January 17, 2023 •Oak Street Funding
The 2023 tax season will see many changes as some tax benefits such as the Tax Cuts and Jobs Act comes to an end and others like the Inflation Reduction act begin. If you are a Registered Investment Advisor (RIA), Certified Public Accountant (CPA) or an Insurance Agent wondering how you can navigate the tax changes and high interest rate environment, we’ve answered some of the most common questions potentially impacting your business. Hear from a panel of experts from Oak Street Funding’s Susie McEuen, RIA Sales VP; Bruce Warren, CPA Sales VP; and Kyle Castle, Insurance Sales VP, and Steve Blake, Principal with Somerset CPAs and Advisors as they provide insights on the potential tax implications.
→ Watch Now: Potential Tax Implications in 2023
What is the acquisition, succession and borrowing outlook for the first quarter of 2023?
Susie McEuen
In the RIA industry, we’re still seeing lots of activity from borrowers and many of the opportunities that we're looking at are related to succession planning. M&A is down a little bit, but I think we're going to continue to see the stronger firms continue to seek financing, even in this rate environment.
Bruce Warren
The velocity of transactions in the CPA industry right now is typical. I don't see any real slowdown. In the accounting industry there's 3,000 to 4,000 transactions per year, whether it's an internal succession or an actual acquisition. Business owners understand that interest rates are the cost of doing business, so they factor that into how they structure deals. As a capital provider, I don't see any slowdown. Even if there's a recession, I think business owners are still going to be buying and selling each other as we have seen in previous economy slow-downs.
Kyle Castle
The tax increases and cost increases greatly affect the individuals and companies that are on the fringes. The increases will negatively affect their net operating income, which has a potential to affect their borrowing ability. However, these incremental increases in taxes and interest rates don't have a vast overall effect on business owners because they're smart individuals, they're building it into their underlying costs of doing business and planning for it. These are well broadcasted tax increases and interest rate increases, so it doesn't have as big effect as one might think, especially in the short term.
How are Federal Reserve increases influencing the makeup of deals in each industry?
Susie McEuen
I think buyers and sellers may look at more opportunities to do internal financing. Some borrowers are considering variable vs fixed loans and what the deal structure looks like. There's a lot of creative ways of structuring these deals and because Oak Street Funding is a conventional lender, we can be a little bit more creative too.
Bruce Warren
I don't think the federal reserve rate increases really affect deal structure. What does affect deal structure is how the buyer and seller feel about the transaction. What I’m seeing now is the buyer putting more responsibility back on the seller for transition risk. So, they want to put less down up front versus the seller carrying paper.
How should business owners react to the tax changes and interest rates related to fiscal and monetary policy?
Steve Blake
There are two ways that the rate increases will impact business owners.
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- Tax Perspective – Historically, the IRS interest rates have hovered around 3% so many business owners chose to pay their taxes late and reinvest those funds back into the business. However, the IRS has announced that their rates will increase to 7%. This increase may lead more business owners to pay their taxes on time to avoid the increased rate.
- Financial Statements – There are changes in the Generally Accepted Accounting Principles (GAAP) that will change how leases are reported. In the new rules, certain lease payments will be listed as both an asset and a liability. While this isn’t a change from a business perspective, it will be important to check with your lender to see if they are adjusting covenants or looking at different ratios when calculating risk.
What tax considerations should business owners be aware of in an M&A transaction?
Steve Blake
Buyers should always look at buying assets because from a tax perspective, you get the benefit of the depreciation and amortization of the assets. If you're just buying the stock or ownership of a company then that's going to go on your balance sheet as an investment in that company, but there's no tax benefit to that. Typically, when you're trying to structure the deal, you want to put as much of the purchase price as you can towards the hard assets instead of goodwill. Goodwill is amortized for tax purposes over 15 years. So, you do eventually get those tax deductions, but it could take you up to 15 years to get them, versus hard assets, where for a lot of them, you can take the full deduction in the year of the purchase.
What M&A strategies are trending in the advisor, accounting, and insurance industries?
Steve Blake
Sellers are wanting to sell at really high purchase prices based on the great results they've had the last couple of years. On the other hand, buyers are more pessimistic about what the future holds for those businesses, especially as we've seen some pretty big slowdowns. So, buyers are looking for longer terms, larger earnouts, and wanting the seller to demonstrate their confidence in the business by taking earnouts over periods of 18 months to five years.
Susie McEuen
It continues to be a tug of war between buyers and sellers. The seller's going to want more for their business because we have experienced so much growth in the RIA industry. The buyer and seller have to be on the same page when they enter a transaction. In the case of internal succession, I've seen sellers already lock in a price because the next generation wants to make sure that they're going to be able to afford the transaction. So, they are being a little creative among themselves, and I think we're going to see more of that.
Bruce Warren
In the accounting industry, there's always been a pretty well-defined revenue multiple for what these practices sell for. What's changing right now is how private equity money is coming into the industry and they're starting to teach these accounting firms that they have to show profit on the bottom line so they can trade at higher multiples of EBITDA, which is a real big change for the accounting industry. Additionally, three-to-five-year earnouts are becoming standard for accounting sales at this point.
Kyle Castle
As we see the cost of borrowing funds increase and we see the rising cost of running a business and increasing tax liabilities, it becomes a little bit more difficult for business owners to do mergers and acquisitions. Even as the costs increase and profitability decreases, often there's still sellers asking premium pricing for their insurance agency, but eventually there's going to have to be a general market correction.
What can business owners do now to help them maximize their success in 2023?
Steve Blake
There are a lot of changes coming over the next few years, so we've been working with our clients to prepare multi-year projections. Typically, in the tax world, things stay the same from one year to the next, but we’re encouraging our clients for a five-to-ten-year lookout because there are a significant number of changes coming over the next several years. Additionally, we are putting together five-to-ten-year strategic plans and helping clients clearly define their goals. What can we put in place now to overcome some of these hurdles that are coming towards us in the next few years?
Susie McEuen
When our borrowers come to us, whether for succession, M&A, or expansion, we ask for a three-year projection. Some of our borrowers who are smaller might not be used to doing that. So, we do encourage them to work with their CPA or accountant to help them map out their future projections, because when they borrow money from us, their situation will dramatically change because of the cash flow they're going to need to repay the debt. Clients need to be prepared.
We do have a lot of borrowers that file taxes late and pay the penalty, or they're on tax plans. The one thing that we really try to strive for is to make sure our borrowers are current with their tax situation. We're probably going to look at that a little bit harder than ever before, just because of the nature of the situation with taxes maybe being higher, cash flow being less, and the volatility in the market with assets under management. We just want to make sure that they can meet all the obligations.
Kyle Castle
The biggest key for 2023 is maintaining profitability and clean financial statements. This is especially important if you are considering purchasing a book of business, acquiring a competitor, or selling your insurance agency. Because as lenders and potential buyers evaluate your agency, they’re looking for clean financials, profitability, and expenses that are in line with your revenue. Even if you're the buyer, you need to have clean financials and show profitability on your financial statements so that you can show that you qualify to service the debt of the target you're trying to acquire. So having clean financials, showing profitability, and being able to produce those documents in a timely fashion are going to be key for any acquiring strategy in 2023.
Bruce Warren
If firm or client is going to pursue strategic acquisition, I think the best thing to do is get feedback from all your trusted advisors. Partner with a law firm, just to make sure your partnership agreements are intact, and everything is above board. Then, get with your capital provider and make sure that you understand what they're going to be looking for as far as structure requirements financially. It's got to be a team effort.
Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.