Corporate M&A 2022

Last Updated April 21, 2022

Israel

Law and Practice

Authors



Naschitz, Brandes, Amir & Co is one of the largest full-service law firms in Israel, with more than 230 lawyers in all areas of commercial practice, including 19 M&A partners and 70 M&A associates and other legal practitioners based in its Tel Aviv office. The firm has one of Israel’s powerhouse M&A practices, advising leading domestic and multinational corporations as well as investors and funds such as FIMI, Israel’s largest private equity fund. With extensive experience in cross-border M&A, the firm’s lawyers are among the most experienced and effective in Israel. They have been involved on the buy and sell side of public and private M&A transactions that include several of the largest cross-border M&A deals ever done in Israel, such as the USD7.1 billion public merger of Frutarom with NYSE-listed International Flavors & Fragrances Inc. The M&A practice is supplemented by the firm’s prominent capital markets, regulatory, competition, real estate, tax, labour and litigation practices.

The number of mergers and acquisitions (M&A) in Israel increased by approximately 70% in 2021, with 238 M&A deals in the year compared to 123 deals in 2020 (according to the PwC Israel 2021 M&A Report), the highest annual deal count in the last decade. The overall value of deals reached USD30 billion in 2021 (or USD82 billion including special purpose acquisition companies (SPACs) and IPOs), an increase of more than 75% compared to the USD17 billion set in 2020.

Overall, after a few months of COVID-19 uncertainty in 2020, the pace of M&A returned to full speed in 2021.

Average deal value dropped in 2021 to USD126 million, which represents an 18% decline (excluding exceptional transactions), over last year’s total. Taking advantage of the attractive US market for publicly traded SPACs and for IPOs in 2021, many companies elected to take the IPO route or merge via a SPAC, which resulted in a decrease in mega deals, with only one M&A deal closing at more than USD1 billion in 2021, as compared to five such megadeals in 2020. The attractiveness of SPACs has been significantly reduced since Q4 2021 however, and we do not expect it to return soon to the record levels it had experienced in early 2021.

One of the main reasons for the significant increase in M&A activity in 2021 was the amount of available cash in the market, while at the same time, large, new public Israeli companies added more companies to the circle of investors, as they designated M&A as a major pillar of their growth strategy and directed significant amounts of money toward this activity. The considerations for acquisitions included rapid achievement of technological improvement, attainment of a competitive advantage in the market, expansion of market share and creation of new markets.

The market also experienced growth in the number of Israeli companies acquired by Israeli companies, which accounted in 2021 for 82 transactions, with a total value of USD2.8 billion, compared with 46 deals in 2020. Of such “local” M&A deals, 44 were in the tech sector, totalling USD1.5 billion, and 12 deals were in services and consumer products, totalling USD291 million.

As in previous years, hi-tech M&A deals dominated in 2021.

The COVID-19 pandemic has increased demand for IT and enterprise software, which continued to lead the pack in 2021 growing significantly over 2020, and for businesses in the internet space, which also experienced impressive growth in 2021. While life sciences deal value increased significantly in 2021, it still remains a relatively small portion of the overall deal volume.

There are three primary methods of acquiring a public company in Israel: a statutory merger, a tender offer and a court-approved merger.

Statutory Mergers

Pursuant to Israel’s Companies Law 5759-1999 (Companies Law), a merger may only be effected between two Israeli companies. Therefore, most acquisitions of Israeli companies by non-Israeli buyers are effected by means of a reverse triangular merger, whereby the acquiring company forms an Israeli subsidiary, which is then merged with and into the Israeli target company.

Tender Offers

The second method for acquiring public companies is by way of a tender offer commenced by the buyer and directed to all company shareholders. If, as a result of the tender offer:

  • shareholders holding less than 5% of the company’s shares had not accepted the offer and a majority of the shares held by shareholders that did not have a personal interest in the offer had accepted the offer; or
  • shareholders holding less than 2% of the company’s shares had not accepted the offer,

then, the Companies Law provides that the purchaser automatically acquires ownership of the remaining shares. However, if the purchaser is unable to purchase (together with the shares it holds) more than 95% or 98% (as applicable) of the company’s shares, the purchaser may not own more than 90% of the shares of the target company. In light of the high squeeze-out threshold, buyers rarely use a tender offer if the goal is to acquire 100% of a public company.

Court-Approved Mergers (Scheme of Arrangement)

The third method available for acquiring public companies is a court-approved merger. This procedure involves an application to a court in Israel on behalf of the target company. The court is authorised to approve the merger, after at least 75% of the shares participating in the vote of the target company, as well as a simple majority of those shareholders attending and voting at such a meeting (as well as creditors, if applicable), approve the merger.

