Technology M&A 2022

Last Updated October 27, 2021

USA

Law and Practice

Authors



Shearman & Sterling LLP advises leading corporations, major financial institutions, emerging growth companies, governments and state-owned enterprises on complex strategic and legal matters. The firm has over 850 lawyers in 25 offices around the world, speaking more than 60 languages and practising US, English, French, German, Italian, Hong Kong, OHADA and Saudi law. Its long-standing M&A practice regularly represents clients in their most important transactions. Shearman’s lawyers focusing on the technology industry comprise several dozen practitioners based in the firm’s San Francisco, Menlo Park, New York, Washington DC, Austin, Dallas, London, Paris, Munich, Abu Dhabi, Dubai, Riyadh, Hong Kong, Beijing, Tokyo and Singapore offices. The firm’s clients include some of the world’s largest technology and software companies, promising venture-backed and privately held companies, as well as investment banks and private equity funds that focus on technology. Partners and counsel in Shearman’s technology group are thought leaders who frequently write and speak on technology industry specialisms to national and international technology development forums, financial institutions, academic and research facilities, and regulators.

COVID-19 significantly curtailed US M&A activity in the second quarter of 2020 as many companies sought to boost their liquidity and raise financing while simultaneously reducing their spending on anything but their most necessary business needs. M&A activity improved significantly in the second half of 2020 and into 2021. In fact, 2021 is on track to be one of the most robust years ever for technology M&A.

COVID-19 has highlighted the importance of innovation as we move towards a more contactless society and develop new ways to work collaboratively from multiple locations. Cryptocurrencies are disrupting financial transactions and the role of banks and creating new markets, climate change is influencing the automotive, transportation and energy sectors, and industrial companies are adopting technology to better enable their businesses, products and solutions.

The stock markets are rewarding growth. This, combined with low interest rates and easy access to financing, has accelerated M&A activity in the technology sector. In addition, the ability to go public or add incremental investments at attractive valuations has resulted in a sellers’ market and pushed valuations higher.

Special purpose acquisition companies (SPACs) continue to impact technology M&A as money continues to flow into these newly formed companies, increasing the demand for M&A bankers and lawyers to guide both SPAC sponsors and target companies desiring to go public through de-SPAC transactions.

The significance of SPACs could change depending on whether any of the new regulations being discussed by the US Securities Exchange Commission (SEC) are adopted. Regulators and the US Congress are also discussing regulation of cryptocurrencies and related financial markets.

Antitrust scrutiny of technology deals has become heightened under the Biden administration.

Start-up companies in the US are typically formed in Delaware as corporations. Delaware has adopted business-friendly laws and has a large, well-developed body of case law that makes judicial decisions predictable, which gives it an advantage over other states. As a result, Delaware has largely become the default jurisdiction in which to form entities for investors, potential acquirers and counsel across the US.

Forming a corporation in Delaware is relatively easy and can be done in a single day. New corporations file a Certificate of Incorporation, adopt by-laws and issue equity to founders, which can be a relatively fast process if there has been sufficient pre-planning.

There is no initial capital requirement for forming a Delaware corporation and founders typically pay for their initial shares of stock with a de minimis amount of money for their “par value” (often USD0.01 or USD0.0001 per share) and by contributing any relevant pre-existing intellectual property to the company.

In choosing a type of entity, entrepreneurs are advised to consider the tax treatment resulting from the entity choice, whether the entity provides sufficient protection from personal liability, whether the entrepreneurs plan to distribute equity incentive compensation widely and whether the entity will seek institutional venture financing in the future. For the reasons described below, most technology and life sciences companies elect to be structured as corporations that are taxed as a “Subchapter C” corporation under the federal tax code (the “Code”).

Tax Treatment

A “Subchapter C” corporation is subject to double taxation, meaning the entity pays tax on any profit generated by the corporation, and each stockholder also pays individual income tax on any distribution the stockholder receives from the entity but may not offset their personal tax burden with losses from the business. Most venture-backed companies do not generate profits for a long period of time, electing instead to increase spending in pursuit of growth. As a result, venture-backed companies often generate significant tax losses and rarely make distributions to stockholders, so the double-taxation issue is often not a concern.

In addition, Subchapter C corporations may be eligible to issue qualified small business stock (also known as “QSBS” or “Section 1202 stock”) if the company meets certain criteria. QSBS is appealing to both founders and investors because, subject to certain limitations and conditions, upon sale of the stock, gains on QSBS may be taxed at a capital gains tax rate as low as 0%, resulting in significant tax savings upon exit. The US Congress is currently considering modifying or eliminating the benefits of QSBS.

Limited liability companies (LLCs) and “Subchapter S” corporations are “pass-through” entities for tax purposes, meaning that income generated by the business is only taxed once at the equity-holder level and equityholders may be able to offset their personal income with losses from the business to reduce their personal tax burden. Subchapter S corporations are subject to strict ownership requirements and are generally not permitted to have entity stockholders.

Personal Liability

Subchapter C corporations, Subchapter S corporations and LLCs all generally shield equity-holders’ personal assets from claims made against the company by creditors or other adverse parties.

Other Considerations

The administrative cost of operating an LLC as a growing company is significantly higher than the cost of operating a corporation because of the additional legal and accounting costs resulting from the accounting and tax reporting for an LLC. Furthermore, it is a more complex process to issue equity compensation to employees and service providers with an LLC or Subchapter S corporation as compared to a Subchapter C corporation. Finally, venture capitalists are generally more familiar and comfortable with Subchapter C corporations and may be reluctant to invest in a pass-through entity, which may further complicate their own tax reporting, and have income and losses pass through to their investors.

Early-stage financing is usually provided by angel investors, accelerators and institutional venture capital funds.

Angel Investors

Angel investors may be wealthy individuals, consortiums of investors that aggregate investment dollars together, or family offices. Angel investors are typically the first investors in a start-up company.

Accelerators

Accelerators provide services and mentorship to founders and often have an industry focus. Depending on the programme, accelerators may provide some initial seed funding to companies participating in their programmes in exchange for an equity interest. Accelerators often have extensive angel networks and affiliations with institutional funds, which may give participating companies opportunities to find investors.

Early-Stage Venture Capital Funds

Some institutional venture capital funds focus on providing early-stage funding and typically lead a company’s first equity financing.

Early-Stage Investment Documentation

Early-stage financing can take the form of convertible notes, Simple Agreements for Future Equity (SAFEs) or preferred equity investments. Convertible notes and SAFEs are designed to be standardised so that companies may raise money quickly and efficiently, and both include features that provide for investment amounts to be converted into equity upon a future financing of the company. A convertible note is a debt instrument that accrues interest and has a maturity date that triggers a repayment obligation of the company. In contrast, a SAFE is a contractual agreement for investment but does not accrue interest, and a company is generally not obliged to repay the amount after a period of time. Convertible notes and SAFEs defer valuing the company until a future financing. Angel investors and accelerators typically use convertible notes and SAFEs for their early-stage investments.

