These are unprecedented times. From a recent global pandemic to rising inflation, the uncertainty of the world is being felt in nearly every industry and sector of business. And for those looking to acquire or merge a business, all eyes are, rightly, on current events. Yet, despite rising concerns and challenges, Nevadans are continuing to buy and sell, and business in the Silver State continues to move forward.
“There are a lot of distinctive external pressures [on the mergers and acquisitions (M&A) industry right now], said Albert Kovacs, shareholder at Brownstein Hyatt Farber Schreck. “There is post pandemic inflation, supply chain disruption, the COVID policy in China slowing down production in certain areas, and the war in Ukraine affecting energy prices. And you have what some say is corporate opportunism by companies raising prices because they have a cover of inflation to do so. This period just may be a little bit unusual in terms of what people predict and expect.”
Slowing Down
With so much uncertainty in the market, M&A activity in Nevada is generally slowing down compared to previous years. “2021 was one of the best years we have seen in terms of M&A activity in Nevada,” said Krisanne Cunningham, partner at Rice Reuther Sullivan & Carroll. “And while there are some headwinds right now in the market generally, I still characterize the M&A market in Nevada as solid with a bit of softening, especially compared to early 2022. But we continue to see strong buyers in the market right now with a mix of private equity and strategic buyers.”
The softening in the market can be attributed to a number of factors, all of which are largely taking place on a national and global scale and impacting nearly every industry. Perhaps the most concerning challenge for those looking to acquire or merge a business is questions regarding the ability to finance certain deals. With increasing interest rates and the uncertainty of their future trajectory, many deals are ending before they have even begun.
“During the course of this year, because of general economic conditions and sentiment, the overall trend is for a slowdown in M&A activity because of concerns about inflation,” said Kovacs. “A lot of M&A activity is facilitated by financing and so [when] interest rates go up, those financing costs become substantially higher, and make some deals more expensive, especially when corporate profits are relatively high. Sometimes that can price people out of the deal, or they may wait until interest rates come down or there is a little more certainty in the market. This situation is a little bit unusual because this doesn’t necessarily feel like the typical up down cycle of the economy growth recession.”
Buyers and sellers in every market are being impacted by interest rates. For the M&A market, some appeal is being lost on sellers who are actively losing value in their business. “The average business owner who may be looking at some sort of an exit sale of their business has to understand that with the increase in interest rates, the multiples that are applied in valuing businesses have come down,” said Mike Kearney, shareholder at Holley Driggs. “Higher interest rates for an acquirer means that the cash flow available to service debt does not support the higher valuation because it is being eaten up by a potentially higher interest rate. You have a lot of folks out there who may have been looking to sell their businesses and had some expectations in terms of valuation based upon what people were telling them a year or 18 months ago, or what they were seeing their competitors receiving and now those valuations have dropped. People’s expectations must catch up with the realities of the finance side.”
Larger transactions in Nevada, specifically in the gaming industry, are also experiencing significant stalling in M&A activity. “When you sign a deal to acquire a casino or an equipment manufacturer, you are looking at anywhere from [about] 13 to 16 months of licensing and investigative process from what I understand from discussions with our gaming control regulators,” said Kearney. “That extenuated timeline really puts off lenders. They have no idea what interest rates are going to look like in 13 or 14 months. They will not commit to fund gaming acquisitions that are that far out. In our state, that really puts the breaks on a lot of the potential gaming acquisitions.”
Fortunately, this hesitancy from lenders, business owners and buyers is not being felt nearly as strongly in middle market transactions. “There was some concern earlier in the year as interest rates started rising that that was going to have a negative impact on deals,” said Jim Newman, partner at Holland & Hart. “And while interest rates have increased, that may have impacted larger deals that involve leverage or borrowing. But I think in the sort of mid-market to smaller sized deals, the interest rate increase has not had as much of an impact as it may have had on larger transactions. For middle market transactions, deal volume is still strong despite the increase in interest rates.”
No One Size Fits All Approach
Most private acquisitions are structured as either a purchase of equity or a purchase of assets, with mergers being a third and less common alternative. Yet, despite possible commonalities between two deals, there is no one size fits all approach. Each transaction is unique and has specific challenges and benefits for both the buyer and seller. “Whether it is an asset sale, or an equity sale, can be the difference of hundreds of thousands or even millions of dollars to a buyer and seller,” said Cunningham. “It is important that each side discuss the structure thoroughly with their advisors even before entering into a letter of intent. The benefits of each type of deal are going to depend really on whether you are the buyer or the seller.”