In addition, Israeli law permits the acquisition of all or a significant portion of the assets of an Israeli public company, in which case the approval of the selling company’s shareholders is not required.

The primary regulators for M&A activity in Israel are the Israeli Securities Authority (ISA), the Israel Competition Authority and the Israel Tax Authority. In addition, the Capital Market, Insurance and Savings Authority in the Ministry of Finance is the primary regulator responsible for approving acquisitions of regulated financial companies and fills a key role in such acquisitions.

There are no general restrictions on foreign ownership of shares in Israeli companies, other than restrictions on residents of countries at war with the State of Israel.

Israeli companies that participate in certain government funding programmes – eg, the research and development grants of the Israel Innovation Authority (formerly known as the Office of the Chief Scientist), and tax incentives of the Investment Centre – require the approval of these agencies prior to certain changes in their shareholding, including when non-Israeli shareholders acquire specified ownership levels.

Generally, an antitrust filing will be required in Israel for a transaction if each of the counterparties (together with controlling, controlled-by and under-common-control entities) has an annual turnover in Israel of at least ILS10 million (which the antitrust authority has proposed be increased to ILS20 million), and both parties together have an aggregate annual turnover in Israel of at least ILS360 million.

In addition, even if these thresholds are not met, a filing would still be required if:

  • one of the parties (together with controlling, controlled-by and under-common-control entities) holds a monopoly in any given defined market in Israel or worldwide; or
  • as a result of the acquisition, the market share of the combined companies (together with controlling, controlled-by and under-common-control entities) in the production, sale, marketing or purchase of a particular asset and similar assets or in the provision of a particular service and similar services, would exceed 50%.

Generally, the approval of employees is not required in M&A transactions. However, a change of control may, in certain circumstances, be deemed a termination of employment, entitling the employees to receive severance payment as if their employment had been terminated. It is also worth noting that employees cannot waive severance rights and certain other employee social rights, and that the enforceability of covenants not to compete in Israel is subject to limitations.

There is currently no general national security review of acquisitions in Israel. However, the Israeli government has formed an oversight committee to review the national security aspects of foreign investments in Israel, which is tasked with evaluating and recommending whether, and in what scope, to implement such an acquisition review process. In addition, Israel may retain certain veto or other rights with respect to natural resources and companies providing essential services.

The COVID-19 pandemic has triggered new challenges to the interpretation of material adverse change (MAC) clauses in M&A deals, with buyers seeking routes to walk away from deals signed in 2019 and early 2020, before the COVID-19 pandemic had spread.

A key Israeli M&A deal, which reached the Delaware Chancellery Court, was the unsuccessful attempt of NASDAQ-listed Comtech Telecommunications to walk away from its USD580 million acquisition of our client, Israeli-based and NASDAQ-listed Gilat Satellite, asserting a MAC. We were successful in defending the case and obtaining a record USD70 million settlement fee for our client.

Since the litigation was settled before the case was fully litigated, the opportunity for a significant court decision affecting the interpretation of MAC clauses in the Israeli M&A context was missed.

See 1. Trends.

The Companies Law provides that an acquisition of shares in a public company must be made by means of a “special tender offer” if, as a result of the acquisition, the purchaser would hold 25% or more of the voting rights in the company, unless there is already another shareholder of the company with 25% or more of the voting rights.

Similarly, the Companies Law provides that an acquisition of shares in a public company must be made by means of a special tender offer if, as a result of the acquisition, the purchaser would hold more than 45% of the voting rights in the company, unless there is already a shareholder with more than 45% of the voting rights in the company.

Accordingly, the ability to build a stake in a target that equals or exceeds 25% prior to launching a special tender offer or entering into merger discussions with the target is limited.

Any person who acquires an interest of greater than 5% in a company listed on the Tel Aviv Stock Exchange (TASE) is required to notify the company of the acquisition. The company is then required to file a notice of this acquisition with the TASE and the ISA. Thereafter, any further sales or purchases of shares by that shareholder, for so long as the shareholder holds an interest above 5%, are subject to similar disclosure requirements.

Shareholders seeking to cross the 25% or 45% ownership thresholds are required to commence a special tender offer as described in 4.1 Principal Stakebuilding Strategies.

Shareholders of public Israeli companies listed on stock exchanges in the USA or the UK are subject to the reporting requirements that apply in those jurisdictions.

Although there is no specific Israeli law that prohibits a company from introducing additional reporting thresholds beyond the mandatory statutory reporting requirements, Israeli companies do not introduce such requirements in their articles of association.

Exceptions apply for companies in industries that require special regulatory approval for passing ownership thresholds, such as companies with licences from the Ministry of Communications, or banks and other regulated financial companies that require the approval of the Supervisor of Capital Market, Insurance and Savings in the Ministry of Finance when passing specified thresholds.

