Proposals by the Biden administration may cause agency owners interested in selling their business in the next five years to accelerate their timeline to 2021.
2020 was another record year for insurance agent and broker merger & acquisition activity. In total, 728 transactions were completed and the prices related to those transactions were also at record-high levels. Imagine telling someone just five years ago that even a premier asset would be trading at guaranteed multiples of more than 14 times earnings before interest, taxes, depreciation and amortization (EBITDA)—you would have been accused of being under the influence of a narcotic.
However, the robust activity of 2020, specifically in the fourth quarter, appears to have created a hangover in early 2021. In the first quarter of 2021, 152 transactions were completed, versus 177 in the same period in 2020, a 14% decrease. This slowdown is largely the result of transactions that would have otherwise closed in the first quarter of 2021 being accelerated into the fourth quarter of 2020 to protect against a retroactive capital gains tax rate increase.
That slowdown is about to end, and we will see an acceleration in the remainder of 2021. The reason: Uncle Sam.
The Biden administration has put forth a widely publicized plan to increase capital gains rates from 20% to 39.6% for the highest wage earners, which likely includes agents and brokers selling their business. And these increases could be made retroactive to a date in 2021. Both January and October are possible options. However, the recent job report and inflation concerns have presented additional challenges to already ambitious plans. As a result, many experts believe capital gains rates will only increase to 28%-30%, which is still a massive jump, and go into effect on Jan. 1, 2022.
Nevertheless, a capital gains increase remains almost certain and may cause agency owners interested in selling their business in the next three to five years to accelerate their timeline to 2021. By doing so, sellers can take advantage of the current market where transaction multiples are at all-time highs and capital gains rates are still at 20%. The chart below illustrates how the change in capital gains tax rates affects the sellers' net proceeds.
History is a good indicator of the impact of a capital gains increase on M&A in the insurance agent and broker market. To evaluate, we looked back to 2012, when capital gains rates increased from 15% to 20% on Jan. 1, 2013.
In 2012, the number of transactions increased 35% in the last three quarters versus 2011, including a 69% increase in the fourth quarter. If the same rush to beat Uncle Sam occurs this year, we might expect to see the same number of transactions in the last three quarters of 2021 as were done in all of 2020—728 transactions.
This does raise some capacity issues. Can buyers handle this type of increase in volume both from a resource perspective and a capital perspective? The typical process from beginning to end for a seller is four to six months. So, can sellers meet the required timelines that may need to be accelerated? Many assume that transactions can and will get done. That said, a capital gains tax rate increase appears inevitable and those sellers that have decided to sell may serve themselves well to act sooner rather than later.
Brian McNeely is a partner at Reagan Consulting. This article will also be published in the June 2021 issue of Independent Agent magazine .