By contrast, most institutional venture capital funds prefer to purchase convertible preferred stock at a set valuation, rather than investing in a convertible note or SAFE.

Typical sources of venture capital in the US are angel investors, accelerators and institutional venture capital funds (including corporate investors). Venture capital financing in the US is easier to access compared to in many other jurisdictions, but founders must still spend considerable time and resources engaging with venture-capital sources in order to secure financing. In recent years, foreign venture capital firms have increased investments in the US. For example, Japan’s SoftBank has made several high-profile investments in the US. Corporate venture capital (CVC) has also substantially increased in recent years. CVCs increasingly lead equity financing rounds and may be the sole source of funding in a round.

In the US, there are well-developed standards for venture capital terms and documentation, which include customary economic, control and contractual terms, such as those relating to dividends, liquidation preferences, conversion rights, pre-emptive rights, anti-dilution protections, voting rights, rights of first refusal and co-sale, rights to designate members of the board of directors, registration rights and information rights.

NVCA

The National Venture Capital Association (NVCA) is a trade association for the venture capital community. The NVCA has developed a well-regarded set of documents for venture capital financing that are publicly available on the NVCA’s website and which generally reflect the terms described above. Because the NVCA documents are well developed, many investors insist that companies use those forms as the basis for equity financings, and companies may find it more efficient to use the NVCA forms.

SAFEs

For convertible note financings, there is less standardisation in the documentation, but convertible note forms tend to include basic key terms such as interest rate, maturity date and conversion mechanics. SAFEs were originally developed by Y Combinator, and the Y Combinator form, which is publicly available on its website, is most often used as the basis for SAFE financings.

A start-up company initially formed as a Delaware corporation typically will not need to change its corporate form. If a start-up company is initially formed as a Subchapter S corporation or an LLC, or in a jurisdiction other than Delaware, the company may be advised to convert into a Subchapter C corporation and/or reincorporate in Delaware, particularly if it is raising venture capital financing.

In recent years, start-up companies were more likely to run a sale process rather than take a company public. M&A sale processes are attractive to investors because they may result in a higher-value exit, provide a faster path to liquidity and are generally easier to accomplish than going public, often in just weeks or a few months. An IPO process is expensive and time-consuming, and it can take several months to a year of planning and preparation to accomplish.

If a US company decides to go public, it is more likely to list in the US than on a foreign exchange, particularly if its stockholders are primarily based in the US.  The capital markets in the US are robust, widely perceived as more investor-friendly and fund a significant amount of worldwide economic activity, so companies worldwide often choose to list in the US to take advantage of its strong markets. Companies are also more likely to be familiar with the accounting standards and other reporting requirements of exchanges located in the US.

It is not common for US-based companies to list on a foreign exchange.

Sellers often use auction processes to attempt to maximise price and achieve the best possible terms. Structuring the sale process as an auction provides the target company and its shareholders with distinct advantages, including negotiation leverage based on information asymmetry (eg, knowledge of the actual number of bids and the depth of market interest in the target company). In addition, a structured and competitive bid process can create momentum by setting out a clear timeline for marketing and bidding, forcing bidders to move quickly.

There are also disadvantages with an auction process, particularly if a potential buyer has already been identified and is seeking bilateral negotiations to pre-empt an auction process. For early-stage companies, many sales happen as a result of a strategic acquirer expressing interest in acquiring the target company, and such transactions are bilateral negotiations. In addition, an auction may lengthen the sale process timeline and may require the target company to provide access to proprietary and confidential information to a significant number of competitors.

A sale of a privately held technology company is often structured as a statutory merger but may also be structured as a stock purchase or an asset purchase.  These transactions typically involve the sale of the entire target company, although many buyers may require key employee shareholders (eg, the target company’s management team) to retain equity in the business or the acquiring company, to ensure a successful transition and future growth following closing.  Venture capital and other financial investors would generally not continue to remain invested in the target company following a sale process, particularly in a transaction in which a controlling interest is being sold.

In acquisitions of privately held technology companies, the consideration payable to target shareholders typically consists solely of cash; however, it is also common, particularly in transactions involving public company buyers, for the consideration to consist of a mix of cash and stock or, less often, all stock.

Where parties disagree on the value of the target business, or in industries or economic conditions with high valuation uncertainty (eg, life sciences), parties may employ an earn-out structure to pay the target shareholders a lower price at closing and additional consideration later if specified business results or milestones are achieved. In addition to bridging a valuation gap, an earn-out structure may also serve as a motivating factor in transactions where the management team holds a significant equity stake in the target company. However, earn-outs are generally not favoured by venture capital and other financial investors and can lead to disputes between buyers and selling shareholders when implemented post-closing.

Alternatively, buyer stock may be used as a portion of the consideration, so that selling shareholders may indirectly benefit from the performance of the acquired business and selling employee shareholders will still be invested in the continued success of the acquired business.

In acquisitions of venture capital-financed technology companies, buyers will often seek to protect themselves from unknown liabilities of the target company by negotiating seller indemnification obligations into the acquisition agreement and/or purchasing representation and warranty insurance.

Negotiation of Indemnification Provisions

Indemnification provisions are typically one of the most heavily negotiated provisions in an acquisition agreement. These provisions primarily benefit buyers by providing contractual recourse against the selling shareholders for losses incurred following closing that result from, among other matters, breach of representations and warranties regarding the target company. In addition, a portion of the consideration (generally 10–15% of the transaction value) may be placed in escrow (or held back by the buyer) at closing to secure the selling shareholders’ indemnification obligations. Generally, selling shareholders, and particularly venture capital investors, will seek to minimise their post-closing liability by negotiating limitations on their indemnification obligations, including deductibles and caps, and will often seek to limit all buyer recourse to the agreed escrow or holdback consideration.

Representation and Warranty Insurance

Consistent with the general trend in private equity transactions, the use of representation and warranty insurance is increasingly common in transactions involving the sale of venture capital-financed companies, particularly in transactions with higher values where the policy premiums are economically feasible.  Any issues that are identified during due diligence will generally not be covered by the policy, so it is common for parties to negotiate indemnification protection into the acquisition agreement to allocate risk of such losses. Selling shareholders often refuse to provide any post-closing indemnification in circumstances where representation and warranty insurance is expected to be purchased.

Spin-offs, which are a form of divestiture involving a dividend of shares of the subsidiary conducting the divested business to the divesting company’s shareholders, allow a company to focus on its core business while unlocking the value of a business that may be undervalued as a part of the diversified entity. There are many reasons why a diversified company may decide to effect a spin-off, including the following.

