Insights on M&A Trends and Issues

Brian Schusterman, a Partner in our Business Entities & Transactions Practice Group, was interviewed by Nevada Business Magazine for his insights on trends and issues involved in mergers and acquisitions. The article titled “Mergers & Acquisitions: Less Harrowing, More Helpful in Reality than in Popular Fiction,” is provided below and available here. Brian’s quotes are highlighted in the article below.

 

Mergers & Acquisitions: Less Harrowing, More Helpful in Reality Than in Popular Fiction
Nevada Business Magazine, November 2024, by Jennifer Rachel Baumer

In the movie Hook, grown up Peter Pan has become a pirate himself, raiding companies through hostile mergers and acquisitions (M&A). In Pretty Woman, Richard Gere is a high powered lawyer bent on taking over a company whose current owners—grandfather and grandson—aren’t sure they want to sell, or at least not to him.

Fictional M&A are more dramatic when mergers are hostile and acquisitions are made by force. There are hostile M&A out there, but they tend to involve large publicly traded companies, and they’re fairly rare. Most of the time, M&A deals are an exit strategy for the seller and an entrance strategy for the buyer. Deals can breathe new life into businesses, and keep companies alive after the retirement or death of the owner.

“Occasionally [deals] are hostile. Those are not really the types of transactions I’ve been involved in,” said Brian Schusterman, partner, McDonald Carano. Usually it’s one company looking to purchase another. “Sometimes [the purchase is by] a competitor. Sometimes it’s a private equity firm or venture capital firm trying to get into the space, or an investment fund looking to get into a certain area, and there may be multiple strategic acquisitions, so sometimes it’s local. Sometimes [the buyer] has a business broker to help them find and acquire.”

Every Business Has a Story—Reasons Behind M&A Deals

“Generally speaking, an M&A transaction is when a seller wants to sell a business to another company or group and that company or group—the buyer—wants to purchase the business,” said Krisanne Cunningham, managing partner, Rice Reuther Sullivan & Carroll. “But [transactions] can take on different forms.” A merger is a transaction when one company merges into another and combines with another until only one of the two companies survives. It involves filings with the secretary of state and specific procedures that require compliance under state law. Acquisitions can take different forms, including equity and asset purchases. When a buyer purchases the ownership interest of a company, that’s an equity purchase. When the buyer purchases the asset of a company, it’s an asset purchase.

“In an asset purchase the company itself is the seller,” said Cunningham. “Very generally speaking, the buyer is going to prefer to purchase the asset, while the seller is going to prefer to sell the equity.” There’s more than one reason for each of the preferences, but in general the buyer prefers the asset because they get a step-up in tax basis, which is the increase in value of the assets the buyer acquires in an asset acquisition. “The default is that they only purchase the asset, they don’t assume any liabilities of the seller other than what’s specifically agreed to,” said Cunningham. The flip side is sellers generally prefer to sell equity, also for tax reasons, because in general, “Selling the equity is a little more tax beneficial to the seller and the default is that all of the assets and all of the liabilities transfer to the buyer except if certain liabilities are specifically included,” said Cunningham. “It’s the reverse in terms of liabilities.”

Triggering an M&A

Almost any company can be part of a M&A deal in terms of who buyers and sellers might be, and there’s a variety of events that can trigger a deal. For the seller, there’s a number of reasons to want to sell or to be acquired. There’s the wave of baby boomers who want to retire, and there are sellers whose business has experienced a period of high and rapid growth who want to capitalize on that.

“We are seeing a lot of baby boomers trying to retire and they’re looking at that as an exit strategy. That’s common,” said Schusterman. “Other times it’s because someone has developed an excellent business and someone else sees an opportunity to acquire that business and grow it.”

“From the buyer’s perspective, they might want to enter the market when they see there’s lower valuation and multiples happening right now. Or there may be strategic reasons, like taking advantage of some synergies or efficiencies they think they may be able to produce by purchasing a particular business,” said Cunningham. “In our area, most [deals] are driven by the retirement of the owner or owners, or a planned event,” said Katrina Loftin, co-founder, M&A Business Advisors. “A lot of private equity groups buy companies in the lower middle market and they will hold on to them for five years, maybe a 10 year hold, and then they have a planned event to put the company on the market and sell it.”

During the hold, the private equity group will build the company through new processes, or they may add it to a portfolio company, adding it to a larger company to increase its revenue. “A lot of times that can simplify some things. If they have other companies in their portfolio that are in the same industry or similar industries, combining them can eliminate certain departments like accounting and HR. That can be a huge savings event on the company, making it more profitable. When they eventually exit that company they will end up getting a higher multiple or higher amount for that company, because of profits being higher.” Which, again, rather than the hostile movie-style takeover, everyone involved is in agreement regarding what’s going to happen. “Private equity groups typically have a plan and I would say probably 30 to 40 percent of our buyers are private equity groups,” said Loftin. Same for the seller. There’s a plan in place, generally one that’s been in the planning stages for a while. “We typically start working with the seller [in a deal] and we try to work with the seller at least one year prior to them selling so that we can help them plan and clean things up so that [the company is] ready to go to market,” said Loftin. “We try to plan one to five years in advance if we can.”