Dealing in derivatives is permitted.

Generally, the reporting obligations for derivatives are similar to the reporting obligations that apply to the underlying securities, as described in the responses to prior sections.

A shareholder is required to make known the purpose of its acquisition and intention if the shareholder commences a special tender offer as described in 4.1 Principal Stakebuilding Strategies.

A TASE-listed company is generally required to disclose active negotiations and the receipt of a non-binding letter of interest. However, aside from public leakage, the company may defer disclosure until a definitive agreement is signed, if the board of directors determines that the disclosure of the negotiations and/or non-binding letter of intent may jeopardise the consummation of the transaction or have detrimental effect on its terms.

Generally, companies tend to rely on the exception described in 5.1 Requirement to Disclose a Deal to defer disclosure until a definitive agreement is signed.

In the context of friendly negotiated deals, it is common to perform detailed business, legal, accounting, finance, tax, intellectual property and other industry-specialised diligence, recognising that no post-closing indemnity obligations exist in public company deals. Following the lifting, in the second half of 2021, of the travel restrictions imposed because of the COVID-19 pandemic, M&A diligence practices seem to have returned to historical practices. 

Standstills are generally not common in the Israeli market. On the other hand, it is common for the board of directors of a public company to undertake a certain exclusivity period as part of its business judgement, particularly if the company has already undertaken a market check process. “Go shop” provisions have also been included in several Israeli public deals in recent years.

Tender offer terms are generally not documented in a definitive agreement other than in the case of agreements between the bidder and a significant shareholder agreeing to accept the tender offer.

Mergers

Following the execution of the definitive merger agreement, each merging party is required to convene a shareholders’ meeting to approve the merger (with advance notice of at least 35 days), and to file a formal merger proposal with the Israeli Companies Registrar. The Companies Registrar will effect the merger and issue a certificate of merger after the later of:

  • 50 days after the filing of the merger proposal; or
  • 30 days after approval of the merger by the shareholders of both merging companies.

Tender Offers

A tender offer must remain open for at least 14 days, or if the offer qualifies as a “special tender offer”, as discussed in the response to 4.1 Principal Stakebuilding Strategies, for at least 21 days. The maximum time period for maintaining a tender offer is 60 days, which may be extended if a competing bid is issued during that period.

Court-Approved Mergers (Schemes of Arrangement)

Following the execution of the definitive merger agreement, the company files a petition to the Israeli court to approve the convening of a shareholders’ meeting and a creditors’ meeting, which can take up to 30 days. The meetings to approve the merger are typically set within 30 days after the date of the court order.

Government measures taken to address the COVID-19 pandemic have not created delays in or impediments to executing and closing M&A deals. 

See 2.1 Acquiring a Company and 4.1 Principal Stakebuilding Strategies.

Israeli law does not regulate the types of consideration that may be paid in a takeover. In recent years, cash has been the more common acquisition consideration but in periods when global interest rates are higher the number of deals that include share consideration tends to increase.

If the consideration is paid in the form of shares or other securities, the bidder must comply with the relevant provisions of the Israeli Securities Law 5728-1968 (Israeli Securities Law), including filing and obtaining the approval of the ISA to publish an Israeli prospectus, unless a prospectus exemption is available. An exemption may apply if the buyer dual-lists its securities on the TASE.

In an environment of deal uncertainty, parties may use caps, floors and collars to address fluctuation in share deals, although the use of such instruments is not presently very common, particularly since cash is currently the dominant form of consideration, given the amount of available cash in the market and low interest rates. 

With regard to mergers, Israeli law does not restrict the type of closing conditions that the parties may agree to include in the definitive merger agreement.

Tender offers may be subject to conditions only with respect to the receipt of governmental consents, permits or licences that the bidder needs to acquire the shares; and to the affirmative offer acceptance by a minimum number of shares specified by the bidder in the tender offer document. A bidder may also withdraw a tender offer if unforeseen and unforeseeable circumstances have occurred since the announcement of the tender offer that have resulted in the offer terms being significantly different from those that a reasonable bidder would have offered had the conditions been known at the time of making the offer.

The level of approvals varies, based on the transaction structure.

Mergers

A merger requires the approval of the board of directors and the shareholders of each merging company. Generally, a simple majority vote is required. However, a merger involving a controlling shareholder’s personal interest may trigger special majority vote requirements. Furthermore, a company may provide in its articles of association for a higher majority vote threshold. Shares held by the other merging company or certain affiliates are generally excluded from the vote.

