Business valuations will look different than they have in years past thanks to the Tax Cuts and Jobs Act (TCJA). Even though the TCJA kept valuation rules the same, the effects it had on both corporate and non-corporate taxes will trickle down to the business valuation domain. Typically, organizations are valued using one of three different techniques – the asset approach, the income approach, or the market approach. Each of these methods will produce different outcomes post-tax reform than it did pre-tax reform, and the hefty reduction in the corporate tax rate is only one of the reasons why. If your organization is being evaluated in the coming years in anticipation of a merger or acquisition, it is important that you understand how these tax law changes will impact your appraisal. To help clients, prospects and others understand the impact, Selden Fox has provided a summary of key considerations below.

Overall Impact

Experts agree that the value of a business is likely to increase under the TCJA. This outcome was almost guaranteed when the federal tax rate was reduced from 37% down to 21%.  The tax law also provided enhanced accelerated depreciation, the improved ability to immediately expense capital purchases, and the 20% QBI Deduction. Unfortunately, the true effects of the TCJA remain uncertain. It is next to impossible to guess how business leaders will pivot their strategies to address the new regulations. Corporations, for example, may find themselves with more cash in hand because of the lower tax rate. How will management direct this cash? Will extra cash on the books look better to potential investors? Will this cash ultimately prove to be a liability? The goal of a business valuation is to answer these difficult questions – and many others.

Asset Approach

An asset-based approach calculates what it would cost to re-create the business by valuing an organization’s assets. Focusing on the balance sheet alone can seem like the easiest solution until you dive in. But the task goes beyond simply searching for the replacement values of property listed on the balance sheet. You must also account for intangible items such as proprietary processes, experience in the market, or value of future tax positions. These intangibles are difficult to value under any circumstance, but under a new tax regime, there may be too many unknowns. Will a business hasten their fixed asset purchases to take advantage of accelerated depreciation? Will an entity use its cash to pay down its debts? Will deferred tax liabilities increase as a consequence to taxes saved today?

Income Approach

An income-based approach requires analysts to determine value as a function of the entity’s cash flows, earnings, or some other signifier of income. Cash-flow modeling will become much more complex under the TCJA because almost all of the tax law’s provisions will have a cash impact. And when you consider that some of these provisions sunset in 2025, the calculation becomes even more nuanced. The income approach relies on long-standing assumptions that must be thrown out and recreated in a new light.

Market Approach

A market-based approach requires valuation firms to look to the market for sales of similar businesses. A 2017 sale may not be the best comp for the sale of a similar business in 2019 because these businesses were operating under completely different tax regimes. This problem is often resolved by applying a “market multiple” to achieve comparability. Unfortunately, determining the correct multiple will be difficult. A blind application of a market multiple without taking a deep dive into how the TCJA will affect the business in the future would be short sighted.

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Will pre-TCJA performance be a reliable indicator for post-TCJA performance? Only time can answer this question. The tax reform may create opportunities for your business (like giving you more cash at the ready), but it can also create problems you didn’t expect. Maybe your investors have unrealistic expectations of how these changes will benefit you, or maybe your creditors expect specific performance ratios. These valuations are complex, and you will need a reputable analyst at your side to help you get the best valuation possible. If you have any questions about business valuations or how the TCJA will affect your upcoming merger or acquisition, Selden Fox can help. For additional information please call us at 630.954.1400 or click here to contact us. We look forward to speaking with you soon.

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