Management

A key motivation for spin-offs is to focus the management of both the retained and divested businesses. A divested business may not receive sufficient attention from the management of the parent company or it may distract the management’s attention from the core business. A spin-off also allows the management of the spun-off business to receive equity compensation tied specifically to the performance of the divested business.

Financial Metrics

A diversified company’s businesses may have different financial metrics. A business with a lower growth rate may be a drag on the value of a business with a higher growth rate. Separating a high-growth business from a low-growth business may allow the high-growth business to trade at a higher multiple while allowing the lower growth business to trade at a multiple appropriate to its own growth, rather than negatively impacting the value of the diversified company.

Business Models

Different business units may have different business models that appeal to different kinds of investors. A biotech company may separate a successfully marketed drug from a drug discovery business. Similarly, a technology company may separate a hardware business from a software business, or a brick-and-mortar retail business from an e-commerce business.

Motivation

A spin-off may be the result of an evaluation of a company’s different businesses by its board or management, or it may be initiated by pressure from activist investors who view the spin-off as a means to unlock shareholder value.

Tax

Unless the diversified company has net operating losses, an asset sale would generate taxable gain to the seller, while a spin-off has the significant tax advantage of being tax free to both the parent company and the shareholders receiving shares of the spun-off business, as discussed in 5.2 Tax Consequences.

Spin-Off or Asset Sale

An asset sale is a viable option for a wider range of divestitures because the divested business does not need to be capable of functioning as a standalone public company. An asset sale also has the advantage of generating cash for the parent company. However, unless the proceeds from an asset sale are distributed to the parent company’s shareholders, the proceeds from the asset sale may not translate into shareholder value. A spin-off would unlock more shareholder value than an asset sale if the divested business is expected to have a higher public market value (after taking into account the increased operating costs of two public companies) than its sale value. A spin-off has all the complexities of an asset sale, plus the complexities of an IPO, and the complexities described below to qualify the spin-off as a tax-free transaction. A spin-off takes significantly more time from planning to completion than an asset sale. Accordingly, while spin-offs are customary in the technology industry, they are less common and more difficult than other divestiture structures such as asset sales.

A distribution of appreciated property by a corporation to its shareholders would ordinarily trigger taxable gain to both the corporation and its shareholders. One of the advantages of a spin-off is that it can be structured as a tax-free transaction at both the corporate and shareholder level under Section 355 of the Code.  However, there are a several statutory and non-statutory requirements that must be met in order for a spin-off to qualify as a tax-free transaction under Section 355, including the following.

Control

The subsidiary to be spun-off (the “SpinCo”) must be under the control of the parent company immediately before the distribution, and the parent company must then distribute control of the SpinCo in the spin-off.

Valid Corporate Business Purpose

The substantial motivation for the transaction must be a corporate business purpose (rather than a shareholder purpose), other than tax avoidance. Examples of valid corporate business purposes include avoiding harm to one business by association with another business, compliance with laws and regulations, facilitating borrowing or raising capital, providing equity compensation to employees, and improving performance. A company planning a spin-off transaction will often obtain a business purpose letter from an investment bank to support this determination.

Five-Year Active Trade or Business

The business to be spun-off must have been an active trade or business (“ATB”) for five years prior to the spin-off. In order to satisfy this five-year look-back, the ATB may not have been acquired during the look-back period. However, expansion of the ATB is permitted, as long as such expansion is “not of such a character as to constitute the acquisition of a new or different business”.

No Device

The spin-off transaction must not be used “principally as a device for the distribution of earnings and profits” of either the parent company or the SpinCo. A company cannot use a spin-off to convert what should have been taxed as a dividend into a tax-free distribution followed by a stock sale by the receiving shareholders at capital gain rates. Satisfying the valid corporate business purpose requirement also serves as evidence that the transaction is not a tax-avoidance device.

A spin-off may be followed by a business combination with an unrelated entity if certain requirements are met, including that both the spin-off and the business combination qualify as tax-free transactions. If the business combination involves the parent company, it is referred to as a “Morris Trust” transaction, and if the business combination involves the SpinCo, it is referred to as a “Reverse Morris Trust” or “RMT” transaction.

Section 355(e) of the Code, known as the “anti-Morris Trust provision”, limits the amount of equity of the parent company or the SpinCo that can be acquired in the business combination to 50%, and establishes other limitations and safe harbours. As long as shareholders of the parent company or the SpinCo own more than 50% of the corporation resulting from the business combination, and the other limitations and safe harbours of Section 355(e) are satisfied, it is possible for the parent company to transfer a business to a third party in a transaction involving stock consideration that is tax-free to the parent company and the SpinCo and their shareholders. The 50% limitation effectively limits this to business combinations with smaller counterparties so that the shareholders of the parent company or the SpinCo own the majority of the stock of the combined entity.

Spin-offs are complex transactions that can take six to nine months or longer to complete.

The key preliminary timing considerations for a spin-off are the identification of the assets and liabilities to be spun-off and the preparation of audited financial statements for the spun-off business. Where the retained and spun-off businesses are already separate, with clearly defined assets and liabilities and no significant overlap or dependencies, and audited financial statements already exist, this planning stage can be completed in as little as two months. However, it can take considerably longer if more work is required.

Implementing the spin-off can take another two to three months. During this stage, the parent company would document the business purpose for the spin-off, draft the definitive transaction agreements to effect the separation of the businesses and define their relationship post-separation, and prepare the SEC filings for the transaction, including an information statement and a Form 10 registration statement.

It could take another three to four months for the SEC to complete its review of the information statement and Form 10 registration statement and declare the Form 10 effective. During the SEC review period, the parent company would continue to work on the implementation of the spin-off and prepare for the launch of the new publicly owned company.

A parent company contemplating a spin-off transaction may seek to obtain a tax ruling from the IRS to provide comfort that the spin-off transaction qualifies for tax-free treatment under Section 355, a process which generally takes approximately six months.

The majority of acquisitions in the US are mutually agreed (a negotiated transaction) and do not involve the buyer building a stake in the target prior to the transaction.

Principal Stakebuilding Strategies

In a hostile or otherwise unsolicited offer, it is common for a bidder to acquire a de minimis stake in a target for the purposes of having the ability, in the capacity of shareholder, to pursue litigation against the target or to seek to review its books and records. However, acquiring a significant stake prior to launching an offer for a US public company is less customary in light of the following considerations.