Tender Offers

In order for the bidder to cross the 90% threshold in the full tender offer, the bidder must acquire either:

  • more than 95% of the company’s shares (including the shares held by the bidder) and a majority of the shareholders that did not have a personal interest in the offer must have accepted the tender offer; or
  • more than 98% of the company’s shares (including the shares held by the bidder), and in this instance the remainder of the shares are squeezed out.

However, if the purchaser is unable to purchase more than 95% or 98%, as applicable, of the company’s shares, the purchaser may not own more than 90% of the shares. In the case of a special tender offer to cross the 25% or 45% ownership threshold, as described in 4.1 Principal Stakebuilding Strategies, at least 5% of the shares must accept the special tender offer.

Court-Approved Mergers (Scheme of Arrangement)

In addition to court approval, the merger is also subject to the approval of the holders of at least 75% of the shares present and voted as well as a simple majority of those shareholders attending and voting at the meeting. The approval of creditors may also be required in accordance with the court’s order.

The parties may agree to condition the merger upon the bidder obtaining financing. A bidder cannot condition a tender offer on obtaining financing.

Merger agreements may contain provisions for break-up fees in the event that the merger is not consummated, typically due to the target company’s board exercising its “fiduciary out”. Non-solicitation, match-up rights and force-the-vote provisions are also common; however, in recent years, the inclusion of limited period “go shop” provisions, as an exception to the non-solicitation, are also becoming more common, particularly in cases where the company did not perform a comprehensive market check before entering into a definitive merger agreement.

As the COVID-19 pandemic has unfortunately become an ongoing concern, parties tend to negotiate the exclusion of COVID-19 pandemic effects in material adverse change (MAC) clauses, and to include representations, warranties and covenants to address compliance with COVID-19 measures. In certain cases, provisions are also included in the definitive agreements to address the need of the target and/or its global subsidiaries to repay COVID-related government grants and loans in different jurisdictions, such as the Paycheck Protection Program (PPP) loans in the USA. 

Generally, any agreement between a public company and its controlling shareholder (defined for this purpose as the holder of more than 25% of the shares), requires the special approval of shareholders without a personal interest in the matter. Accordingly, it is difficult for the bidder to obtain special rights from the public company.

Shareholders can vote by proxy in Israel.

See 2.1 Acquiring a Company and 6.5 Minimum Acceptance Conditions. The squeeze-out threshold under Israeli law is very high and therefore the acquisition of 100% of a public company is typically conducted by way of a statutory merger or court-approved merger and not by a tender offer.

In many friendly negotiated merger transactions, significant shareholders execute voting or support agreements with the buyer undertaking to vote in favour of the merger at the general meeting of shareholders.

A voting or support undertaking typically provides that the shareholder may revoke its undertaking if the board of directors of the target company changes its recommendation in accordance with the terms of the merger agreement.

See 5.1 Requirement to Disclose a Deal.

As described in 6.3 Consideration, if the consideration is paid in the form of shares or other securities, the bidder must comply with the relevant provisions of the Israeli Securities Law, including filing and obtaining the approval of the ISA to publish an Israeli prospectus, unless a prospectus exemption is available. An exemption may apply if the buyer dual-lists its securities on the TASE.

Depending on the scope of the transaction, pro forma financial statements may be required to be included in the disclosure documents. Israeli law requires financial statements to be prepared in accordance with International Financial Reporting Standards (IFRS). However, in the event the Israeli company is listed on a US stock exchange and is therefore also subject to SEC rules, then the Israeli Securities Law permits the company to report using US generally accepted accounting principles (GAAP).

Generally, the Israeli Securities Law requires detailed disclosure of the key transaction documents, but it is not mandatory to file copies of the documents themselves. However, if the Israeli company, being listed on a US stock exchange, is also subject to SEC rules, then the Israeli Securities Law requires disclosure in the same manner as required under SEC rules, which would also include the filing of copies of the key transaction documents.

The approval of the board of directors is required with respect to a statutory merger and a court-approved merger. In fulfilling such a duty, the board of directors, by virtue of its duty of care and the duty of loyalty, has a duty to maximise shareholder value. In a statutory merger, the board of directors of each merging company is required to consider not only the interest of the shareholders but also the ability of the merged company to meet its obligations to its creditors.

With respect to a full tender offer, in the absence of a specific provision regarding the required conduct of the board of directors, there is uncertainty as to whether the board of directors is required to evaluate the price offered and express its view, or leave the shareholders to make their own independent determination on the proposed terms, being a direct transaction between the bidder and the shareholders to which the company is not a party.

In a special tender offer, the Companies Law requires the board of directors to either make a recommendation to its shareholders as to whether the offer is fair or, if it elects not to make such a recommendation, to disclose the reasons for not making one.

In transactions involving parties in which directors, officers or significant shareholders have a personal interest or a conflict of interest, it is common for the board of directors to establish a special ad hoc committee of non-interested directors (or appoint the audit committee of the board of directors) to negotiate the transaction and present recommendations to the board of directors.

