Q and A: The More Things Change, the More They Stay the Same

It seems fair to say that change is the one constant that every business faces. Whether the pandemic, inflation, or increasing interest rates for the first time in a decade, the fact that there will always be change, challenges, opportunities, and surprises remains one of the few constants. Currently, I am getting a number of questions about how these changes are affecting our clients and the market. Here are some of the most common questions.

How Have Interest Rates Impacted M&A and Investment Activity?

Interest rates clearly have an impact on M&A and investment activity (both internal and external), both in terms of the cost of deals and speed to market. However, we have not seen the large negative impact many feared. Certain industries have clearly been more directly impacted by interest rate changes, including homebuilders and developers, who are impacted both in their own cost structures and the fact that home loans are more expensive for buyers. But for other industries, the interest rates are not high enough to stop growth plans, plant expansions, or strategic acquisitions that are expected to provide significant returns. In addition, climbing interest rates were counterbalanced by reductions in other costs, such as shipping costs that have now basically returned to pre-pandemic levels. 

From what I have seen, I believe it is fair to say that the macro environment matters, but firm-specific factors are much more important in most situations. Many Iowa businesses continue to have significant demand for their products, face challenges finding workers, and need additional space. Those firm-specific factors have continued to support reasonable levels of investment and strategic M&A activity in a number of markets. Many have fairly strong balance sheets as well, making them less sensitive to borrowing costs when making investment and M&A decisions. 

Overall, I expect to see slightly slower M&A and investment activity overall in 2023, but within the normal variation we see here in Iowa. 

Am I Still Going to be Able to Transition my Business in this Economic Environment?

Another major factor driving some M&A activity is the lack of a transition plan for many business owners. As baby boomers continue to age and retire, many have not seriously invested the time and resources into building a strong transition plan, whether to their children, their employees, or to a third-party buyer. Some sellers also fear that more challenges could be coming and want to get out before the other shoe drops. While these owners desire to get a good price for their business in order to meet their retirement goals, they also know that they can’t wait forever. Their timing is driven more by personal factors than by the macro environment.

For family transitions, the higher interest rates and other macroeconomic factors may lead to lower projections and valuations for gifting purposes. Combined with the estate tax exemption that is scheduled to be cut in half after 2025, now may be a good time to consider intra-family transactions to move a transition plan forward. Time remains the one asset you can’t get more of, so acting sooner rather than later tends to pay real dividends when it comes to family transitions and estate planning. 

For those without family members interested in the business, many are taking the opportunity to look at alternative transition structures, like sales to employees directly or through an ESOP transaction. While not a fit for all businesses, selling to a company’s employees can meet both the owner’s financial expectations and their long-term goals for the business and community. Iowa and the upper-Midwest have long had a strong employee-ownership culture that tends to fit the values and interests of transitioning owners. The owner also has the advantage of not having to search for a buyer, but rather can find one internally or build it themselves instead of having to negotiate with private equity or other third-parties. 

Lastly, while slightly slower we still see strategic and financial acquisitions from other companies and private equity firms. While those deals are moving a little slower and the multiples may have mellowed a bit from some frothy peaks in recent times, they are still available for companies with strong and stable cash flow, management, and markets. 

Are Noncompete Agreements Really Going to be Banned?

Another hot topic that has been in the news a lot in 2023 is the FTC’s proposed ban on noncompete agreements. As background, in January the Federal Trade Commission (“FTC”) proposed a rule banning nearly all noncompete clauses and would require all existing noncompete clauses to be rescinded. The comment period with respect to the proposed rule ended in April, and it is unclear if/when a final rule will be issued. It is generally expected that the final rule will be challenged in court regardless of the particular language implemented, which will further delay the implementation of the rule. The FTC has also stepped up enforcement against specific companies with respect to their noncompete practices, claiming that the specific policies of those employers constituted unfair trade practices. 

Unwilling to wait on the FTC, many states and the U.S. Congress have also increased their activity in this area. Numerous states have passed bills banning or otherwise limiting the use of noncompete clauses. For example, in Iowa the legislature recently passed a rule prohibiting noncompete clauses in healthcare employment agency contracts. The U.S. Senate is considering a bill to ban noncompete clauses as well. The trend to ban or limit noncompete clauses clearly has some momentum and we expect noncompete clauses to come under increasing pressure over the coming years through regulations. Businesses would be well served to start preparing for changes now. 

Since a number of states have already banned noncompete clauses, businesses have already started adapting and finding ways to protect themselves and their businesses. For companies with substantial intellectual property, trade secret protection under state law and the federal Defend Trade Secrets Act (“DTSA”) will become even more important that it is currently. Employee handbooks, polices, and agreements should be reviewed to confirm that you have appropriate confidentiality and trade secret language, including the required language under DTSA. 

Companies with sales employees will likely also rely more on customer non-solicitation clauses. Such provisions will need to be carefully constructed to be reasonable in scope and duration, reasonably tied to the job performed by the subject employee, and not so broad that they are effectively treated like a noncompete clause. 

Practical protections to secure your proprietary information will also become more important. If you have sensitive information, making sure you have implemented strong access controls, audit trails/access logs, encryption, and copy protection can help ensure your data is protected and can’t be taken with a departing employee. The audit trails/access logs will also provide evidence about what data the employee accessed and may have taken with them if you ever need it. As with all secrets, it is easier to prevent someone from using or sharing the information if they never had access to it in the first place.