  • Firstly, the acquisition of voting securities of a US company having an aggregate value of greater than an amount set annually by the Federal Trade Commission (FTC) (USD92 million effective from 4 March 2021) typically requires antitrust approval under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the “HSR Act”). Seeking that approval would result in disclosure to the target of the bidder’s intention to acquire the securities.
  • Secondly, acquisition of beneficial ownership of more than 5% of a class of equity voting securities of a US public company requires public disclosure of the acquisition through a filing with the SEC.
  • Thirdly, bidders who have engaged in negotiations with a target may be subject to confidentiality agreements which contain restrictions on acquiring the target’s shares, or may have obtained material non-public information regarding the target that prohibits the bidder from trading in the target’s securities under US insider trading laws.
  • Finally, a number of states, including Delaware, have “anti-takeover” statutes that prohibit or restrict a shareholder that has acquired a specified amount of a company’s shares (15% in Delaware) from acquiring additional shares for a significant period of time (three years in Delaware) unless certain conditions are met (such as the approval of the acquisition by the company’s board of directors and by a super-majority vote of the shareholders).

Material Shareholding Disclosure Threshold

Federal securities laws require that any person who acquires beneficial ownership of more than 5% of the outstanding shares of a class of US public company voting equity securities must report the acquisition by filing a Schedule 13D with the SEC within ten days of the acquisition. A beneficial owner of a security includes any person who, directly or indirectly, has or shares either:

  • the power to vote or to direct the voting of the security; or
  • the power to dispose or direct the disposition of the security.

Filing a Schedule 13D results in public disclosure of the acquisition, including the required disclosure of the purpose and funding of the acquisition and the filer’s plans regarding control of the target company. Once a Schedule 13D has been filed, amendments must be filed promptly after the occurrence of any material change in the facts set forth therein. Passive investors meeting certain requirements who would otherwise be required to file a Schedule 13D are permitted to file a Schedule 13G, which contains less onerous disclosure requirements than a Schedule 13D, but a stakebuilding strategy is not a passive investment intent.

Tender offers in the US are generally subject to regulation by federal securities laws, which do not impose a requirement for a shareholder or group that acquires a given threshold of securities of a company to make a tender offer for the remaining shares of the company. In addition, Delaware law does not impose any such requirement. However, a small number of US states do have “control share cash-out” statutes that require a shareholder that gains voting power of a given percentage of a company to purchase the shares of the other shareholders at a fair price upon demand.

An acquisition of a public company is generally structured as a statutory merger, often referred to as a “long-form” or “one-step” merger, or as a combination of a tender offer and a statutory merger, often referred to as a “two-step” merger.

One-Step Merger

In a one-step merger, the target company will merge with the buyer (or a subsidiary of the buyer) and the target company’s shareholders will receive the merger consideration in exchange for their shares by operation of law. A one-step merger is implemented pursuant to a negotiated merger agreement that is signed by the buyer and the target company and must be submitted to the target company’s shareholders for approval.

Two-Step Merger (with Tender Offer)

In a two-step merger, shareholders are first asked to tender their shares into a tender offer in exchange for the offered consideration. A tender offer is an offer made by the buyer directly to the target company’s shareholders to purchase their shares. In a negotiated transaction, the buyer and target company will negotiate the terms of the offer and the target company’s board of directors will recommend that shareholders accept the offer. Tender offers do not, however, need to be approved by the target company’s board of directors and, therefore, they are often used in “hostile” transactions. Tender offers are referred to as exchange offers where the consideration includes equity securities of the buyer.

The second step of a two-step merger is a statutory merger, used to acquire any remaining shares held by shareholders that did not participate in the tender offer (often referred to as a “squeeze-out” merger). In a negotiated transaction, the merger agreement will expressly provide for this second step and shareholders in the merger will receive the same consideration as those shareholders who tendered shares into the tender offer.

In acquisitions of publicly traded US companies, the consideration payable to target shareholders consists solely of cash in more than half of these transactions (particularly where the buyer is not another publicly traded US company). In all other cases, consideration consists of either all stock or a mix of cash and stock (which may be fixed or subject to the election of each shareholder). The stock component of the consideration may be expressed as a fixed exchange ratio or a fixed value at closing. With a fixed exchange ratio, the value of the consideration fluctuates, and with a fixed value, the number of shares issued fluctuates, in each case, based on changes in the buyer’s stock price between signing and closing.

Unlike private company transactions, contingent consideration, such as contingent value rights, are not typically used in acquisitions of US public companies.

A tender offer will generally be subject to a number of conditions, including:

  • the tender of a minimum number of shares;
  • the receipt or expiration of applicable regulatory approvals or waiting periods;
  • there being no law or government order prohibiting the consummation of the offer; and
  • the target not having suffered a material adverse effect.

An unsolicited or “hostile” offer will often include the following additional conditions:

  • the target’s removal of any structural defences (eg, a shareholder rights plan or poison pill);
  • the receipt of sufficient financing; and
  • the absence of a competing takeover offer.

While a bidder generally has significant flexibility in defining the conditions to its offer, regulators require that conditions must be based on objective criteria and not be within the bidder’s sole control. They also require that conditions must be applicable to the entire offer (as opposed to establishing different conditions for different shareholders).

In acquisitions of publicly traded US companies, the target company and the acquirer enter into a merger agreement which contains representations, warranties and covenants on behalf of both the target company and the acquirer, although once the closing occurs there is generally no liability for target company shareholders for breaches of the terms of the agreement. The target company typically agrees to covenants to operate its business in the ordinary course between signing and closing, to not solicit third-party proposals and to make commercially reasonable efforts to cause the closing conditions to the transaction to be satisfied.

The minimum acceptance condition to a tender offer usually corresponds to the number of shares required to effectively control the target and to approve a subsequent second-step merger to acquire any remaining shares held by shareholders that did not participate in the offer (usually one share more than 50%). A company’s organisational documents or the corporate law of the company’s state of incorporation may provide a higher threshold requirement.

If at least 90% of outstanding shares are tendered into a tender offer, the bidder has the ability under the laws of many states to effect a “short-form” merger that does not require a shareholders' meeting and vote to occur.

In addition, amendments to Delaware’s corporate law in 2013 and 2014 eliminated the need to hold a shareholders' meeting and vote to approve the second-step merger in situations where the bidder has acquired enough shares in the tender offer to approve the merger, but not the 90% required to enable the use of the short-form merger statute.

Shareholders that remain following a successful tender offer are generally squeezed out by effecting a second-step merger. This will be a short-form merger (if available), or a long-form merger where the required shareholder approval is assured because of the number of shares held by the buyer following the tender offer.

A business combination in the US may be conditional on the bidder obtaining financing; while this would typically be the case in large hostile cash bids, most negotiated transactions do not include this condition.

As financing conditions are rare, the focus in transactions that include significant third-party financing tends to be on the level of effort that the bidder must expend in order to obtain and consummate the financing. In the US, it is common for a bidder to have financial “commitments” from lenders at the time of signing transaction documents.

