Fear of Higher Taxes a Cause of Sell-off

Spending a lot of my time with tech/telecom executives – many in smaller companies, and private companies – I have recently begun to notice a major trend, which had been present in other corners of the market for about 6-9 months earlier, but is now reaching new ground. What I am talking about are asset sales targeted for 2008 closings, in order to avoid higher capital gains taxes in 2009 and beyond.

Specifically, CEOs and board members especially of smaller and private companies have expressed to me a desire to sell their companies in 2008, as opposed to infusing more capital and/or look to IPOs for exits. You may have noticed an almost complete absence of venture-backed IPOs in the first half of 2008. Instead, acquisitions are becoming the only exit of choice – er, necessity.

In talking to private company CEOs and board members (principally Venture Capitalists), the thinking seems to be something like this: (1) Going public has become more costly "thanks" to Sarbanes-Oxley and other regulatory overhead, (2) the IPO market has died off with essentially zero venture-backed IPOs in the first half of 2008, (3) Therefore, we have to sell unless we want to continue to fund the company, and (4) If we are going to sell, let's sell in 2008 so that we don't risk getting caught in the potential "Obama-tax" that could hit us as early as 2009.

I would venture to suggest that there are very few Silicon Valley and other investment bankers that haven't heard this reasoning increasingly in recent weeks/months.

This, of course, is a very negative sign for the health of the US entrepreneurial economy. With the list of sellers mushrooming, prices for these exits will likely be kept at very low levels from an historical perspective. I challenge anyone to point out more than the most random recent acquisition or two, where industry observers have been in awe about a high valuation, as opposed to a historically low valuation.

In addition to the desire to sell the companies in 2008, I am also beginning to hear that some of the people coming to this kind of conclusion about the companies they run and/or are invested into, are also considering unloading some of their personal real estate in 2008 for the same capital gains tax reason. In some cases, a CEO may have a second house, apartment in Chicago or Paris, or equivalent, and he/she would tell me that this is the right time to sell this asset because it's better to pay a 15% nominal capital gains tax rate in 2008 than risk having to pay a 28% rate in 2009 or later. Of course, these tax rates are not inflation-adjusted, so the real rates they represent are in all cases materially higher, even further exacerbated by the increasing inflation rate – "bracket creep" for those of you who remember the income tax rates of the 1970s.

These are a gloomy set of observations indeed, and they pile on top of all the other headwinds to the markets and the economy in recent years and decades: Sarbanes-Oxley driving stock market listings abroad, the general litigation mania driving up costs for investment banks and mortgage providers, sharp increases in the money supply causing inflation, and the anti-trade political sentiments. The US already has the second-highest corporate tax rates among the most industrialized nations, and we are now starting to feel the consequences of proposals by one candidate for the highest office to increase taxes further on various forms of capital gains.

The inevitable consequence of this anti-achievement view of how to fund a Federal government of record size ($3.1 trillion Federal budget in 2008, compared to $100 billion in 1962 – a 30x increase not adjusted for inflation) has already started to depress asset prices, ranging from the stock market to real estate. Small private companies don't have an IPO exit opportunity anymore. These are very serious threats to our economy indeed.

Disclosure: As of this writing, Anton Wahlman is an individual investor who has long and short positions in a variety of stocks. Anton Wahlman was a sell-side analyst from 1996 until May 2008, first at UBS, then at Needham & Company and most recently at ThinkPanmure.

Comments

[Tom B:]

I'm not sure your analysis goes very deep. Poor VC funding probably also has a lot to do with losses from sub-prime exposure-- a fallout from POOR regulation by the GOP of the banking industry. Blaming the Govt. is a national pastime among CEO's when, in many cases, they need look no further than the noses on their faces.

2008 Jul 11 09:12 AM

[Midas Mulligan:]

Well done, Anton. Very little commentary has addressed the deleterious effect which higher taxes under an Obama regime would have upon industry.

