. This is likely to lead to slower economic growth and higher borrowing costs for businesses and consumers. As a result, asset prices are likely to fall and borrowers will face more difficulty accessing capital.


Marks believes that this sea change will create opportunities for investors who are willing to take on risk. He argues that lenders and bargain hunters will be well-positioned to profit from the coming market volatility.


In the context of the small business world, these conclusions suggest that the steady and broad-based increase in business valuations is over. Going forward, this privilege will be reserved for those businesses with superior operations.


Further Reading

Writer's picture: Robert KnauerRobert Knauer


The above pair of photos has been circulating on Twitter and are meant to depict Adjusted EBITDA versus Cash Flow — the suggestion being that sellers occasionally overrepresent the amount of cash their businesses generate by aggressively adding back expenses that are supposedly temporary or otherwise not representative of normal operations. Of course, this characterization is unfair. Most sellers and brokers strive to make an accurate representation of a company's earnings because they are honest people, and they are also aware that the truth will come out in due diligence.

This does not mean there are no gray areas. And because buyers, sellers, and bankers often think in terms of Adjusted EBITDA multiples, coming to an agreement on the Adjusted EBITDA can be a matter of some contention.

EBITDA is a straightforward calculation off of the Income Statement or P&L. The adjustments is where the controversy can come in. These adjustments, also commonly called "add-backs" though they are not always positive, are intended to provide "normalized" earnings. For example, if an owner is paying himself a salary that is above market rate, the portion of the salary above market rate could reasonably be added back.

A good practice when thinking about whether a given adjustment to EBITDA is reasonable to ask oneself, would another owner be able to run this business with similar success absent whatever the expense in question paid for? Making this more concrete, here are some broad guidelines:




Further Information:



UPDATE (December 28, 2021): Contrary to earlier indications, attempts to nearly double the capital gains tax for high income earners is on hold for the time being.


As of summer 2021, all indications were that changes to the tax code are coming. These were considered necessary to fund the sharp uptick in government spending and are generally favored by Democrats, who 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.



There was even some talk of these changes to the tax code being implemented retroactively, meaning that they would apply to the 2021 tax year, though the general consensus was that this was unlikely. However, inquiries to financial advisors had indicated that there was 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.

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