WASHINGTON: An Introduction to Corporate/M&A

M&A in the Pacific Northwest
 

Midmarket M&A activity in the Pacific Northwest is extremely healthy. Buyers have access to debt and equity. Premier public companies like Amazon, Costco, Microsoft, Starbucks, Boeing and others have created an ecosystem of vendors and suppliers who are attractive targets for both financial and strategic buyers. In addition to public company ecosystems, there is a vibrant community of investors and startups, who have reinvested from prior equity events to create new and vibrant pre-IPO operating businesses with extremely bright futures. Businesses that are operating within these multiple operating channels mean stable and growing balance sheets.

In addition, many owners who made it through the 2008 downturn and then made it through the COVID-19 pandemic, are poised for an exit. They have made it through two “once-in-a-lifetime” events and are not waiting for a third. So, while the last year presented significant challenges, the companies that emerged with sound balance sheets and stable operations are well positioned for a lucrative equity event. A match of buyers with liquidity and sellers ready to transition has created a healthy M&A market where activity will continue into the foreseeable future.

Notwithstanding the general picture, the M&A markets in the Pacific Northwest are more complex than just a straight analysis of financial statements. The workforce in the region is highly skilled, with an abundance of opportunities from different employers. A growing commitment in the region for social justice, change and equity has translated into an express desire by both employees and employers to embrace ideals of diversity and a living wage. This means that acquirers should be prepared to embrace values other than just financial performance and be attuned to engaging in a conversation with their workforce on issues traditionally unrelated to jobs.

The same commitment to social justice caused legislatures to be more activist in this region. The Washington State legislature has enacted multiple laws in recent sessions that any party initiating operations or acquiring an operating business in the region should be mindful of, including, but certainly not limited to: a new capital gains tax (see Senate Bill 5096), restrictions on the scope and scale of noncompetes (see RCW Chapter 49.62), restrictions on the disclosures of salary information (see RCW Chapter 49.58) and a requirement that each employee have long-term disability insurance (see House Bill 1323). In addition, many local governments in the Pacific Northwest have also enacted new taxes on the payroll expenses of large employers (Seattle) and on higher-end personal incomes (Metropolitan Portland and Multnomah County). Notwithstanding the abundance of statutory changes that some would argue might impair economic growth, the region’s tax revenues remained strong during the COVID-19 pandemic and the groundwork exists for a robust and quick recovery to pre-COVID-19 pandemic economic activity, which will also facilitate M&A activity. In fact, as of the date of this writing, the recovery seems complete in most sectors, except restaurants, hospitality, and fitness-oriented businesses.

Washington State continues to impose transfer taxes on transactions that parties must consider when doing either a merger, asset or stock transaction. Real estate excise tax must be paid on the transfer of the target’s Washington real estate in any transaction, whether asset or equity, when the target’s owners are paid off. Sales or use tax can also apply to the conveyance of personal property in an asset deal, though some major categories like manufacturing equipment are exempt. Typically, the buyer pays the tax and it is generally in the vicinity of 10%. Washington State does not have a bulk sales exemption on the application of sales or use tax, unlike many other jurisdictions. Real estate excise tax is also a transfer tax but typically paid by sellers. The tax is high, with new graduated rates that approach an effective rate of 3.5% of the value of the real estate conveyed (also a 2019 product of legislative “rebalancing” of Washington tax burdens). We suggest that if the assumption is that either of the taxes are not due in connection with a transaction in Washington State, further analysis should occur to confirm that conclusion because of the complexity of Washington State’s atypical tax system.

From a legal perspective, the region aligns with the trend of complex transactions becoming more commodified and follows national trends on market terms. The ABA M&A Committee and other sources have done an excellent job of creating national guidelines on specific transaction components that enable parties to negotiate deal terms more efficiently. Areas of transactions that were historically difficult to negotiate like MAE clauses, “sandbagging”, “scrapes”, escrows, indemnity provisions, transaction covenants and other provisions are much more easily negotiated because sophisticated practitioners are uniformly using independent and reliable metrics provided by third parties to speed transactions along. Notwithstanding, complex deals have become more deliberate and arduous because parties are more rigorous in their diligence and financial modeling.

The one area of M&A practice that has undergone the most evolution is the use of representation and warranty insurance products. Twenty years ago, representation and warranty insurance was a rare and exotic tool. Now the insurance is used in many deals. Typically, the insurance has been used to fill gaps where the parties have agreed that the seller may not be able to perform in the event an indemnification claim is made. Recently, the policies have even evolved to a “no seller indemnity” structure where the seller, for an increased premium, is relieved of all liability, except for fraud. Sophisticated practitioners need to be conversant on the process of acquiring the coverage, as well as the negotiation over the policy exclusions. We believe that over the next decade representation and warranty insurance will be as ubiquitous as title insurance.

The next year should provide excellent opportunities in the midmarket M&A arena in the Pacific Northwest. The best values likely exist in areas that were most negatively impacted by the COVID-19 pandemic such as aerospace, fitness, restaurants, hospitality and food and beverage. However, even in this frothy market, Davis Wright Tremaine remains focused on specific industry verticals. The M&A team at Davis Wright Tremaine is deeply committed to healthcare, food and beverage, advanced manufacturing, seafood, restaurant, technology and family-owned businesses. Each industry vertical presents unique challenges and opportunities. Having an in-depth knowledge of these industries is key to creating positive outcomes and avoiding disaster. Please go to dwt.com if you would like to learn more about Davis Wright Tremaine’s M&A practice.