Generally, in the absence of a conflict of interest, or of alleged self-dealing or conflict of interest scenarios, Israeli courts defer to the judgment of the board of directors of a target company in a takeover situation. It is also important to note that the Companies Law provides for specific approval procedures for transactions involving personal interests on the part of directors, officers or significant shareholders, which may trigger separate approval requirements by the independent audit committee and by a special majority vote of the non-interested shareholders. Israeli law also mandates personal interest disclosure by directors and prohibits a director from participating and voting at board and committee meetings on matters in which a director has a personal interest.

In many cases, the courts focus their involvement on the manner in which the personal interest was disclosed and addressed in the context of the transaction approval.

In transactions involving parties in which directors, officers or significant shareholders have a personal interest or a conflict of interest, it would be common for the special independent committee to engage its own legal counsel, separate from the target company’s counsel. In certain cases, the special committee would also engage a separate financial adviser, and – depending on the circumstances – that adviser would also provide a separate fairness opinion alongside, or instead of, the financial advisor of the entire board.

Conflicts of interest have been the subject of judicial scrutiny in Israel. As noted in 8.4 Independent Outside Advice, given the specific approval procedures for transactions involving personal interests in the Companies Law, Israeli courts focus their judicial review on the manner in which the personal interest was disclosed and addressed in the context of the transaction approval.

Hostile tender offers are permitted in Israel. However, if the intent of the bidder is to acquire 100% of a target company, it is difficult to reach that with a tender offer, bearing in mind the high threshold for squeezing out shareholders who do not accept the tender offer, as described in 2.1 Acquiring a Company and 6.5 Minimum Acceptance Conditions.

Accordingly, hostile M&A activity is typically used as an avenue to engage a resisting incumbent board of directors, and, if successful, eventually leads to a merger structure recommended by the board (in its new or old composition).

The board of directors, by virtue of its duty of loyalty and duty of care, has a duty to maximise shareholder value, and to act in good faith and for the benefit of the company, which, depending on the circumstances, may include the use of defensive measures.

A number of takeover defences are available to Israeli target companies, including a staggered board and the board’s ability to issue blank cheque preferred stock (which is not permitted for companies only traded on the TASE). The COVID-19 pandemic has not resulted in new or different defensive measures.

See 9.2 Directors Use of Defensive Measures.

In taking any action to frustrate a takeover attempt, the board of directors must carefully exercise its fiduciary duties to evaluate the proposal together with appropriate advisers, particularly in a scenario in which members of the board may be deemed to have a personal interest. The right of directors to “just say no” has not been tested in an Israeli court.

Although it has increased in recent years – an example of this being the Delaware Chancellery Court MAC litigation of the Israeli M&A deal of Comtech and Gilat Satellite, as described in 3.1 Significant Court Decisions or Legal Developments and 10.3 “Broken-Deal” Disputes – litigation is not common in M&A deals in Israel. It usually occurs in alleged self-dealing and conflict of interest scenarios.

When litigation arises, it would typically be filed in the period after a definitive agreement is signed and announced and prior to the shareholders’ vote on the proposed transaction.

The COVID-19 pandemic triggered new challenges to the interpretation of material adverse change (MAC) clauses in M&A deals, with buyers seeking routes to walk away from deals signed in 2019 and early 2020, before the COVID-19 pandemic had spread.

A key Israeli M&A deal, which reached the Delaware Chancellery Court, was the unsuccessful attempt of NASDAQ-listed Comtech Telecommunications to walk away from its USD580 million acquisition of our client, Israeli-based and NASDAQ-listed Gilat Satellite, asserting a MAC. We were successful in defending the case and obtaining a record USD70 million settlement fee for our client.

Since the litigation was settled before the case was fully litigated, the opportunity for a significant court decision affecting the interpretation of MAC clauses in the Israeli M&A context was missed.

Activism has become more popular in Israel in recent years, particularly in Israeli companies traded on US stock exchanges. Since many of the largest Israeli companies are traded on the NYSE and NASDAQ, the scope of activity in such companies has increased.

Activists in Israeli companies typically focus on shaking up the board of directors, bringing in new blood to the board, encouraging M&A activity and cutting expenses.

Activism has encouraged some companies to enter into M&A transactions. One example is the stake-holding position Starboard acquired in Mellanox, an Israeli company traded on the NASDAQ. The activist attempted to replace the board of directors, and publicly encouraged Mellanox to reduce expenses and engage financial advisers to strategically evaluate M&A alternatives. Following such developments, Mellanox’s board of directors accepted an offer to sell 100% of the company to Nvidia for US6.9 billion, and it delisted from the NASDAQ following completion of the recommended sale.