It is not uncommon for the bidder to be obliged to seek to enforce (via litigation, if necessary) the obligations of its third-party debt financing sources to provide the bidder with the agreed amount of debt financing at the closing of the transaction, and to seek to obtain alternative financing on similar terms if the original financing is unavailable.

In addition, bidders are often required to pay a “reverse termination fee” to the target company in the event that the transaction does not close due to the unavailability of debt financing to the bidder.

In the acquisition of a publicly traded company, a bidder can seek a number of deal protections, including:

  • “non-solicitation” provisions that prohibit the target board from soliciting alternative transaction proposals but allow the target board to pursue unsolicited proposals that may result in an alternative transaction that is superior to the pending transaction;
  • “matching” or “topping” rights that allow the bidder the opportunity to improve the terms of the current transaction if the target receives a superior transaction proposal from a third party;
  • break-up fees payable to the bidder in the event that the transaction agreement is terminated in favour of an alternative transaction proposal (these fees, based on guidance from the Delaware courts, tend to be in the range of 2-4% of the transaction value); and
  • “force the vote” provisions that require the target board to submit the transaction to its shareholders for approval even where the board is no longer recommending the transaction (eg, where it receives a superior alternative proposal).

Private transactions usually involve agreements with significant shareholders of the target company to vote to approve the transaction, thereby creating more closing certainty and eliminating the need for the deal protection measures set forth above.

This is not applicable in the US.

Whether a buyer seeks to obtain an irrevocable commitment from the principal shareholders of a target company to tender or vote in favour of a transaction and not tender or vote in favour of an alternative transaction (often called a “lock-up”) is highly fact and transaction-specific. It will depend on, among other factors, the identity of the principal shareholders and the size of their holdings. Confidentiality considerations and the target company’s willingness to involve the principal shareholders in transaction discussions prior to a public announcement may also be relevant factors.

While Delaware law generally permits the use of lock-ups, current case law in Delaware generally prohibits a buyer from obtaining lock-ups of a number of shares that would make shareholder approval of a transaction a mathematical certainty.

Merger Transactions

The SEC has the right to review proxy statements (for all-cash mergers) and registration statements (consisting of a combined proxy statement and prospectus for mergers where some or all of the consideration is stock). Prior to distributing proxy/registration statements to shareholders, companies file a preliminary statement with the SEC and the SEC has ten days to inform the company whether it intends to review or comment on the statement. If the SEC comments on the statement, the statement may not be distributed to shareholders until the company has cleared the SEC's comments. The SEC does not review all merger proxy statements, but where the SEC does review and comment, such comments can typically be cleared within 30 days. In the case of a registration statement, the SEC will generally provide comments within 30 days of the filing date. In some transactions, the SEC may not review (or may conduct a limited review of) the registration statement. While a definitive proxy statement may be distributed to target company shareholders if the SEC does not inform the company that it intends to review or comment on the proxy statement, the SEC must declare the registration statement effective prior to it being distributed.

Tender Offers and Exchange Offers

Transactions structured as tender offers (for all-cash offers) and exchange offers (for offers where some or all of the consideration is stock) are also subject to SEC review, but they have a timing advantage over merger transactions because the offer documents can be distributed to target company shareholders at the same time as they are filed with the SEC, allowing the offer period and the SEC review period to run concurrently. While the offering materials may need to be amended and the offer may need to be extended if there are SEC comments, and in the case of an exchange offer, the SEC would need to declare the registration statement effective before the offer can close, all of this can occur after the offer has commenced rather than before documentation may be distributed to target company shareholders, as is the case in a merger transaction.

In the US, it is permissible to extend a tender offer via a public announcement prior to the termination of the tender offer. Generally, merger agreements will require that the tender offer be extended in the event that the closing conditions, including regulatory approvals, are not satisfied prior to the scheduled expiration of the offer. For this reason, it is typical to commence tender offers prior to receipt of regulatory approvals in order to enable transactions to close promptly following receipt of the relevant regulatory approvals.

There are no particular regulations that generally apply to starting up a new company in the technology industry in the US.

The SEC

The primary regulator of the US federal securities laws is the SEC. The federal securities laws govern many facets of M&A activity involving US public companies and the purchase and sale of securities, including the information that must be provided to shareholders being solicited to vote to approve a statutory merger or to participate in a pending tender offer, as well as the procedures that must be followed by both the buyer and the target company in the conduct of a tender offer to the target company’s shareholders.

Corporate and State Laws

The substantive corporate law of the state of incorporation of the target company will regulate a wide variety of matters related to M&A transactions involving both publicly traded and privately owned companies, including the level of shareholder approval that is required for certain transactions, the applicable fiduciary duties of the directors of the target company in considering and approving a transaction, and the mechanics relating to the convening of shareholders’ meetings and providing information to shareholders in connection with the transaction. In addition, certain state laws (often referred to as “blue sky” laws) govern issues relating to the sale and purchase of securities in that particular state.

Stock Exchange Rules

Stock exchange rules (such as those of the New York Stock Exchange and the Nasdaq Stock Market) can also be relevant to M&A transactions involving US public companies, including whether a vote of the buyer’s shareholders is required if the buyer is issuing more than 20% of its outstanding shares in the transaction.

CFIUS

Transactions involving foreign investment in target entities where US national security could be impacted are potentially subject to restriction. Under US law, the US president is empowered to review the national security implications of acquisitions of, or investments in, US businesses by non-US persons and may impose conditions on, or prohibit or even unwind, such transactions when they threaten US national security. The president has delegated these national security review authorities to the Committee on Foreign Investment in the United States (CFIUS), an inter-agency committee chaired by the US Department of the Treasury.

National security concerns can be implicated by transactions involving a broad range of companies; however, technology companies are of particular interest given the national security implications of retaining control of strategically important technology, intellectual property and access to personally identifying data. To avoid the uncertainty imposed by the possibility that a transaction may be prohibited or unwound, parties often voluntarily make a filing to CFIUS requesting review of a proposed transaction. Once cleared by CFIUS, a transaction is insulated from further US national security review or from being prohibited or unwound.

Expanded jurisdiction

In 2020, the US Department of the Treasury issued regulations that significantly expanded the jurisdiction of CFIUS to allow it to review minority, non-controlling investments in certain US businesses developing or producing critical technologies; owning or operating US critical infrastructure assets; and possessing or collecting sensitive personal data of US citizens (previously, only investments that would result in foreign “control” of a US business were reviewable). The regulations also mandate CFIUS filings (which were formerly only elective) for many foreign investments in US businesses producing or developing certain critical technologies and for transactions in which a foreign government-controlled entity acquires control of certain US businesses.

