How President Biden’s Proposed Capital Gains Tax Changes May Affect Founders

Founders of middle-market SaaS companies could be affected to the tune of millions of dollars as a result of changes in the tax code proposed by president Joe Biden in his budget for fiscal year 2025, which begins October 1, 2024, and ends September 30, 2025.

If put in place, the proposed hike in capital gains rates could significantly reduce the take-home amount founders receive upon the sale of shares in their business. As such, founders should evaluate the timing of a potential acquisition or capital raise in 2024-2025 before such a tax change could take effect.

What Are President Biden's Proposed Tax Changes for Capital Gains?

Historically, federal and many state tax bureaus have instituted a lower tax rate on income from the sale of capital assets. Instead of taxing income from capital assets at the ordinary income rates, these entities created different or related brackets and rates.

2024 tax rates on long-term capital gains (for capital assets owned > 1 year) were set at 0%, 15%, and 20% at the following levels of Single taxable income (or adjusted gross income):

Tax Brackets for Long-Term Capital Gains

(Source: IRS.)

As part of his 2025 budget, president Biden has proposed changing the special treatment on income from the sale of capital assets (capital gains tax). He proposes that for individuals with taxable income greater than $1M in a year, their capital gains would be taxed as ordinary income under standard income brackets—up to 39.6%.

Because the net positive sale of business stock is considered a capital gain, founders should consider how these changes could affect what they take home post-transaction on a full sale or capital raise and the timing of said transaction.

Higher Tax Rates Could Offset Earnings from Growth

For companies with moderate growth (10-30%), the higher tax rates could result in founders taking home less money post-transaction despite revenue growth.

For example, consider a SaaS company with $10M in annual recurring revenue (ARR) at the beginning of 2024 growing at 20% YoY. (For simplicity, assume the founder owns 100% of the company and there is no state tax.) In a full-sale transaction and at the given growth rate, the company could reasonably sell at a 5x ARR multiple—$50M. At the current long-term capital gains tax rate (assuming the founder has owned the company stock >1 year), the proceeds to the founder would be $40M (see table below):

Taxes & Proceeds Under the Current Tax Code

Now consider what would happen if this same founder waited until after the tax change (potentially at the beginning of 2025). While revenue would have grown 20% (another $2M in revenue and additional $10M in enterprise value at a 5x ARR multiple), unfortunately the math doesn’t play out in the founder’s favor due to the increased tax rate—instead of taking home $40M, the founder takes home $36.3M.

Taxes & Proceeds Under the Proposed Tax Code

* Assumes the founder is filing singly. Tax brackets and rates are based on 2024 tax code, with the exception of the highest bracket, which is set to Biden’s proposed rate. All examples are hypothetical and for illustrative purposes only.

† The net present value of the proceeds, discounted at an 8% investment rate.

If you consider the time value of money, the founder takes home even less. The discounted value of the $36.3M proceeds to the founder in the second scenario is $33.7M, meaning the founder in the second scenario effectively took home $6.3M less than the current potential $40M, and after putting another year of talent and risk into the business and growing the business 20%.

In other words, the increase in incremental enterprise value was more than offset by the increase in taxes.

(For illustrative purposes only.)

Also note that any other income the founder would have in that same year would be taxed at the top rate of 39.6%.

While the math will play out differently depending on a company’s growth rate and revenue, the increase in taxes paid (in this case, from $10M to $23.7M) could have an impact on proceeds to founders.

How likely is the tax code to change? Will capital gains tax change in 2024 or 2025?

We’re not political analysts, so we can’t tell you how probable it is that Biden's bill would pass Congress without any significant alteration changing the impact on founders. Like other bills, Biden's proposed tax changes will need to pass through a Republican House and Democratic Senate before landing on the president's desk for ratification. We can as investment bankers, however, speak from our own expertise and say that:

1. Running a full sale or capital raise transaction can take up to 6 months, so if you wait for surefire signs of a tax change to appear, you may be too late as the tax changes would, if approved, likely take effect in early 2025.
2. In general, founders may be better off taking some money off the table when they’re growing by pursuing a private equity recapitalization/capital raise, then swinging for the fences with a new capital partner and larger financial resources.

What Founders Should Consider for a Potential Tax Change

To prepare your company to sell in the event you want to transact before any changes may take place, then you as a founder might consider the following:

1. Speak to an investment bank to determine if your revenue and growth rate put you in a position where a sale in the next year makes the most sense.
2. Speak to a personal wealth/tax professional about your tax & estate situation to help you capitalize on tax-advantaged vehicles like charitable trusts and gifting of stock.
3. Begin cleaning up your key metrics for selling a SaaS business and investing in business intelligence to streamline information gathering for a potential sale/capital raise.

Founders who take these steps may be better positioned to conduct a timely transaction in the event that all signs point to tax hikes. To take the first step, speak to a qualified, unconflicted investment bank.

This material and the opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. It should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney or tax advisor. Vista Point Advisors does not provide legal or tax advice.