Technology M&A in Israel
2020 was considered a somewhat moderate year due, among other things, to the global turndown derived from the COVID-19 pandemic, while 2021 could well be one of the most significant years in the Israeli tech industry. With cautious optimism, we may be at the point of putting the pandemic (at least with respect to the Israeli tech landscape) behind us. The emerging technologies, unprecedented valuations and venture-capital investments have added to the reality that 2021 will be no less extraordinary a year in the Israeli tech world. Other than the figures underlying 2021's transactions and growth, a subtle change is also being noticed in the negotiation and drafting landscape of 2021 with respect to purchase agreements in M&As, requiring legal advisers to approach the subject with more dynamic and flexible objectives.
As of the third quarter of 2021, investments in Israeli start-ups have reached, in the aggregate, USD21.42 billion correlating to over 695 rounds of funding and, in the third quarter alone, start-ups raised USD5.89 billion in over 177 investment transactions. 2021 is not even over yet and it can already be said with certainty that Israeli start-ups have doubled, in the aggregate, the investment amounts of 2020. This is despite the current decrease in the number of deals in 2021, in contrast to 2020.
Over the course of the first three quarters of 2021, Israel experienced a record number of exits, with 180 transactions worth USD18.9 billion – 225% more deals and 506% more money raised during all of 2020. This includes initial public offerings (IPOs) (both local and foreign capital markets), buy-outs and mergers and acquisitions. This is also due to an increasing trend of Israeli start-ups reaching a certain growth level, which allows them to substitute the common M&A exit with a public offering. Early-stage investments remained more or less the same, but an increase in mega rounds (100 million or more) has definitely been noticed in 2021 compared to 2020.
The Israeli ecosystem is well known for several technology sectors, which include internet, software and services, health and life sciences, semi-conductors, cybersecurity, fintech and foodtech, to name but a few. Two sectors that have impacted the Israeli tech landscape in 2021 specifically are fintech and cybersecurity. So far this year, cybersecurity companies have received, in the aggregate, USD4.5 billion in investments, and fintech companies are close behind, with USD4.4 billion in funding. With respect to the cyber sector in the third quarter of 2021, cyber companies have raised more than USD1.6 billion, significantly surpassing the previous year's aggregate investments of USD1 billion in the sector. Part of the increase isdue mainly to the constant change and increase in the venture capital (VC) arena in Israel. Each year, Israel's cyber ecosystem attracts more and more VC funds for investment, providing for a very competitive playing field, resulting in a constant increase in the companies' valuations. The pandemic of course contributed to this growing investment and the need for more cyber-attack solutions. Moving the work from the office to home exposed many vulnerabilities. Employees working from home established more connections from devices at home without underlying sufficient cyber security infrastructure, providing for more attack opportunities from hackers.
Coming out of the pandemic, fintechs have proven their value in a changed world for consumers and business, with online preferred to face-to-face transactions, building on a decade of advances in mobile payments, online lending, digital banking and back-office innovation.
There is a powerful mix of factors converging this year - break-out business fundamentals, strategic M&A by traditional financial services players, high-profile IPOs, growing interest by private equity firms and blank-cheque acquisition vehicles, together with historic levels of venture-capital funding to form and develop hundreds of new fintech innovations. Classic tech, healthcare and traditional financial services consolidations are leading the way. But fintechs, for a decade the proverbial outsiders knocking on the door of established institutions, are posting growth that other sectors only dream of, with no sign of slowing down, which in turn attracts a wide range of buyers and investors. In the first nine months of 2021, 35 blank-cheque companies announced plans to merge with fintech firms, according to data from investment banking boutique FT Partners, more than double those in all of 2020, when 15 special-purpose acquisition companies (SPACs) agreed to merge with fintech companies. At least five fintech SPAC deals have been completed this year, including Payoneer. EToro, when its deal closes, will be the biggest of the bunch. SPAC-deal activity dipped in the spring, when regulators toughened their stance, but has since come roaring back.