Other Restrictions

Beyond CFIUS, there are also specific restrictions that can be applicable to foreign investment in certain US shipping, aircraft, communications, mining, energy and banking assets. There are also restrictions applicable to foreign investment in certain US entities that contract with the US government.

US export control regulations are another area that can impact foreign investments in US businesses. These regulations can restrict the ability of US businesses to export, or otherwise make available, certain US products, technologies or other items to foreign entities.

EAR and ITAR

The primary US export control regimes are the Export Administration Regulations (EAR) and the International Traffic in Arms Regulations (ITAR). The US Department of Commerce is responsible for enforcing EAR, which governs the export and import of most commercial items, including those with defence or military applications (so-called “dual use” items). ITAR governs the export and import of defence-related articles and services, and it includes a specific category for space-related products, services and technologies. All manufacturers, exporters and distributors of defence items and services and associated technical data need to be registered with the US State Department’s Directorate of Defense Trade Controls (DDTC) to be ITAR compliant.

Export Licences

Export licences may be required before a US business may export or otherwise make available dual-use or defence-related products and technologies to a foreign entity, including a foreign acquirer. Each business is responsible for determining whether any of its products or services require a licence. It is therefore very important for foreign acquirers or investors to understand the implications that US export control regulations may have on their acquisitions of, or investments in, US businesses.

Review of Business Combinations

The HSR Act enables the US Department of Justice (DOJ) and FTC, which have concurrent general jurisdiction to enforce the antitrust laws, to review business combinations for possible anti-competitive effects before the transaction closes. This is accomplished by requiring that parties to transactions that meet a specified valuation threshold (USD92 million effective from 4 March 2021) notify the FTC and DOJ and observe waiting periods prior to the closing of the transaction. In the case of transactions that do not require a lengthy review, the applicable waiting period will generally be 30 days post-notification unless it is terminated earlier by the reviewing agency. The FTC and DOJ announced a temporary suspension of early termination grants as of 4 February 2021 and, at the time of writing, had not resumed or announced a timeline for resuming early termination grants.

The initial HSR waiting period may be extended if the reviewing agency issues a request for additional information or documentary material, usually called a “second request”, which begins a second-phase investigation. A second request may be issued if, for example, the parties have overlapping product lines in a concentrated market or if customers express concern about the competitive effects of the acquisition. If a second request is issued, the waiting period typically does not terminate until 30 days after all the parties have complied with the second request. It typically takes parties two to four months to comply with a second request, although the time period may be much longer.

Potential Actions by Reviewing Agency

At the conclusion of its investigation, the reviewing agency will take one of three possible courses of action. Firstly, it may close its investigation without taking any further action. Secondly, it may allow the transaction to close while insisting on certain structural remedies, such as divestitures of facilities or product lines, or behavioural remedies, such as transparency or non-discrimination requirements, to mitigate the anti-competitive effects of the transaction. Thirdly, the agency may seek to prohibit the parties from closing by initiating proceedings in a US federal district court.

The DOJ and the FTC also have the ability to review business combinations that are not subject to the notification and waiting period requirements of the HSR Act, as well as business combinations that have already been consummated.

In connection with M&A transactions, buyers should consider regulations and other impacts with respect to employment, labour, employee benefits and compensation matters. Both federal and state, as well as local, laws can be implicated with respect to these matters.

Employment and Labour

Employment arrangements in the US are generally “at will”. Buyers need to consider worker classification (ie, whether the service provider is properly classified as an employee or a contractor), which may differ based on the state of employment, and proper visa status of workers. Buyers should be aware of the Worker Adjustment and Retraining Notification (WARN) Act and similar state laws that may give employees the right to early notice of impending lay-offs or plant closings (or salary in lieu of notice). Buyers should also be mindful of sellers that utilise the services of a professional employer organisation (PEO) to provide certain human resources functions, as such arrangements may create a co-employment relationship or trigger other analyses regarding benefit plan compliance.

Buyers need to review employee equity plans and the impact of a change of control on outstanding employee equity. Unlike many industrial companies, most technology companies offer employee equity to all levels of their workforce and equity can be a material portion of an employee’s compensation.

Employees may be subject to restrictive covenants, including non-compete and non-solicit agreements, either under agreements in place prior to a transaction or under agreements that the buyer intends to put in place in connection with a transaction. The enforceability of such agreements is determined on a state-by-state basis, with California being one of the most restrictive. Buyers should also consider federal, state and local privacy and non-discrimination laws in connection with implementing employee on-boarding polices, such as background checks and drug-testing policies.

Employee benefits

Buyers should be aware of the Employee Retirement Income Security Act (ERISA), which governs the operation and terms of certain employee benefit plans, including their treatment in connection with transactions.

Health plans must be reviewed for compliance with the Affordable Care Act (ACA), which includes certain benefits mandates. The parties must also understand their obligations with respect to the Consolidated Omnibus Budget Reconciliation Act (COBRA) and similar state laws that provide benefit continuation coverage after termination of employment. Certain states may also require the payout of accrued leave or other benefits.

Employee compensation

Finally, buyers should evaluate the target's prior compliance with the Code and the tax impact of transaction compensation. Section 280G of the Code regulates "golden parachute" payments made to certain key employees in M&A transactions. Section 409A of the Code regulates non-qualified deferred compensation and imposes a steep excise tax on non-compliant compensation. The Code may impact decisions on post-closing employment arrangements, including employment agreements, retention plans or agreements, and equity compensation. Equity grants must also comply with federal securities laws and similar state “blue sky" laws, which require securities granted to be registered or to fit within an exemption.

No currency control regulations or central bank approvals are required for US M&A transactions.

A significant recent legal development related to M&A involved the first finding by a Delaware court that a material adverse effect (MAE) had occurred in the time between the announcement of a transaction and its closing, entitling an acquirer to terminate its acquisition agreement. The absence of an MAE having occurred with respect to a target’s business is a customary closing condition found in agreements governing US M&A transactions.

In its October 2018 decision in Akorn, Inc v Fresenius Kabi AG, the Delaware Court of Chancery found that Akorn’s decline in financial performance since the parties signed their merger agreement was material, and that the underlying causes of the drop in Akorn’s business performance posed a material, durationally significant threat to Akorn’s overall earnings potential. The Chancery Court’s decision, affirmed by the Delaware Supreme Court in December 2018, confirms that an MAE may be recognised in Delaware and provides helpful guidance as to the quantitative and qualitative analysis of what constitutes an MAE.

In an M&A transaction, a selling company would generally disclose to bidders:

  • the material contracts to which it is a party (including joint venture agreements, research contracts, and IP or IT licences);
  • a schedule of patent, copyright and trademark registrations and applications and internet domain names owned by the company;
  • a summary of pending and threatened litigations to which the company is a party; and
  • the company’s template employment agreement, including a template employee invention assignment agreement. 

