Beware buying or selling private company equity with debt.

When it comes to private company equity purchases, both the buyer and seller often rely on debt to facilitate the transaction. However, this approach can be detrimental for several reasons:

·?????? Limited Tax Relief: For Canadian corporations and US C-corps, taxes on profits range from 9% to 20%, offering minimal tax relief on interest expenses. For S-corps, the situation is even worse. Although higher tax rates provide a larger tax refund, they significantly impact principal payments, which are made with after-tax dollars.

·?????? Cashflow Issues: The combination of tax payments, interest, and principal repayments can create severe cashflow problems. Generating cash is crucial for all private companies, and intentionally reducing cash flow can be fatal.

·?????? High Cost of Financing: Consider a purchase price of $2 million financed at 6%. The total net after-tax cash flow required over 10 years amounts to $3.7 million. Paying this much while becoming financially weaker is akin to telling a car dealer, “I don’t care about the sticker price; I want to pay more!”

·?????? Sales Growth Requirement: To make this work, sales would need to increase by 47%. However, if cash is being depleted, where will the necessary working capital come from to support increased sales and ongoing projects?

·?????? Tax Burden on Sellers: Sellers face significant tax liabilities, whether they are an S-Corp, C-Corp, or Canadian Corp. For US sellers, the tax hit on a sale could be as high as 44% of the proceeds under proposed tax legislation. Canadian sellers also face increased capital gains taxes.

·?????? Net Proceeds for Sellers: At these tax rates, a US S-Corp seller nets only slightly more than half the sales price, even though the buyer paid 86% more in cash to complete the transaction. C-Corp and Canadian Corp owners also face substantial tax burdens.

·?????? Retirement Concerns: This leaves retiring business owners with limited cash for their future. Savvy owners must consider whether the net proceeds from the sale are worth the hard work and sacrifice required to build the business.

·?? Hiccups: Issues like Covid, inflation, shortage of labour or materials, and pricing can unexpectedly hit when you are most exposed. This applies to buyer and seller.

·?????? Alternative Solutions: There is a simple solution. Refer to my Case Study to explore alternatives that provide $6 million without selling shares, making the hard work and sacrifice worthwhile.

·?????? Tax Article: (16) The Impact of New Capital Gains Tax Rules on Small Business Owners | LinkedIn