2008 Jul 11 09:56 AM

[Who's the p...:]

Utter nonsense. The market has been in the tank for months. There are 3 trillion reasons more important than the possibility of a slight increase in capital gains. Budget deficits under Bush, the destruction of American influence abroad and concomitant loss of interest among foreign investors in the US market, restrictions on the inflow of immigrants who have fueled innovation here for decades, the decline in foreign students coming here to add their intellectual capital to our society, the rise in inflation because of Bush's deliberate policy of devaluing our currency, Bush's active encouragement of expanded credit (you don't have to sacrifice for my war, just go shopping)....you can go very far down a very long list before you reach the Bogeyman Obama.

2008 Jul 11 10:08 AM

[ezrasfund:]

What about the phantom Bush tax increase which will some day be paid? Or not.

If I charge $1000 on may credit card instead of paying cash is that not money that will have to be paid? In the aggregate goverment spending and taxes will have come into balance. Will the "great deleveraging" ever extend past Fannie and Freddie all the way to the US Treasury? And will the US pay up or default? Finally the banks can't grow their way out of their leveraged positions. Will the US government be able to grow its' way out of high debt ratios forever? Including some auto company style legacy costs?

Good luck. "In the long run we'll all be dead," but does that include our government?

2008 Jul 11 10:15 AM

[Edward Janeck:]

That is simple economics. But, will it make the country worse? Maybe on the corp. side. But, not for the average person.

2008 Jul 11 12:03 PM

[sorno:]

The post is pretty superficial, since it basically assumes everyone wants to get out of capital market because of increase in tax. If people pull out money from the capital market, where will they put the money? CD and bonds, which has lower growth and higher tax rate? The sell off in market has nothing to do with potentially increase in tax, it's clearly due to the credit crisis and the slowdown of the economy. The lack of IPOs is also due to the slowdown of the economy. Why do you think people who started a business simply because they want to sell it? I seldom heard people put a sell price in mind when they run their business and if they do, they properly can't run a good business.

2008 Jul 11 02:12 PM

[monday1929:]

I think we should impeach Obama right now for the damage he is causing to the economy. He also failed to prevent the Sept. 11 attacks, and I am following a tip about his involvement with the Titanic.
This article is part of what appears to be an organized attempt to Blame Obama for the coming Depression, and started months ago.

2008 Jul 11 05:35 PM

[icandoitdon:]

let's see...

higher future tax rates stimulate asset sales currently to avoid the higher tax rates. as i recall, it's also a republican mantra that lower tax rates stimulate asset sales to take advantage of lower tax rates.

from this, i would simply conclude that sales and purchases of capital assets generally occur regardless of modest changes in tax rates.

while it's human nature to want to pay as low a tax rate as possible, it is just one variable among many in determining the timing of the sale of a capital asset.

your notion that capital asset sales due to a pending increase in tax rates are somehow undesirable is simple minded drivel for the uneducated masses who believe our government is evil in all things except war.

2008 Jul 11 06:00 PM

[sbenard:]

Wow! It's an Obama neighborhood here.

I don't think the author is suggesting that Obama is the sole cause of a depressed market. He is merely suggesting that it is another factor contributing to it. If so, this phenomenon will accelerate through the second half of the year, especially if polls suggest Obama is likely to win.

Small business owners that I am talking to are particularly concerned about an Obama presidency. Several have already started laying off workers in anticipation. They are definitely in the mode of contracting and preparing for the possibility, and rebalancing their assets to try to shield themselves. Anything less would be poor business management. The phenomenon is real, whether we want to admit it or not. The degree to which it affect the economy is certainly debatable, but denying ANY impact is simply DENIAL on our parts.

2008 Jul 12 12:35 PM

[sbenard:]

icandoitdon,

You claim that anyone who disagrees with you is by definition "uneducated" and that therefore their though processes are "mindless drivel" is truly elitist, just like Obama. Your post has to be one of the most condescending statements I've heard in a very long time. Typical liberal elitism that suggests that anyone who disagrees with you must therefore be stupid. Excuse me while I go to the restroom and puke!

