Valuations are often an essential part of business buy/sell agreements, sales and acquisitions, and estate and gift planning and preparation. They serve a variety of purposes and provide unique insights into the operations of your business.
Value is determined on:
1. The value of all assets, tangible and intangible, including goodwill;
2. The demonstrated earning capacity; and
3. Other factors set forth in the regulations relating to valuation of corporate stock, to the extent applicable.
Is it time for you to take a look at the value of your business?
U.S. C-Corporations have been among the highest-taxed in the developed world, with a top marginal corporate tax rate of 35% on worldwide income. The new tax reform reduces the top marginal corporate tax rate to 15%. And this has an effect on business valuations.
It is a good thing for company management and executives to understand what these value implications mean to your company.
This article discusses the changes to the valuation of C-Corporations using the Income Approach (discounted cash flow valuation) in which the changes are limited to an enterprise-value level and with a cash-free and debt-free basis (the seller keeps all cash and pays off all debt at the time of the sale of a business).
Increased free cash flow The decline in the corporate tax results in increased levels of free cash flow. Management will need to consider the best uses for the increased cash flow, perhaps revisiting dividend or distribution policies; fixed asset investment; expanding the business; new products or services; and/or use of debt.
Capital structure Valuations with a greater level of debt, depending on capital structure, will have a larger impact on the overall Weighted Average Cost of Capital. Your management team should consider the value implications of decisions surrounding whether the company should take on more debt or pay down its existing debt. It is important to consider your optimal capital structure in terms of value maximization when considering your best use of increased free cash flows.
The new tax law essentially eliminates the double tax and may encourage pass thorough corporate structures to change to a C-Corp. The reason for pass through corporate structures was to avoid the double taxation of C-Corps. Call us to learn if a change in corporate structure would be advantageous for you.
Other considerations There are scores of factors and considerations built in to fair value valuations. It would behoove management teams to consider many before making decisions.
Corporate tax rate changes may have a significant impact on a decision surrounding the deal structure of a merger or acquisition. They may also affect goodwill impairment valuations. In general, asset transaction deals allow the buyer to step up the tax basis of the acquired tangible and intangible assets to fair value, with the (typically) higher tax basis resulting in a tax shield. Because the tax rate and the Tax Anticipation Bill are positively connected, the corporate tax rate change can lower the value of the tax shield.
Valuation allowance A valuation allowance must be created if you determine that some (or all) of your deferred tax assets will not be realized. Management may have to reevaluate its method of determining applicable valuation allowances because of the decreased corporate tax rates.
Bottom line
The corporate tax rate reduction will benefit companies from a valuation perspective and will take time to fall into place. It will pose different questions for both you and us.
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Did you know?
Nebraska’s top statutory corporate tax rate is 7.81% to the $100,000+ tax bracket. Iowa levies the highest of all states at 12 percent to the $250,000+ tax bracket (and for comparison, 10% for the $100,000-$249,999 tax bracket).