It is not uncommon for a company to withhold providing reports or opinions of counsel relating to the company's activities, such as intellectual property opinions pertaining to infringement or the company’s freedom to operate, on the basis of preserving confidentiality and attorney-client privilege. A company should also consider the protection of its trade secrets when deciding what documents to provide throughout the diligence process.

A company may be impeded from providing bidders in the US with due diligence information to the extent that such information is protected by data privacy laws or confidentiality agreements with third parties. Information that is legally or contractually prohibited from disclosure may be redacted, or consent of the relevant third party may be obtained, to allow a company to share documents that are otherwise material to the due diligence process.

Public companies do not have an affirmative obligation to disclose diligence information to bidders or to provide all bidders with the same information. However, a board of directors should act in accordance with its fiduciary duties to its shareholders when deciding whether to disclose diligence information to bidders and should have a reasonable basis to support providing different levels of information to different bidders.

There are both legal and contractual restrictions that could limit the due diligence information provided by a technology company in the US. Before providing due diligence information in connection with an M&A transaction, a company should assess which federal, state and non-US data privacy laws may apply to the company’s business. US state and federal laws, as well as EU laws, frequently apply to cross-border M&A deals. More specifically, if applicable, the EU General Data Protection Regulation (Regulation (EU) 2016/679) and the California Consumer Privacy Act of 2018 restrict a company’s ability to share certain personal data (ie, information relating to an identified or identifiable data subject). In addition, a company should ensure compliance with its published privacy policies and agreements with third parties containing privacy-related requirements. There is no comprehensive legislative privacy framework in the US. However, the US government has enforced Section 5 of the Federal Trade Commission Act – which prohibits unfair or deceptive acts or practices – against companies that fail to protect personal data or comply with published privacy policies. All of the foregoing should be carefully assessed before sharing personally identifiable information, such as client information or employee details (including social security or bank account numbers), during the due diligence process.

The rules relating to disclosure of M&A transactions in the US are generally the same for companies in the technology industry as for companies in most other industries.

Negotiated and Hostile Transactions

In the context of a negotiated transaction, a bid would not generally be made public until a definitive agreement has been reached between the bidder and the target. At that time, the transaction would be jointly announced by the parties. In a hostile bid, the bidder usually issues a press release announcing an intention or proposal to bid for the target.

In both negotiated and hostile transactions, bidders or targets may sometimes disclose that negotiations are ongoing or that offer letters have been sent or received, but this is less common. In addition, it is possible for news of a potential transaction to “leak” into the public domain through the media prior to a formal public announcement of a transaction.

Publicly Traded Companies

If the target company is publicly traded, the material terms of the transaction, including price, conditions to closing and any special terms or break-up fees, must be disclosed on a Form 8-K filed by the target company (and generally the buyer, if it is also a public company) with the SEC within four business days following execution of the transaction agreement.

Business Combinations

Depending on the structure of the transaction, shareholders would then receive either a proxy statement from the target or a tender offer document from the bidder and a recommendation regarding the transaction from the board of the target, all of which would be filed with the SEC. The substantive disclosure required for business combinations is broadly similar, regardless of structure, and would include previous dealings between the target and the bidder, a summary of the material terms of the transaction and certain financial information. Detailed disclosure regarding any fairness opinion rendered by the target’s financial adviser to the target board must also be included.

Issuance by the bidder of shares as consideration in a proposed transaction requires the bidder to register the share offering under federal securities laws, unless an exemption is available, such as private placements to only “accredited investors” satisfying requirements regarding their income, net worth, asset size, governance status, or professional experience. If required to register, the bidder must prepare a registration statement containing a prospectus with additional disclosure relating to the bidder and its shares, including the bidder's financial statements. When a registration statement is required, it is generally combined with the proxy statement or tender offer document into a single document.

Requirements in respect of bidder financial statements are complex and a case-by-case analysis of the financial information requirements of each transaction should be undertaken by bidders for US public companies. Unless the bidder’s financial condition is not material to the target’s shareholders (eg, in an all-cash offer for all outstanding shares that is not subject to a financing condition), the bidder's audited financial statements are generally required for the last two fiscal years (for an all-cash transaction) or three fiscal years (where bidder shares are offered as consideration), and unaudited but reviewed financial statements are required for the most recent interim period. Pro forma financial information may also be required for the most recent interim period and fiscal year.

The bidder's financial statements must be presented in accordance with US Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), or reconciled to one of these standards.

A US public target company is generally required to file with the SEC a copy of any material definitive transaction agreement reached with a buyer within four business days of its execution on a Form 8-K or with the target’s next quarterly report on a Form 10-Q (or, if earlier, its next annual report on a Form 10-K). These documents become publicly available immediately upon filing.

In addition to the definitive transaction agreement, any other agreements that are material to the transaction, which could include voting agreements or agreements relating to the financing of the transaction, must be described in detail in the relevant disclosure document provided to shareholders and filed with the SEC (and a copy of the agreement may also be required to be filed as an exhibit to the disclosure document).

Although the SEC can grant confidential treatment for portions of transaction documents that are required to be publicly filed, this is not common. Nevertheless, parties are permitted to, and typically do, omit from their public filings any schedules and similar attachments to transaction agreements if the contents of those schedules or other attachments do not contain material terms of the transaction or other information material to the shareholders’ investment decision; however, parties may still be required to provide such materials confidentially to the SEC upon request.

Directors of Delaware companies owe two principal fiduciary duties to the company and its shareholders: a duty of care and a duty of loyalty. These fiduciary duties are generally not owed to any other constituencies, except in unusual circumstances, such as a company insolvency, where duties may be owed to company creditors. Certain other states have “other constituency” statutes, which permit directors to consider the impact of a potential business combination on constituencies (such as employees) other than the company and its shareholders.

The Duty of Care

The duty of care requires directors to exercise reasonable care in making decisions for the company. This duty requires directors to inform themselves of all available material facts and circumstances, devote sufficient time and deliberation to the matters under consideration, participate in board discussions, and ask relevant questions before making a decision or taking a particular action related to a potential business combination.

The Duty of Loyalty

The duty of loyalty requires directors to be loyal to the company and its shareholders, to act in good faith and to not act out of self-interest or engage in fraud, which includes a prohibition on self-dealing and the usurpation of corporate opportunities.

It is not uncommon for boards to establish special or ad hoc committees to negotiate and evaluate potential business combinations. A committee of independent directors is often formed in situations where the potential transaction involves a controlling shareholder or management participation, or where the majority of directors are conflicted. In these situations, the forming, empowering and effective functioning of a special committee of disinterested and independent directors can be an effective part of demonstrating that the directors have discharged their fiduciary duties in evaluating and approving the transaction.