Buyer—and Seller—Beware

One of the biggest pitfalls for buyers and sellers in an M&A deal is one or both sides not bringing in professional advisors to help create the most tax efficient structure. There can be real traps for the unwary with tax consequences on the sale, Cunningham indicated. There can also be benefits from bringing in professionals. “The specific structure used can save one side or the other hundreds of thousands, if not millions of dollars.”

In M&A, deal structure refers to terms and conditions of the transaction. That includes how the purchase price will be paid, the legal and regulatory requirements, and the allocation of risks and rewards between buyer and seller. “Early in the discussion or negotiation the selling party won’t consult with their legal and/or tax advisors; they fail to bring in their professional advisors early on and some decisions with respect to structure can have significant tax implications, for example. And it’s not always easy to un-ring the bell if you’ve been in negotiations with the acquirer for a long time and all of a sudden you’re proposing a different structure of the transaction,” said Schusterman. “That’s one of the things that’s costly, one of the biggest pitfalls that I see.”

Sellers also want to do due diligence in making certain if they’re going to receive some ownership from the buyer as part of the purchase—called rollover equity—that they’re comfortable with the value of the rollover equity they’re getting. “In terms of the basics, you want to make sure there’s a meeting of the minds on the key business terms, for example through a letter of intent, before the buyer starts drafting a document, because there’s significant fees and costs and time involved in an M&A transaction,” said Cunningham. “You want to make sure you have a meeting of the minds before you get too far into the deal.”

One pitfall in M&A deals is customer concentration. Like the old “don’t keep all your eggs in one basket” rule, businesses should avoid having one customer represent 15 percent or more of sales. Otherwise there’s danger of losing a big customer and having the company lose value. Keeping good management in place is important. A recent trend Loftin has seen is owners reaching retirement age and their management team is as well. “It’s important to have good management in place when you are ready to step down and sell the company,” Loftin said. If, for example, a private equity group buys the business, they’ll have some sort of management in place, but they rely on existing management to run the company, at least at the outset. “It’s really important to have that management in place and make sure they’re not going to leave with the owner.”

Buyers also need to be aware of transferrable contracts. Many aren’t, so it’s important for buyers to talk with each individual customer to make sure the contract will transfer to the new owner. “Depending on the type of industry, sometimes the selling party will need to obtain consent from a third party with respect to a contract that they have, or some kind of regulatory consent, and they don’t run those into the ground early enough. That can create a pitfall in terms of delaying closing or preventing closing,” said Schusterman.

Trends

Private equity groups that buy businesses and hold them for a number of years typically have a plan for that business. What that plan is depends on the private entity group in question. A current trend Loftin has observed is that some private equity groups actually plan on holding the companies for the long term. “We have some that will eventually turn the ownership over to the employees of the company, and that’s been a recent trend that’s also different,” said Loftin. If that sounds positive, that’s because it is. “And it should be,” said Loftin. “Very rarely do we have adversarial [deals]. Sometimes there is an occasion where someone has to sell their business, either from a health event or someone has died, it’s a family business and the father dies and there’s no succession plan within the family or within the company for someone else to take over. Sometimes those are difficult situations, but we hardly ever see adversarial ones.

Another current trend in M&A is those looking to acquire compelling pre-closing reorganization; internal company reorganizations that will allow the buyer to achieve the tax outcomes that they want. In other instances the seller is utilizing rollover equity and either retaining ownership in the business that’s selling, or more commonly, according to Schusterman, they’ll get a stake in the business that’s acquiring them. “It’s also fairly typical for the seller to stay for a period of time depending on where they are in their career trajectory, and how old or young they are. They might stay on for some period of time to help with the transition and particularly if they’ve received rollover equity, to help make sure the business is on the right path so they’re preserving their investment in the new entity,” said Schusterman.

“We had an uptick in lower middle market because SBA (Small Business Administration) limits a couple years ago went higher, so they will do up to $5 million for a business acquisition, and up to $25 million on real estate,” said Loftin. That’s increased the buyer pool by making it possible for regular people to buy a $2 to $5 million business. That said, deal volume decreased about 25 percent between the first half of 2023 and the first half of 2024, according to Cunningham. It’s down across all industries, but probably more so in the private equity space.” I’m expecting there to be a rebound in the second half of 2024, and especially in the first half of 2025, with some industries rebounding more quickly than others.”

Cunningham is seeing more strategic corporate buyers than private equity buyers in the current market; corporate buyers tend to have cash right now while private equity buyers often require funds to finance part of the purchase price. With interest rates as high as they’ve been and financing more expensive in recent years, sellers are taking their time and considering their purchases carefully, waiting for quality assets and businesses. The Federal Reserve lowering interest rates in September for the first time since 2020, and the expectation that rates will continue to go down, is part of the reason Cunningham expects to see deal volume increase in early 2025. The most important thing for anyone involved in an M&A deal is planning. Planning before there’s an illness or death in the company, before there’s the loss of a manager or a big client. It’s important to meet with advisors long before considering buying or selling a company. Before acting to merge with or acquire a business, sellers need to structure their merger or acquisition deal as an exit strategy, and buyers need to understand how the deal works best for them as an on-ramp.

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