How Federal Corporate Tax Reform Impacts the Enterprise Value of Midsized Companies

Posted on January 17, 2018

by Glenn Fishler, CEO to CEO Principal

I was CEO of a privately held B2B professional services company for 15 years before we put the company to the market and sold the firm to a strategic buyer in 2015.  When the company was founded in 1990, our vision was to build and run the business with the intention of someday creating a liquidity event for the shareholders.

Over the years, we paid attention to the valuation drivers and how to increase the market value of the business.  I recall thinking on multiple occasions about the tax consequences of selling the company.  This was a particularly sensitive subject because, being a California-based firm, the projected combined state and federal taxes from a sale were daunting.  Unfortunately, the tax laws were never very favorable to our business; the taxes paid by corporations were always going up, and when the company was finally sold, the shareholders paid more than their fair share of taxes.

Now, as a management consultant to CEOs who are potential buyers and sellers of businesses, there is something new in the world of corporate taxes I am paying attention to: how the recently enacted Federal Tax Cuts and Jobs Act (TCJA) will impact the valuation of midsized companies.

My intuition tells me that because the new tax rates will require businesses to pay less in corporate taxes, businesses will have higher after-tax earnings and will generate more cash.  Although there are multiple methods for valuation (e.g., market comparables and multiples of revenues, sales, earnings, etc.), one of the main valuation methodologies used by analysts is the Discounted Cash Flow (DCF) method.  With DCF, current and discounted future cash flows are modeled to determine enterprise value.  If cash flows increase because less cash is being used to pay corporate taxes, one can surmise that DCF analyses will result in higher enterprise values.

I am also starting to see experts in business valuation comment on the subject.  Here’s a link to an article recently published on this subject: http://rog-partners.com/the-tax-cuts-and-jobs-act-and-your-firms-value/.  In the article, business valuation expert Ian Rusk of ROG Partners gives some detailed analysis about how the TCJA will positively impact enterprise valuations.

The jury is still out on how tax reform will impact enterprise valuations, but indications are that enterprise values of profitable firms are likely to rise as a result of Federal tax reform.  We at CEO to CEO will be keeping a careful watch on this important subject, one that is near and dear to many of our midsized CEO clients.