The COVID-19 Effect
The COVID-19 pandemic continued to have its fair share of effects on the negotiation landscape of 2021 with respect to M&A transactions, requiring legal advisers to approach them with more dynamic and flexible objectives.
MAC (material adverse change)
MAC clauses are relevant to the period between the signing and the closing of such transactions. Essentially, they reflect an occurrence of certain circumstances (between signing and closing) that adversely affect the target and were not predictable. Such defined clauses allow the buyer in question either to terminate the transaction, demand a price reduction or re-negotiate the terms. Sellers initially rejected the inclusion of the pandemic in such clauses, but eventually compromised on more specifically defined MACs with concrete terms or, where possible, with the COVID-19 crisis carved out from such definitions altogether.
Quarantines affected the day-to-day operations of most governmental agencies. Parties experienced delays with respect to good-standing certificates, certifications, permits, antitrust rulings, and more. Delivery periods of documents were naturally extended to cope with the delays in processing times and to prevent withdrawal from agreements on the basis of technicalities.
Representations and warranties
More demand from buyers for extensive detailed and targeted warranties in the purchase agreements has been witnessed during 2021. Financial projections and material contracts are key, especially as a result of the uncertainty arising from the presence of the virus. Moreover, buyers are requiring contingency plans and compliance with COVID-19-related law (eg, paycheck–protection programme (PPP)). 2021 also provided an unprecedented amount of ESG (Environmental Social Governance) representations, which most likely stem from the increase in regulatory oversight and the impact on deal viability.
2021 also reflected an overwhelming demand to invest by venture-capital funds and angel investors, even with the substantial rise in company valuations, so much so that, in many cases, a certain degree of over-subscription can be witnessed. One way of dealing with this is through secondary sales where founders, management and employees sell shares in the course of financing rounds. This is generally compatible with late-stage privately held companies but also in early-stage companies. Conservatively, the amounts invested through secondary deals are in the billions, introducing a new kind of "exit".
#MeToo in M&A
The "#MeToo" movement has definitely impacted the world of mergers and acquisitions. Today, a majority of purchase agreements include representations related to sexual harassment and misconduct in the workplace. Sellers are committed to applicable representations in that regard and this is mostly due to the impact that the misconduct of C-suite (that is, top senior executives) and business leaders has had on such companies.
Super pro rata rights
In 2021, it became more common (although still not market standard) for investors to demand “super” pro rata rights, which permit the investors to increase their percentage ownership in subsequent financing rounds. In other words: “Super” pro rata rights provide the investor with the right to invest more than its pro rata share in the subsequent financing rounds. Such a right allows the investors to grab a larger stake of the company, but it comes on account of the company’s ability to raise funds from outside new investors.
During 2021, more and more investors and, specifically, venture capitalists, have been seeking commitments from their prospective portfolio companies to build diverse and inclusive workforces. For example, companies should consider interviewing at least one qualified woman and/or minority candidate for each executive-level position and independent board-director opening at their company, if they do not do so already. Investors believe that building diverse and inclusive teams will lead a company to be more innovative and competitive.
Global Point of View
Israel was not the only country to experience a constant rise in tech-funding momentum. From a global point of view, by the end of the third quarter of 2021 the global tech ecosystem incurred investments of up to USD160 billion – a 78% increase from 2020, according to Crunchbase. In addition, an aggregate amount of USD103 billion was invested in mega-rounds (ie, investment rounds above 100 million). In comparison to 2020, that is a 97% increase in mega-round investments. It would be remiss not to mention the most significant change in the early-stage funding segment; as of the third quarter of 2021, a growth of 104% in early-stage funding from 2020 can be noted, reflecting 1,900 companies, according to Crunchbase. Even before the year's end, it can already be stated with certainty that 2021 will be a tremendous year in contrast to 2020, as up until the third quarter, USD454 billion were raised, surpassing the USD332 billion invested in the whole of 2020.
To sum up everything that has been stated thus far, the tech ecosystem is in constant flux. Legal standpoints are adjusting nicely to the COVID-19 era, which looks like it is here to stay. Most likely, 2021 will finish with a bang, but one can only speculate on the outcome of 2022.