True up for tax increases?

searcher profile

September 18, 2021

by a searcher from University of California, Los Angeles - UCLA Anderson School of Management in London, UK

Sellers have asked for a true up in the purchase price if the pending tax increases are passed (during the diligence period). Has anyone else experienced this? Thoughts? It's an increase of 5% of the current pay portion and 8% of the earn-out, assuming the current proposals hold.

I know they're considering an ESOP as their second alternative, which is tax advantaged.

Thank you.

1
5
100
Replies
5
commentor profile
Reply by an intermediary
from The University of Chicago in Chicago, IL, USA
I am in the middle of 4 sell-side. None has asked for tax increase adjustment.
Is the opposite not true? That is, should price go down b/c of tax increase? I guess not for Search Funders b/c majority value based on multiples.
Having said above, if Seller's tax is low, a 5% change will not materially change the overall price. Strategic buyers have more reasons to buy than just ROI; hence small delta in price increase is irrelevant.. (Example: If seller's taxable gain is 50% of price, and if taxes go up by 5%, then buyer agreeing to picking up tax increase, increases price by 2.5%. Is that material? Most likely no unless the buyer is buying with very low equity.
ESOP is a rainbow or a mirage for most. It is a good solution if it is a 100% ESOP; nightmare otherwise. Most companies are not ESOP ready. Most seller's do not get "true" advise on pros/cons of ESOP (pre-transaction, post-transaction and eventual exit in case of a partial ESOP). I am currently advising a $2 M EBITDA engineering services company. We are looking at a) sale to a 3rd party with managers owning a equity, b) managers buying the company and, c) partial or 100% ESOP.
commentor profile
Reply by a professional
from New York University in New York, NY, USA
It really depends how much more they want. In general, I discourage saying yes to this unless it's speculative (and tax rates are almost certain to increase). I've had a few where we agreed to this, but the amounts are not substantial and it was negotiated (i.e., they didn't get it all). The important thing to remember is that if you say no and walk away from the deal, are they going to be able to sell the company to someone else? Selling to an ESOP has significant benefits (i.e., essentially perpetual deferral), but they don't get access to the proceeds unless they're willing to pay taxes (at the higher rates). In many ways, a sale and the use of an Opportunity Zone has the same effect (if not better).
commentor profile
+3 more replies.
Join the discussion