2008 Jul 12 12:40 PM

[icandoitdon:]

sbenard,

a few points:

1. people can disagree with me if they choose...it's a free country.
2. many "uneducated" people hold formal degrees...but that doesn't confer upon them wisedom or judgment.
3. you might think the masses are educated, but i dont. i think they're preoccupied with their SUVs, their over-mortgaged homes and finding their next line of credit. they will support any war we start, whatever the rationale, and change their mind about it later if it proves misguided. sound familiar?
3. "elitist" is a meaningless, overused characterization of the smug, intolerant right used to brand those with whom they disagree. if i am elitist what does that make you?

instead of doing the same thing you accuse me of doing (name-calling) why didn't you challenge my view of the author's post? there is another argument to be made, you know, and the author didn't make it very effectively. if you'd like to try, have at it. like rush dumbaugh says i'll tie half my brain behind my back to give you a fair chance.

2008 Jul 12 02:16 PM

[ArtfulDodger:]

Good points Anton:

We need more articles pointing these worries out.

Surely everyone knows that a healthy percentage of the fears and worries out there today are over an OSamba presidency.

Many people in business that I know are really worried about OSamba and aren't very enthusiastic about McCrazy either. It's not a great choice, but the latter is clearly the only choice for businesses and investments.

Dumborats are control freaks, Controlrats if you will, with deformed frontal lobes. They are cynical and believe that government must control every inch and ounce of society.

You can't change their minds. No truth, evidence, or reason will move them. Their Marxist ideals are set forever in the way they want to control others.

Black Liberation Theology is essentially revolutionary Marxism—Catholic priests in South America deserted Christianity, but kept their frocks and took up cultural and economic Marxism about sixty years ago.

This is the root of Black Liberation Theology—there is no real religion in their teaching, only cultural and economic revolution, where Darks take over where Lights once ruled, where capitalism once ruled, socialistic wealth and property transfers take over via government taxation and bureaucratic regulation.

This is what Michelle and Barack Hussein Obamba listened to in their "church" for twenty years, yet claim to know nothing about it! What else?

Marxism is at the root of all the vengeful things they've written and said in the past, but are now trying to hide so they can deceive the American public this fall and take over the government.

Higher taxation won't even be the worst of what they'll do with a Liarcrat Congress and Senate.

Don't expect the media to expose them, either, because practically every outlet is pro-Marxist and thus pro-OSamba.

Most everything happening negatively in the world today has been brought about by the Dumborats' and leftist Republicrats' statism.

There is no sign of that getting any better, because leftist propagada has convinced most of the world that government has an answer for and must do something about everything from their hang nails to their constipation.

Those are serious things to be concerned about if you love freedom, as I do!

2008 Jul 12 06:06 PM

[sorno:]

On Jul 11 06:00 PM icandoitdon wrote:

> let's see...
>
> higher future tax rates stimulate asset sales currently to avoid
> the higher tax rates. as i recall, it's also a republican mantra
> that lower tax rates stimulate asset sales to take advantage of lower
> tax rates.
There is a pitfall in your logic. Lower tax rate gives people more incentive to buy assets at higher price, which is good for the economy (especially current economy). With the same logic, changing from low tax rate to high tax rate decreases assets value, which is bad.
> from this, i would simply conclude that sales and purchases of capital
> assets generally occur regardless of modest changes in tax rates.
>
>
> while it's human nature to want to pay as low a tax rate as possible,
> it is just one variable among many in determining the timing of the
> sale of a capital asset.
It's just one variable doesn't mean it's not a big one. You know why buy-and-hold works? Because comparing to short-term trading, it incurs much lower tax payments.
> your notion that capital asset sales due to a pending increase in
> tax rates are somehow undesirable is simple minded drivel for the
> uneducated masses who believe our government is evil in all things
> except war.
I havn't encounter a person has this kind of thinking. I believe your "uneducated masses" is out of your imagination and it's a way to boost your own ego because you think you are well above the masses.

2008 Dec 24 10:30 AM