Non-Profits: To Tax Affect or Not to Tax Affect?
April 1st, 2010 by Brian Alwine | Tags: Non-Profits, Tax Affecting | Posted in Tax Affecting |By now, most business appraisers are familiar with the pass-through entity tax debate. The issue is whether an S Corp. or similar “pass-through” entity is worth more than an equivalent C Corp. simply because of a tax election. (See for instance this presentation handout from 2003 by Mr. Mercer or simply do a search for “S Corp tax affect debate.”)
What I have not seen discussed often is the tax affect issue related to not-for-profit entities. Deals involving not-for-profits occur routinely in the health care industry. For instance, a study in 2008 referenced in this article indicated that 78% of hospital mergers and acquisitions involved non-profits as buyer, seller, or both.
Let’s say you were valuing a non-profit entity for financial reporting purposes (e.g. fair value standard) using a discounted net cash flow analysis. Would you apply an income tax effect to the net cash flow stream? Why or why not?
Rather than an either/or approach, what about using a weighted tax affect based on the probable market participants?
Using the hospital reference above, one might argue a 64% chance the buyer would be a non-profit (e.g. no tax affect) and a 36% chance the buyer would be a for-profit (e.g. a C Corp. or pass-through entity with some sort of tax affect). If non-profits have a lower hurdle rate due to tax status, it seems they would constitute the majority of buyers as appears to be the case in the hospital industry.
Of course, there are plenty of other reasons non-profits might have different hurdle rates or acquisition motives, but income taxes seem to be a material factor.
