Cinven Acquisition of TaxAct Raises Questions About Propriety

One effect of sustained inflation that (rightly) isn’t getting as much attention as rising food and energy costs is the effect on mergers and acquisitions. As the overhead cost to maintain a business soars, the cost of purchasing those businesses decreases. In February 2022, the value of M&A deals was down 30% from the same month in 2021.

While overall deal volume was down, the software and internet services sector has remained busy. Sectors outside of the technology realm have largely taken a step back from expanding while they wait for better market signals for what the short-term future holds. One could easily miss the consolidation in tech, which has in large part continued unabated. Indeed, when we emerge from this period of economic uncertainty, we may find the diversity of firms in many sectors substantially reduced. The latest landscape-changing acquisition is tax preparation service TaxAct, which sold for $720 million to private equity firm Cinven.

If that last sentence gives you pause, you’re not alone. Let’s get to know the newlyweds.

Cinven

London-based private equity firm Cinven made news earlier this year when it raised funding for a $1.5 billion financial services-focused fund. Cinven holds major interests in myriad sectors from telecom and medical diagnostics to pet care and casual dining.

In addition to making headlines for gobbling up firms, Cinven, through its subsidiaries, was at the center of a National Health Service scandal last year wherein the United Kingdom’s competition watchdog alleged the firm and others conspired to hike drug prices to the tune of 10,000% for commonly prescribed and readily available hydrocortisone tablets. Needless to say, Cinven’s record for fair dealing is at least in question.

TaxAct exists, and has thrived, in a sector that is no stranger to scandal. The company made its bones as the cheaper alternative tax preparation service to Intuit’s TurboTax. TaxAct advertised its federal tax preparation service as free for all filers with the idea it would charge for state filing and related services or protections.

The company was on some level blessed by the IRS as a member of the Free File Alliance, a group of tax preparation companies that negotiated with the IRS to provide free federal filing to 60% of taxpayers, with the decision of selecting the criteria for eligibility left up to the individual companies. Where other companies limited the free filing option to individuals below a certain income or within a specific age bracket, TaxAct advertised its federal filing as entirely free for everyone. The scheme worked, and TaxAct was wildly profitable.

Despite its profitability, TaxAct remained something of a bit player on the tax filing stage, so it largely avoided the negative publicity and government action that befell TurboTax, the largest provider. An earlier attempt by H&R Block, the second-largest tax preparation service, to acquire TaxAct was rebuffed by the Department of Justice.

A close-up of two hands grasping each other in a firm handshake.

Photographer: Fox Photos/Getty Images

The Union

Cinven’s acquisition of TaxAct fills a consumer-facing hole in its tax preparation offerings, with its 2021 investment in Drake Software targeting professional tax preparation. While tax preparation was and has remained a for-profit endeavor for some time, there is something disquieting about the idea of an equity firm seeing a growth market in consumer tax preparation. The growth envisioned is almost certainly not in software quality, service value, and customer service, but in the aforementioned ancillary services, from loans to “audit protection.”

Users of Drake Software noted a nearly 50% increase in prices for the service in late 2021 following the acquisition by the private equity firm. It seems if Cinven adheres to its past practices, TaxAct will see a similar increase. Whether the individual income tax preparation business can sustain such a hike in a more crowded market remains an open question.

More concerning than price hikes, private equity acquisitions have a well-earned reputation for spelling disaster for their targets. The thought is that they are structured to emphasize short-term value over long-term value and rapid returns over things like quality of service, brand loyalty, and all those other feel-good things we imagine put a human face to corporate ownership. When those motives interface with things like music and retail, the results can be frustrating. When they slam into the potentially predatory market of tax prep and financial services, the results may be catastrophic.

Details of the acquisition are scant, so it is not known yet how the financing shakes out—whether, for instance, this was a leveraged buyout where TaxAct will be taking on new debt to help finance its own acquisition. In either case, the sudden raising of rates isn’t a side effect of private equity ownership—it’s by design. Funds like Cinven extract management fees from entities held in their portfolio, and they make money whether or not the individual companies do. So TaxAct changing hands isn’t just about lowering one flag and raising another over HQ. It necessarily and immediately adds another debtor to the service’s bottom line. The business can continue to operate exactly as it did, and it nonetheless has more overhead simply by virtue of its new ownership structure. That can put pressure on a business to explore all avenues for potential short-term growth, which is worrisome in the tax prep space.

The Bottom Line

Filing your taxes should be free and not in any way involved with any entities motivated by profit—full stop. As it stands, most Americans are able to file their taxes for free, but it seems only about 3% do. This is largely due to tax preparation services making their business model obfuscate the free options they use to lure in customers. Only time will tell if TaxAct and Cinven is a match made in heaven or hell, but all past information would suggest the warmer of the two.

This is a regular column from tax and technology attorney Andrew Leahey, principal at Hunter Creek Consulting and a sales suppression expert. Look for Leahey’s column on Bloomberg Tax, and follow him on Twitter at @leahey.