As noted in 11.1 Shareholder Activism, activism has become more popular in Israel in recent years, particularly in Israeli companies traded on US stock exchanges. However, we do not believe such increase resulted from, or was impacted by, the COVID-19 pandemic.

Although rare in the Israeli market, the USD800 million acquisition of NASDAQ-listed EZchip (represented by NBA) by Mellanox became the subject of activism interference by Raging Capital following the announcement of the definitive agreement and prior to the shareholders’ vote on the merger.

Naschitz, Brandes, Amir & Co

5 Tuval Street
Tel-Aviv 6789717
Israel

+972 3623 5000

+972 3623 5005

info@nblaw.com www.nblaw.com
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Trends and Developments


Authors



Yigal Arnon & Co. has an M&A practice that is widely recognised as a market leader in Israel. It specialises in representing Israeli and foreign companies, both private and publicly traded, in important, complex and large transactions in the Israeli M&A space of virtually every possible structure and size, and in almost all fields and industries, including biotech, hi-tech and in the infrastructure sector; global mega acquisitions; complex investments deals; as well as purely Israeli transactions. Tapping into lawyers in both its Tel Aviv and Jerusalem offices – rare in Israel – the firm has specialty teams in all areas related to complex M&A. This includes corporate structuring, Israeli and US securities laws, all types of regulation (environmental, financial and technology, including the latest fintech, cyber and encryption regulations) as well as labour, tax, antitrust, real estate, IP, and litigation.

SPACs, Unicorns, Holdbacks and Other Exotic Features of the Contemporary Israeli M&A Market

The year 2021 will be remembered as the year of the “unicorns”, special purpose acquisition companies (SPACs), secondary deals and talent mobility, all of which had a substantial impact on 2021 M&A transactions. In addition to these phenomena, increased use of representation and warranty insurance (RWI) policies in cross-border Israeli transactions has been a clear trend, as well as, at times, the difficulties in procuring such insurance when insurers struggle with the concept of insuring the acquirer of an Israeli target. The one thing that did not appear to have a significant impact on the M&A scene in Israel was COVID-19.

The year 2021 showed, yet again, that the perceived value of acquiring or investing in Israeli companies overcomes possible geopolitical concerns. In May of 2021, rockets were fired from Gaza into the Gush Dan area, where Tel Aviv and the majority of Israeli start-ups are located. Not even rocket attacks that resulted in a temporary disruption of air traffic at Ben Gurion international airport slowed down the pace of investments in Israeli tech companies. Foreign investors continued to shower Israel with funds from venture capital firms, growth capital funds and private equity firms, as well as proceeds from IPO, SPAC and M&A transactions.

The numbers for Israel were phenomenal, eclipsing any previous year. Over USD25 billion were invested in Israeli start-ups, in over 770 financing rounds. There were 75 IPOs, including SPAC transactions, and over 160 M&A deals totalling some USD12 billion. All this for a country the size of Rhode Island.

In short, 2021 was a whirlwind. This article will attempt to highlight certain transactional trends that became more prevalent over this past year.

SPACs

The “SPAC craze” did not skip over the Israeli hi-tech industry. A number of quite prominent companies went public through a merger (a “de-SPAC” transaction) with a SPAC, with the target company surviving as a publicly traded entity. The merger or share acquisition was typically accompanied by substantial private investment in public equity into the now publicly-traded operating company. SPACs have a variety of advantages for the target company, including greater certainty of price, and in general greater certainty of getting the deal done. Over a dozen Israeli companies went public in 2021 via a SPAC, most of the deals in Q2. The SPAC craze has slowed down, but is far from over. Unfortunately, six months to a year after these SPAC IPOs, many of them – as well as companies which went public with more traditional IPOs – were trading at significantly below their IPO value, disappointing investors, and perhaps more importantly, disappointing employees who found their options significantly underwater.

Unicorns

The year 2021 also distinguished itself as one during which a significant number of private Israeli companies enjoyed successful financing rounds, raising hundreds of millions of dollars at valuations exceeding a billion dollars. There were over 85 such “unicorns” in Israel by the end of 2021. These fantastically high valuations bring with them some unique problems.

Growth pressures

Unicorns are subject to relentless pressures from their investors to sustain rapid growth to justify their high valuations. In order to meet these growth expectations some unicorns began turning their attention to acquiring other private companies, achieving growth through acquisition, and not organically. Accordingly, if prior to 2021 acquisition transactions typically involved global players seeking to get their hands on new technologies by acquiring technology-savvy companies in Israel, in 2021 we witnessed a rise in acquisitions of Israeli companies by other (relatively) young private or public Israeli companies, which were flush with cash or able to use highly valued shares as acquisition currency.

