Could Potential Tax Changes and a Private Equity Black Hole Undermine the Value of Your Business?

Tax and Financial News for June 2017
Could Potential Tax Changes and a Private Equity Black Hole Undermine the Value of Your Business?

Until a few years ago, the average private equity fund’s multiyear performance materially outperformed the S&P 500. More recently however, the average private equity fund is performing more in-line with this benchmark, causing a growing number of people to believe private equity as an investment asset class is “maturing.” So what does this have to do with how much your business is worth? First, let’s go over a little background.

Market Categories

Generally speaking, markets categorize private companies into groups based on their annual revenue. There are a few broadly recognized categories of private companies considered “middle market” with revenues of $500 million-plus, $100 million to $500 million, $5 million to $100 million and finally micro business with annual revenues of $5 million or less. Typically, private equity focuses on the three larger groups and doesn’t touch companies in the $5 million or less range.

Low interest rates for nearly a decade meant it was cheap to borrow money and leverage your purchase of a company. Coupled with low return on fixed income and their performance track record, this combination of factors has pushed a lot of money into private equity funds – and as a result, private equity funds have been on a buying spree. All this translates into higher valuations for companies, creating a seller’s market. It also means that most of the “good deals” (for the private equity firms, that is) are already taken.

Market Cycles

Studies of middle market mergers and acquisitions activity show approximate 10-year cycles. Generally, during this 10-year cycle it will be a seller’s market for five years and then a buyer’s market for the next five. Essentially, many in the field see the private business landscape as picked through; combined with the cycle timing, it is creating a sense that we are approaching the top of the seller’s market cycle.

It’s not just the turn of the private equity market cycle that could impact the value of your business. There are potential tax changes that could combine with it to further drive down the price private equity funds are willing to pay.

Changing What We Tax Changes How We Value

There are currently a few proposals that are stepping stones toward a flatter tax system. An essential part of that is a move toward taxing Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) instead of net income. Taxing EBITDA instead of net income means that interest expenses would no longer be deductible. So why would this tax change matter? Well, typically private equity firms value companies as a multiple of the EBITDA they will receive; but if the “I” for interest no longer applies, it could alter valuations.

Not all private equity funds have the same strategy, but a common one is for funds to be financial buyers. Financial buyers craft deals primarily based on the financial structure of the purchase, often through what is called a leveraged buyout (LBO).

Why the ‘I’ for Interest Matters

LBO models typically include a number of financing sources as part of the deal structure. Typically, the buyer will provide a small part in cash, another small portion as a note from the seller and the majority remainder is borrowed (about 75 percent or more).

By using mostly borrowed funds to finance a purchase, LBOs mean that the new company structure will have a lot of debt – and therefore, a lot of interest expense as well. Currently, this is irrelevant if the private equity fund is valuing the company as a multiple of its EBITDA, since their valuation is based on the company’s performance without factoring the interest.

Under some new tax proposals, the interest will no longer be deductible and this messes up the whole LBO model – it essentially breaks it. As a result, financial buyers will have to start valuing the company with the interest expense factored into the target company’s earnings, but while still applying the same valuation multiples. Let’s look at an example to better understand.

If a company had an EBITDA of $10 million and the private equity fund was willing to pay a multiple of 5x, then they would buy the company for $50 million ($10 million x 5). Under the new rules, the private equity buyer would further reduce EBITDA by the amount of the now non-deductible interest expense, so the company’s earning base for the valuation multiple would now be say $1.5 million less (a very rough approximation of the interest expense). The private equity fund would then apply the same multiple of 5x the earnings base at $8.5 million ($10 million EBITDA, less $1.5 million in interest expense) and only be willing to pay $41.5 million instead of $50 million.


The result of this tax change could mean that financial buyers will be offering less for private companies. Coupled with the perceived market cycle timing, and we could be looking at private equity funds being willing to pay a lot less for private companies in the near future.




General Business News for June 2017
How to Select the Right Domain Name

When it comes to selecting a domain name, there’s more than just registration involved. Selecting the right domain name involves a lot of consideration. This includes making sure it represents the company and its products or service correctly, making sure it doesn’t create an intellectual property conflict, ensuring the name resonates with customers and ensuring it can become search engine friendly.       

Making it Memorable – Search Domains

When it comes to selecting a domain name, one consideration is to make is memorable. The first recommendation is to not include any hyphens because doing so makes it harder for people to pronounce, recall and therefore brand a domain name. Something to avoid are words that might sound distinctive but are hard to pronounce or spell, such as anemone or onomatopoeia. It might end up being counterproductive, especially when it’s said fast or flashes across a screen for a few seconds before it’s gone.

