Preparing for Change

Wednesday, October 1, 2008

Benjamin Franklin put it best, “In this world nothing is certain but death and taxes!” This political season is likely to bring meaningful changes to the “taxes” part of Mr. Franklin’s maxim. Dividend, capital gain and estate or death taxes are likely to increase in the next four years when the new President is elected. Corporate managers and business owners beware. This is a non-partisan issue that should cause anyone looking to divest, spin-off or sell a business to pay attention and get prepared.

First, let’s look at the high-level economic reality. Security-related assets are holding up reasonably well in this economic environment, with no precipitous declines so far. We have seen the electronic security industry grow more than 50 percent, from about $100 billion in 2003 to an estimated $160 billion industry this year, according to the well-regarded industry analyst Jeff Kessler. Given all the macro geopolitical and security trends, our industry will probably make similar or superior gains again over the next five years.

The question for us all: Is now a good time to take some profits or let the investment ride?


What are your options, given the attractive metrics of our industry and hopefully for your business, in the context of enhancing your net worth or building shareholder value?

Refinance the business and pay yourself a dividend The objective here is to safely borrow money and use part of that capital to pay yourself a dividend. Dividends are taxed at 15 percent today. Tomorrow, who knows?

Take some chips off the table Find an investor who would like to partner with you in order to grow your business. This will allow you to sell part of your ownership interest in the business, pocket some cash, and then continue to grow the business for three to seven years. At the end of this period, you and the investor will find a new investor to buy into your business or you sell the business to a strategic acquirer. This effectively gives business owners “a second bite at the apple” after having diversified holdings from the initial transaction. Capital gains are taxed at 15 percent today. Tomorrow, who knows?
Exit You may wish to exit a business completely if you do not wish to have involvement in the business or you feel now is a good time to cash out in order to retire, avoid tax rule change risk or redeploy your investment capital in a new business. Capital gains taxes are at a historically low 15 percent. It is very probable that it will be increased in the next administration. Estate tax is 45 percent currently, and even if it were to decrease to a 25 percent floor as discussed by some, an after-death sale would be less advantageous than the capital gains treatment in an organized sale process. Plus, you’re likely to achieve a higher sales price, as well.

Keep the business You may decide to keep running your business as long as possible or even “keep it in the family.” But that requires analysis and effort to minimize taxes for your family, as well, during and after the transfer.

Why now?

At the end of the day, planning and timing are critical. The Tax Reform Act (TRA) of 1986 was the most recent major simplification of the tax code, with top tax rates lowered from 50 percent to 28 percent and the bottom rate raised from 11 percent to 15 percent. Many features of the tax code changed to the detriment of potential alarm company sellers and there was a wave of transactions between the time of passage in the fall of 1986 and when the law took effect January 1, 1987.

While not of the same sweeping nature as TRA, the risk of an increased capital gains tax is already motivating alarm industry sellers and the activity is likely to increase as we approach the end of 2008. Consult with your tax and legal advisors as everyone has different circumstances, but everyone should be prepared for change.

As our old friend Ben Franklin said, “Employ thy time well, if thou meanest to gain leisure.”