Individual circumstances also determine the quality and experience of a transaction on both sides of the aisle. “There are pros and cons to each approach, and the legal and tax consequences vary widely depending on the specific circumstances of both the buyer and the seller,” said Brian Blaylock, partner at Snell & Wilmer. “There’s a range of legal and tax consequences depending on how the entities are treated for tax purposes, what the nature of the ownership is, what industry the business the target is in, and what kinds of assets it holds. Whether the business has long-term contracts or not, whether the business has fixed assets or not, and a host of [other] circumstances will determine the more or less appropriate structure. That said, there is a cliche or an expression that all things being equal, buyers often prefer to buy assets and sellers often prefer to sell equity. But there are so many exceptions to that guideline that, ultimately, the way transactions get done is by assessing the pros and cons in light of the party specific circumstances and ultimately negotiating a resolution that works well enough for each side.”
Each transaction also carries with it its own individual tax implications. “One of the most important things for businesses and sellers and buyers to understand is that the tax treatment of the transaction is very important,” said Newman. “[For example], if you are selling your company for $25 million, you probably are not going to net $25 million when the transaction closes. Part of the reason is that you probably are going to have some type and level of tax due on that transaction.
Businesses, buyers and sellers need to understand that there are really three categories from a tax standpoint. You either have a transaction that is taxable, tax deferred, or there is potential that you have got a hybrid where some of the consideration might be taxable and some of it might be tax deferred. It is important to understand those different tax landscapes as you go into a transaction.”
A Team Sport
Deciding to buy, sell or merge a business is a complex process that requires a significant financial commitment and an extensive amount of due diligence. While it is not a decision to be made lightly, there are a number of things that business should be aware of before taking the leap. Priority among those is placing an emphasis on assembling a team of experts. “Mergers and acquisitions are potentially very high reward transactions,” said Blaylock. “However, those potential rewards are often associated with high risks and working with advisers who specialize in mergers and acquisitions can help mitigate those risks.”
Especially in Nevada, it is imperative that business owners educate themselves and hire experts to guide them throughout the M&A process. Although the Silver State is known for being pro-business, Nevada laws are unique and increasingly complex compared to other states. Failure to pay attention to detail could end a deal or mean the difference in a significant amount of capital. “For Nevada businesses in particular, one thing that I think is very important from a legal perspective is that people should not make assumptions,” said Kovacs. “They should not go on their instinct or what they have heard on TV, or what they have read about in business books in terms of how things should be negotiated or what the rules of the road are. In Nevada, our legal framework for the decision-making process and the approval processes for M&A activity [is very complicated]. Whether you have a corporation or an LLC, [or] whether you are a public company or a privately held company, it is important to know the distinctions under Nevada law because the rules of the road here are slightly different and, in some cases, substantially different than other jurisdictions.”
Recognizing that Nevada is unique in terms of business law, assembling a team of experts that communicate with one another is one of the first steps to a successful transaction. “Mergers and acquisitions work best as a team sport,” said Blaylock. “For business owners and for people who are looking to buy and sell businesses, I cannot recommend enough to introduce your advisors to one another. Whether you are a buyer or seller, do not receive advice in a vacuum. In other words, your CPA knows different things than your M&A lawyer, who knows different things than your estate planner, who knows different things than your commercial banker. The input from your CPA may very well change a recommendation from your M&A lawyer and input from your M&A lawyer may very well change the recommendation from your estate planner or vice versa. Make sure your advisors are talking to each other and to you so that everybody can collaborate on accomplishing the client’s objectives.”
A Great Place for Business
Buying or selling a business is no ordinary event. “If you are a first-time buyer or a first-time seller, the entire process from start to finish is likely going to be more involved and complicated than you think,” said Cunningham. It is something that requires extensive due diligence on both sides of the transaction, a team of experts and usually a lengthy period of time. Paired with the innate challenges already existent in the M&A process, is the reality and impact of current events on this subset of the legal industry. Yet, despite the many challenges facing business owners and potential buyers, M&A activity in Nevada continues to move forward, and the Silver State continues to be a great place for business.
“With respect to Nevada, our corporate and LLC laws are distinctive from other jurisdictions and usually in ways that make people happy when they hear those distinctions,” said Kovacs. “Nevada generally has a very pro-business climate overall and our corporate LLC laws mesh with that ideology well. [There is] a very good balance of flexibility and accountability. It is not a free for all, but the laws give folks who own and run companies the flexibility to make good decisions for them, for their employees, and for their company in their circumstances, without being too boxed in by one size fits all approaches that you may see in other jurisdictions.”