With many of us experiencing a pandemic rebound, operating cash and earnings are at all-time highs.
Each of us would be lucky to “go out” on top. Historically, that was a primary driver in determining whether to sell your vacation rental business. More recently, multiple external implications and industry dynamics have generated a flurry of questions for our M&A team. Of course, selling a business for maximum value is paramount, but other considerations are becoming increasingly material. We’ve been working through vacation rental transactions for more than 20 years, and this has been one of the most interesting years ever.
With unprecedented earnings recognized in many operations, determining a reasonable valuation has been difficult in recent years. Company owners obviously want to use 2020 earnings, but buyers are looking for more of an average or weighted average. It’s important to note that nearly all transactions are based on a multiple of earnings (if you’re considering a sale of the business where a market valuation method is not being used, you should be asking “Why not?”).
If the sale of your business is based on a multiple of four-times earnings, prospective buyers are looking to realize similar earnings each year moving forward, hopefully over the next four years. However, if your business has had an extraordinary increase in performance, like many of us had in 2020, it would be difficult to model a successful investment in your business.
It also appears that 2021 will be a banner year, but will 2022 or 2023? This is where a reasonable, weighted average of net income is a solid middle ground and may be the difference in finalizing a successful transaction.
Other factors influencing the sale of businesses domestically were recently announced. The current administration has proposed an over 100 percent increase in the federal capital gains tax rate, and while it remains to be seen whether business households making less than $400,000 per year will pay more in taxes, those exceeding $400,000 per year are expected to receive a tax increase.
So, what does this mean for me as a VR business owner?
For starters, it means less free cash flow. In the event you are considering exiting the business, I would strongly encourage you to look at selling in the 2021 tax year. While it’s not guaranteed that all these proposed tax increases will get passed, certain taxes will increase. The government will be forced to raise taxes to offset the increase in spending and programs being proposed. So, when you think about going out on top, don’t consider only the purchase price—think about the timing and tax consequences that may come into effect.
Another material consideration to the rising taxes and slowing economy is inflation. If the capital gains tax increase comes into play and inflation rises, we as business owners will expend more cash for the same goods and services. And if this is happening in your business, you can bet this is happening with each family that stays with your rental operation.
Be mindful of changes on the horizon. There are major shifts at play that could dramatically affect your decision-making and/or business in 2021. Understanding the true cost of selling your business will help ensure the sale of your vacation rental operation is a success. The same is true for generating a material profit.
If you have questions about preparing your business for sale, are curious about your vacation rental operation’s value, or have questions about increasing your company’s profitability, please do not hesitate to contact Ben Edwards with Weatherby Consulting via phone at (850) 496-7360 or email at Ben@WeatherbyConsulting.com.