So, just like everybody else in the accounting profession, the new tax law has had valuation professionals scurrying around trying to figure out its impact. I hope to write some more as the implications are more fully understood and once the IRS has issued some additional guidance as to how the new law will be interpreted.
However, one effect may be that the fair market value of many operating companies that are organized as C Corporations increased as the ball dropped in Time Square. This is because when we use the income method to value a company we are relying on the after-tax cash flows of a business to support the value. Since the C corporation tax rate was reduced to 21% on the stroke of midnight on New Year’s Day, these cash flows go up and, ergo, value goes up!
But not so fast…when using the market method of valuation we often rely on a multiple of cash flows which reflect a company’s earnings before taxes, interest, depreciation and amortization (EBITDA) which by definition excludes the effects of taxes and would therefore not be affected by the change in the tax rates. Without further adjustment, we may see a widening discrepancy between the value indications derived from the income and market methods. It will be interesting to see if multiples shown in transactions increase to reflect the availability of higher after tax cash flows to owners.
Now, as to the effect on the value of pass-through entities – that’s a topic for another time…