James Brandell
A year ago, hopes for a bright 2022 were quickly thwarted by global unrest highlighted in Europe with Russia’s invasion of Ukraine, rampant inflation domestically, and lingering pandemic restrictions. More recently, the results of the midterm elections, which resulted in divided control of Congress for the first time since 2017, can give us some insight into what the legislative and regulatory environment may be for this year as companies look to make decisions on future transactions.
According to Dykema’s annual survey of M&A executives and professional advisors, nearly two-thirds of respondents reported that macroeconomic conditions had caused deals to be delayed or outright aborted in the 12 months prior. While economic indicators struggled throughout the year to avoid an official recession, economists have mixed thoughts about what 2023 may hold. The results of recent midterm elections, which resulted in divided control of Congress for the first time since 2017, can give us some insight into what the legislative and regulatory environment may be for this year as companies look to make decisions on future transactions.
While some may see divided government as a potential roadblock to growth, the results may, in reality, indicate some stability that companies will welcome when contemplating future deals. In Dykema’s report (compiled pre-election), respondents were asked how each of the four possible outcomes for the 118th Congress would impact M&A dealmaking: a Republican-controlled house and Democrat-controlled Senate—as will be the case—was viewed as having the least potential for negative effects, reflecting the report’s overall theme of tempered optimism for the coming year. With the House and Senate control split between the political parties, chances for sweeping pieces of legislation becomes minuscule. This fact translates into more regulatory certainty, for example with respect to the tax code, as companies plan for at least the next several years.
There are several areas related to M&A to keep an eye on either from the impact of legislation already enacted, or the potential change that could possibly arise with the current makeup of Congress.
Over the last two years, the Democrat-led Congress proposed sweeping changes to the corporate and individual tax codes under President Biden’s Build Back Better plan that would have impacted businesses large and small. However, after a year-long negotiation, the completed Inflation Reduction Act left rates intact but created a new corporate minimum tax for only the largest corporate entities.
However, one item that companies should take note of is the change to the expensing of research and development costs. Under the 2017 Republican tax reform bill, the ability to immediately deduct these costs changed starting in 2022. Beginning this year, research and development expenses must be amortized over five years rather than deducted in the year they occurred, which will impact the bottom line. Companies with significant spending on research and development should not expect a quick fix to change this back to immediate expensing.
Over the next several years, some positive impact will come from significant pieces of legislation recently passed by Congress. Funds from the bipartisan Infrastructure Investment and Jobs Act, which passed a year ago, will continue flowing to state and local governments and the private sector, boosting companies in numerous sectors such as road building, energy, and water infrastructure. For example, the bill earmarks $8 billion for establishing multiple regional clean hydrogen hubs across the country to nurture clean hydrogen production. The Department of Energy is taking grant applications from interested companies through April this year. These investments are already catching the attention of M&A dealmakers—according to Dykema’s panel, the energy sector will be one of the most active in the M&A world in 2023.
In the automotive sector, the Inflation Reduction Act’s $370 billion for climate and energy initiatives includes significant funding to speed up electric and emissions-free vehicle production and adoption. Competitive grants will start to be awarded over the next several years to companies that fit the criteria. And with the political divide in Congress, companies will have certainty that they will not face the risk of these incentives being withdrawn or canceled.
Another area companies should not overlook is the increased funding to the Internal Revenue Service and what that could mean to their bottom line. Congress recently passed an increase of $80 billion to the tax collecting agency over 10 years. Over half of the funds will go toward strengthening enforcement activities which means more audits for companies.
Debt-Ceiling Standoff – Here We Go Again?
The election results also revive a potential debt-ceiling standoff or government shutdown in 2023 that could impact financial markets. While Washington has avoided these standoffs over the last several years, a newly divided Congress could see them return. Congress will need to raise the country’s debt ceiling sometime this year as well as fund the government for its yearly budget. Some Republican members of Congress are threatening to hold back support on a debt-limit increase this year unless significant spending reductions are enacted. This could lead to a repeat of previous standoffs.
The U.S. has never defaulted on its debt, but a default would have severe and lengthy financial and economic effects on the country. The U.S. credit rating would almost certainly be downgraded, and interest rates would rise even further for many consumer loans. In 2011, even coming close to default caused the rating agencies to lower the U.S. credit rating.
Even when the debt ceiling battles settle, the threat of a government shutdown can negatively impact businesses relying on government contracts. We have seen partial government shutdowns happen more frequently recently, including twice during the Trump administration and once under the Obama administration. After several consecutive years of large spending packages by Democrats, the new Republican majority in the House is eager to attempt to reign in federal spending. In 2023 the odds of at least a partial shutdown will grow if Congressional leaders cannot reach an agreement on annual spending levels.
Companies should also be aware that the next Congress will see a greater focus on China and intense scrutiny of business dealings involving Chinese parties. The incoming House Republican majority plans to create a select committee on China to focus on various competitive economic and military issues with the geopolitical foe. Firms with supply chains linked to China, especially in the energy sector and life sciences, will come under the microscope of Congressional hearings. Despite the divide in Congress, China is one of the areas where members hope bipartisan work can be accomplished.
Overall, the midterm election results should usher in some relative stability for companies as they look to make their financial plans for the coming year, including with respect to M&A. However, history has demonstrated that stability rarely lasts long. With a presidential election now less than two years away, the policy ideas impacting future transactions will be coming fast and furious. It is crucial companies keep engaged with policymakers in Washington to ensure their priorities are being heard.