Easy to Enunciate

Much like making a domain name memorable, another way to make it stick in people’s heads is to make the domain’s word or words easy for people to say. Through the so-called “processing fluency,” the easier it is to pronounce a word or phrase, the more likely an individual is to remember and create a positive associate with the company and its domain name.

Purchasing an Existing Domain Name

Another consideration when selecting a domain name is determining if it’s been blacklisted or is heavily penalized from a search engine rating. A domain name might be blacklisted if it was previously in the hands of an owner who used it to generate and distribute spam. Similarly, an existing domain may be penalized in search engine rankings, reducing the likelihood of being found by users through a keyword search. Depending on how poor a domain’s search engine optimization (SEO) ranking is, that would be another factor when looking to purchase an existing domain name.

Intellectual Property Considerations

Generally speaking, in order for a name to be trademarked, it must have distinctive characteristics. This could be accomplished by the name being used in a subjective manner or if the name is invented for a business’ use.      

Along with a good fit for a particular industry, it’s naturally best to double check the U.S. Patent and Trademark Office to determine which trademarks currently exist and if any trademark applications are under review. Similarly, abbreviations and modified spellings of a trademark should be explored. Looking through business name registries is also advised to ensure all iterations of a potential trademark are explored before selecting a domain name.

One important point to keep in mind when selecting a domain name, especially with trademark issues, is to ensure there are no similarities with it that may cause customers to confuse it with the trademarked domain name. The following are some questions to ask that, along with legal help, can reduce the likelihood of trademark issues for a domain name.

Will your domain name be in the same industry as the trademarked domain name? What’s the likelihood of the intended domain name being confused or taking sales away from a similar one? How common or similarly spelled or sounding is another domain name to the intended domain name? These questions can help determine if any similarity exists.

While these are just a few considerations when selecting a domain name, understanding how the selection process works can undoubtedly save time and money for entrepreneurs.




What’s New in Technology for June 2017
What Does WannaCry Teach Us?

The global ransomware attack dubbed WannaCry marked an unwelcome precedent in the dark world of cybercrime. It is the first cyberattack that combined ransomware with the self-propagating power of a “worm” to generate a wide-ranging global attack, affecting some 200,000 computers in more than 150 countries with the toll still rising. The hackers behind the scheme took standard ransomware and were able to replicate it on a global scale.

Ransomware has been around for a while. It is malware that encrypts all the contents on a computer user’s hard-drive, locking them behind a password. Typically, it comes with a demand for payment (a ransom) and a deadline. Notably, this international malware attack, WannaCry, snarled the operations of the entire National Health Service in the U.K., forcing hospitals to cancel surgeries and preventing patients from accessing emergency services. It created a nightmare that many cybercrime analysts had foretold – one that experts had warned us would happen unless we beefed up with stronger security throughout the internet.

Web security experts have been trying to warn us that cybersecurity is only as strong as the weakest link on the internet. Now, perhaps we know what they mean. Here’s what you should know:

  • Small businesses statistically are targeted frequently by cybercrooks – nearly one-third of all reported attacks occur at firms with less than 250 employees.  
  • More than 50 percent of cyberattacks can be attributed to human error at the targeted company.
  • Any organization that uses remote and/or third-party employees is especially vulnerable; i.e. any firm where employees are able to access and transmit corporate data via their own personal devices. Remote workers and onsite staff using personal technology (smart phones, iPads, laptops, etc.) to connect with company data potentially provide hackers with many entry points for malware like WannaCry.
  • The only way to avoid being vulnerable is to install security patches and updates as soon as operating system companies and software manufacturers issue updates.  
  • Microsoft has stopped supporting Windows XP – although the company did release emergency patches for XP and 2003 in response to the WannaCry crisis. If this doesn’t convince you to ditch out-of-date operating systems, it is hard to know what will. The longer you continue to use systems that are no longer supported by Microsoft and other OS providers, the greater risk you run of being a ransomware victim.
  • Although the cost to businesses of cyberattacks like WannaCry can be astronomical when we tally the full cost of lost income, interruptions to business operations and the cost of remedial work, the impact on human lives and safety is incalculable when essential health care services like the U.K.’s National Health Service are brought to a halt.
  • Keeping yourself educated on what’s happening in cybersecurity is crucial. It is also vital that your staff training programs educate your employees on how to keep their computers updated, and that you have appropriate guidelines and rules for employees who use personal devices (unprotected by your firewalls) to interact with company technology. 
  • Be proactive. Develop an action plan – engage a consultant to help if needed – so that your employees know how to spot potential problems and know what to do if the company is the target of a ransomware attack.

The experts believe that WannaCry might just be the first of many global ransomware attacks. Your best defense is a proactive stance and a willingness to learn from the hard lessons many organizations received from this recent cyber blackmail.