Tax issues with stock consideration

Since the new unicorns do not have the same cash reserves as the global giants, an increase in transactions where the buyers, public or private, used their stock as all or a part of the acquisition consideration was evident. These stock deals trigger unique Israeli tax consequences. In general, and unlike some other jurisdictions, the sale of shares in return for shares – a stock for stock deal – is taxable in Israel for the party selling its shares. When a public acquirer uses its shares to acquire a target, the Israeli Income Tax Ordinance permits, under certain conditions and subject to receipt of a ruling from the Israeli Tax Authority (ITA), payment of the associated tax to be deferred for a period of up to four years. However, if the acquiring company is private, the same tax event is triggered but a tax deferral may be obtained only if the parties comply with various complex requirements, including post-closing obligations and restrictions that impact the acquirers and the surviving company post-acquisition. In short, stock deals in Israel are subject to tax complexities not always present in other jurisdictions.

Global workforce changes

Access to talent and a skilled workforce is one of the prime attractions for potential buyers of Israeli companies. The year 2021 was characterised by global labour shortages, increases in wages, and an across-the-board upgrading of employment-related benefits in the hi-tech sector. Frequent employment moves and talent mobility are the 2021 trend that employers have come to dread. The desire to retain a skilled workforce and talent following an acquisition became a staple post-acquisition concern, with many transactions including a negotiated holdback and retention components.

Retaining founders

Aside from cushy post-acquisition compensation packages, retention of founders is typically achieved through application of a holdback arrangement: part of the consideration payable to the founder in consideration for their shares is held back, and paid over time subject to the continued employment of the founder. The main issues relating to these holdback arrangements in Israel are tax-related. The big concern is that the “held back” consideration, which is now subject to continued employment of the founder, will be characterised by the ITA as employment income, and taxed accordingly. In this case, the ITA has published guidelines that clarify which holdback arrangements will preserve capital gains treatment for the held back consideration (a tax rate of approximately 25%) and which arrangements would trigger ordinary income taxation (a tax rate of approximately 50%). In order for the selling founder to enjoy the lower tax rates, the holdback needs to comply with certain conditions, including (i) that the per share consideration to be paid to the founder is the same as that paid to other shareholders holding ordinary shares, and (ii) that the consideration subject to the holdback does not exceed 50% of the aggregate consideration payable to the founder for the sale of their stake in the company. Under Israeli law, the tax on the held back consideration is payable at closing, before such funds are actually released to the founder. As such, when determining deal economics the parties will need to make sure that the founder receives enough cash consideration at closing to allow them to be able to pay these taxes. If, ultimately, all or part of the held back consideration does not end up being paid, the founder will receive a refund from the tax authorities on any excess tax paid.

Retaining employees

Buyers are not only interested in retaining founders after the deal, but they are also concerned to retain, to the extent possible, the skilled workforce. These retention mechanisms included post-closing retention bonuses released over time subject to the employee’s continued engagement, and use of customary equity compensation arrangements (stock options, restricted stock units, etc). Retention payments are treated as bonuses for tax purposes and subject to tax at ordinary income rates, so if an acquirer wishes to further incentivise the employees the retention can be structured through the grant of options and other equity incentives that afford their holder, under certain conditions, capital gains treatment on the subsequent gains. In order to qualify for these benefits the acquirer will need to adopt an Israeli equity incentive plan, either as a standalone plan or as a country-specific sub-plan of the acquirer’s existing equity incentive plan. The Israeli plan will need to comply with certain filings and other procedural requirements dictated by the Income Tax Ordinance and its regulations. These involve the filing of the Israeli plan with the ITA, appointment of a designated trustee (an Israeli firm which the ITA recognises as an authorised trustee for purposes of compliance with the applicable tax requirements), a two year holding period, and other technical and substantive requirements that must be adhered to in order for income derived from sale of the equity incentives to be taxed at capital gains rates.

