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Tech Entrepreneurs Should Contemplate Early Exits Amidst 2024 Election Uncertainty

The looming specter of the 2024 U.S. elections casts a long shadow over its tech landscape, with few entrepreneurs fully aware of the potential fallout of proposed tax reforms under a possible second Biden term

Serge Jonnaert
CEO & M&A Advisor – Software & Technology

President Biden’s 2025 budget proposal post-election packs a potentially devastating punch, wielding significant tax reforms that threaten to fundamentally alter the ‘calculus’ for tech entrepreneurs.

One of the most significant changes proposed by President Biden is an increase in the corporate income tax rate from 21% to 28%. This hike would significantly affect tech companies, many of which already operate on slim profit margins due to high up-front R&D costs. Even more concerning for tech entrepreneurs is the proposal to raise the top long-term capital gains rate from the current maximum of 20% to 39.6%. When combined with the 3.8% Net Investment Income Tax (NIIT) and the additional Medicare tax, the total capital gains rate could soar to 44.6%, potentially exceeding 50% in some cases. Currently, most tech entrepreneurs pay between 15% and 20% in capital gains when selling their company. For instance, on a $20 million sale, they might owe around $3 million in taxes. Under the new proposal, the tax burden on the same amount could balloon to nearly $10 million, taking away almost half of the proceeds from the sale of their company. This drastic increase should be alarming for entrepreneurs considering waiting to sell their companies.

The reverberations of these tax reforms will also extend deep into the realm of the venture capital (VC) world. Diminished after-tax returns may compel VC investors to demand higher yields, placing startups under intense pressure to deliver even higher growth and profitability metrics. Additionally, the specter of higher capital gains taxes will loom large over startup valuations, as investors recalibrate future cash flows in light of increased tax liabilities. Early-stage startups, reliant on angel investors and seed-stage VCs, may find themselves particularly vulnerable to these tax headwinds, potentially triggering a cascade of negotiations aimed at offsetting tax burdens with more favorable terms.

Some of the tech ecosystem is already adapting accordingly, not always in favor of US interests. Incubator firms like Techstars that once only had accelerators in the U.S., now have locations across Asia, Europe, and the Middle East. Executives and wealthy investors from other countries are increasingly offered special tax incentives, affordable talent pools, and ‘golden visas’ to set up or move their companies to other countries, instead of the US. That should be a major concern…

You have to ask why? The tech sector is a major contributor to the U.S. economy, accounting for about 10% of the total US GDP. For California it is even more, contributing $482B or 18.9% of the state’s annual GDP. The tech industry creates high-paying jobs, innovative products and services, and broad-based growth. The tech sector is also a leading exporter. The average annual compensation per worker in the IT industry is more than double the average U.S. private sector wage. Considering growing global competition, and the US already ranking third in the Global Talent Competitiveness Index 2023, as well as concerns that the U.S. is losing its technological infrastructure necessary for competitive leadership, one would think that it is a sector that deserves extra care and incentives, not a higher tax burden.

For entrepreneurs still harboring grand aspirations of a substantial exit payout for their latest venture, the impending 2024 US elections loom as a pivotal juncture, promising an unprecedentedly sobering impact not solely on their prospects but on the broader US tech landscape. Optimists cling to the expectation of a pronounced pivot towards a change in policy that fosters innovation and favors business interests. Those less hopeful might be wise to expedite their exit well in advance of the electoral repercussions taking hold.

For an exploratory M&A discussion, contact us at info@the.merger.company

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