Secondary transactions

Prior to 2018, secondary transactions involving sales of equity by the founders and employees of private companies were seldom seen, and even frowned upon. The conventional wisdom was that founders and employees needed to stay with the company and lead it to greatness (or at least try), and that sale of equity by the founders signalled to investors that the founders were doubting the rosy future of their companies. These days, and especially in 2021, secondary transactions whereby founders and employees sell a portion of their holdings in the company in parallel to or in conjunction with primary investment rounds, are much more common. The reasons for this vary, but in an interest-based world an investor would be willing to allow the founder to enjoy a “mini-exit” at an earlier stage of the company’s development. That way the founder is under less financial strain, and is incentivised to seek out an exit that will yield the investors a higher return, instead of settling for any offer because the founder needs the money or wants to have an “exit” under their belt. It has been known for companies to receive acquisition offers ranging in the nine figures where the founders do not insist on selling if there is a reasonable expectation of further increases in the value of the company, because these founders already have their mortgage paid out and can live the rest of their lives comfortably. Typically, outside of Israel, these deals are done by having the corporation purchase some of the founder’s common stock, while at the same time issuing new preferred stock to the investor. However, unlike Delaware corporations, the ability of an Israeli company to purchase the ordinary shares of the founder (and in parallel sell the investor preferred shares) is limited, as the Israeli company needs to comply with certain profitability and solvency requirements in order to be able to buy back its shares. This type of transaction also needs to be structured in a manner that does not trigger adverse consequences to the buyer or seller. This gets more complicated if the buyer wants the ordinary shares purchased in the secondary to be converted into preferred shares as a condition for the transaction. That conversion may be seen as a tax event for the selling founder, if not properly structured.

MAC/force majeure

Unfortunately, Israel experiences periods of conflict with its neighbours every few years. This was the case in May 2021, when Israel’s skies were dotted with missiles and counter-missile rockets, while our legal teams kept working around the clock to enable and close mega-financing deals and acquisitions which were indifferent to the daily pyrotechnic displays and did not slow down at all. Surrealism at its best – feelings of sorrow and concern over the political issues mixed with satisfaction as the hi-tech sector continued to make progress. The main take here is that though these conflicts need to be taken into account when transacting with Israeli companies, these events have not had a material adverse effect on the Israeli hi-tech sector. As such, careful thought should be put into “material adverse change” termination and force majeure provisions to ensure that they are balanced when addressing these types of political-military unrest.

RWI for Israeli deals

Use of RWI in Israeli acquisitions became significantly more common in 2021, starting to catch up with the situation in Europe and the USA. Nevertheless, the fact that the premiums sought by the insurers were often substantially higher than those that would have been quoted had the transaction not involved an Israeli target cannot be ignored; as insurers who are not familiar with Israel or the Middle East automatically increase their premium to make up for the potential risk of the “unknown”. Accordingly, when considering a RWI component in an Israel-focused transaction, it is always best to work with brokers who are familiar with the Israeli market (and there are a few who have developed such a specialty), who can reduce the insurers’ concerns, get various insurers interested and mitigate the cost of the increased premium. Working with professionals that have a familiarity with the Israeli market a makes a big difference.

Conclusion

It is highly probable that some of the trends identified above will continue to be relevant in 2022. So far, the year has started out strong, but things can change in a heartbeat. The recent stock market fluctuations, and the situation in Ukraine, are putting a strain on valuations, and in particular have dramatically reduced the marked prices of the Israeli companies that recently went public. Lower prices, however, do not mean fewer M&A deals, just that the deals are done at lower valuation. The Israeli M&A market has shown that it is able to adapt when the economy is at a low point. Here’s hoping next year’s article will end on a positive note as well.

Yigal Arnon & Co.

22 J. Rivlin St.
Jerusalem
Israel

+972 2 623 9200

+972 2 623 9236

info@arnon.co.il www.arnon.co.il
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Law and Practice

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Naschitz, Brandes, Amir & Co is one of the largest full-service law firms in Israel, with more than 230 lawyers in all areas of commercial practice, including 19 M&A partners and 70 M&A associates and other legal practitioners based in its Tel Aviv office. The firm has one of Israel’s powerhouse M&A practices, advising leading domestic and multinational corporations as well as investors and funds such as FIMI, Israel’s largest private equity fund. With extensive experience in cross-border M&A, the firm’s lawyers are among the most experienced and effective in Israel. They have been involved on the buy and sell side of public and private M&A transactions that include several of the largest cross-border M&A deals ever done in Israel, such as the USD7.1 billion public merger of Frutarom with NYSE-listed International Flavors & Fragrances Inc. The M&A practice is supplemented by the firm’s prominent capital markets, regulatory, competition, real estate, tax, labour and litigation practices.

Trends and Development

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Yigal Arnon & Co. has an M&A practice that is widely recognised as a market leader in Israel. It specialises in representing Israeli and foreign companies, both private and publicly traded, in important, complex and large transactions in the Israeli M&A space of virtually every possible structure and size, and in almost all fields and industries, including biotech, hi-tech and in the infrastructure sector; global mega acquisitions; complex investments deals; as well as purely Israeli transactions. Tapping into lawyers in both its Tel Aviv and Jerusalem offices – rare in Israel – the firm has specialty teams in all areas related to complex M&A. This includes corporate structuring, Israeli and US securities laws, all types of regulation (environmental, financial and technology, including the latest fintech, cyber and encryption regulations) as well as labour, tax, antitrust, real estate, IP, and litigation.

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