Board’s Role in Negotiations

Negotiation of an M&A transaction is usually conducted by the management of the companies, with regular updates to and input from their respective boards of directors. A company’s board of directors must ultimately approve any sale of the company and the material terms of the sale.

Shareholder Litigation

Shareholder litigation is very common in connection with the acquisition of US public companies, but the overall levels of such litigation have fluctuated in recent years. The fluctuation is tied to at least two developments in the laws concerning merging litigation:

  • firstly, decisions by state (principally Delaware) and federal courts have attempted to curtail the use of “disclosure only” settlements used by shareholder plaintiffs to extract additional information and legal fees from target companies in M&A transactions; and
  • secondly, Delaware courts continue to extend the application of the business judgment rule (ie, the most lenient standard of judicial review) to decisions by boards of directors of target companies in certain merger transactions approved by a fully informed, uncoerced shareholder vote, making it more difficult for shareholders to challenge such transactions and easier to obtain dismissal of such challenges early in the proceedings before shareholder plaintiffs can seek discovery.

However, the measures taken by states such as Delaware to reduce shareholder litigation have resulted in plaintiffs seeking alternative means and jurisdictions to resolve merger-related disputes and seek money damages.

In addition, appraisal actions have been prevalent in M&A related litigation, particularly in Delaware. However, recent decisions by the Delaware Supreme Court may reduce the frequency and outcomes of appraisal actions in that state. In those cases, the Delaware Supreme Court held that significant, if not dispositive, weight should be placed on market-based indicators of value, including the target’s stock price or the transaction price, where the shareholders seeking appraisal fail to demonstrate that the market for the target’s stock is inefficient and/or that the transaction price did not result from a robust sale process.

Although litigation challenging M&A transactions continues to occur routinely in the US, it is relatively uncommon for it to result in a meaningful delay in the transaction or personal liability to the target company directors that approved it.

A board considering a possible business combination transaction will generally engage outside legal and financial advisers and may also seek the advice of outside accountants and consultants.

Directors are permitted to rely upon the advice of outside professionals (as well as internal management and other employees within the scope of their expertise), and the receipt of robust advice from outside advisers is an important aspect of the discharge of a director’s fiduciary duties.

Boards of publicly traded target companies will almost always request that their financial adviser deliver a “fairness opinion” to the board, which will opine that the consideration to be received by the target company’s shareholders is fair from a financial point of view.

Shearman & Sterling LLP

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+1 212 848 4000

www.shearman.com
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Shearman & Sterling LLP advises leading corporations, major financial institutions, emerging growth companies, governments and state-owned enterprises on complex strategic and legal matters. The firm has over 850 lawyers in 25 offices around the world, speaking more than 60 languages and practising US, English, French, German, Italian, Hong Kong, OHADA and Saudi law. Its long-standing M&A practice regularly represents clients in their most important transactions. Shearman’s lawyers focusing on the technology industry comprise several dozen practitioners based in the firm’s San Francisco, Menlo Park, New York, Washington DC, Austin, Dallas, London, Paris, Munich, Abu Dhabi, Dubai, Riyadh, Hong Kong, Beijing, Tokyo and Singapore offices. The firm’s clients include some of the world’s largest technology and software companies, promising venture-backed and privately held companies, as well as investment banks and private equity funds that focus on technology. Partners and counsel in Shearman’s technology group are thought leaders who frequently write and speak on technology industry specialisms to national and international technology development forums, financial institutions, academic and research facilities, and regulators.

The Surge in Technology Transactions

Transactions in the technology sector have been on a hot streak, with an increase in mergers and acquisitions, capital funding, and initial public offerings and de-SPAC transactions, fuelled by both growing general optimism about the economy’s rebound as well as the major transformative changes that the world is going through. We are in a seller-friendly market with high valuations. Corporate investors are flush with cash, and many are choosing to invest in technology. It is a major growth segment of the economy right now, and smart companies are looking to position themselves accordingly.

Industry sectors such as energy, finance, healthcare, automotive, transportation and real estate are experiencing technology-focused disruptions in their markets. In the rush to stay competitive, many companies are forgoing development of their own technologies and opting to make strategic acquisitions to fill their business needs. Low interest rates and high investor appetites are adding fuel to this technology-deal fire.

In the past year alone there have been several multibillion-dollar transactions in the technology space, including Square’s USD29 billion acquisition of Afterpay, Salesforce.com’s USD27.7 billion acquisition of Slack, Microsoft’s USD19.7 billion acquisition of Nuance, Zoom’s USD14.7 billion acquisition of Five9, Intuit’s USD12 billion acquisition of Mailchimp, and Hitachi’s USD9.6 billion acquisition of GlobalLogic.

The pandemic is spotlighting the value of technology

The widespread remote working environment that started with the COVID-19 pandemic has put technological solutions front and centre for many businesses. Technological innovations enabled companies to carry on crucial aspects of their work, maintain operations, engage employees and keep robust security protocols, all with workforces outside of traditional office environments. Video-conferencing and other digital working solutions helped keep productivity high and minimised the disruptive aspects of the pandemic. Distributed workforces are becoming more common, which is increasing reliance on digital communication, collaboration apps and cloud-based productivity tools.

By the same token, technology companies were more insulated and less affected by the uncertainties related to macro issues coming out of the pandemic, such as industrial companies' need to staff sites that cannot be operated remotely, shifts in energy production and consumption, and the uncertainties in sectors such as hospitality and other service-related industries. Technology is typically seen as an important investment area, but the pandemic drove values into the stratosphere.

Growth itself has become a credo

As companies turn to technological solutions to stay relevant and grow their market share, they are faced with a decision to either develop the technology themselves or buy it. Technology is also frequently the key to keeping up with shifting consumer appetites and regulatory demands. Cryptocurrencies, self-driving cars and green energy solutions are examples of technological disruptors in different industries.

Deal structures are seeing pandemic-related changes

The pandemic has also encouraged some widespread changes to deal structures, many of which are likely to become standard. Most M&A deals now include some relief or reduced contingencies in regard to COVID-19-related market uncertainties, and these are frequently being extended to include any government mandates that may affect business. This is impacting the definition of “material adverse effects” in definitive agreements, as well as exceptions to covenants that require the company being bought to operate its business in the ordinary course between signing and closing.

There has also been widespread adoption of representation and warranty insurance in many deal structures. Private equity transactions have typically included representation and warranty insurance in recent years, and it is now being increasingly adopted by strategic buyers. The typically reasonable cost of this insurance is enabling sellers to get more upfront cash and have less exposure to post-closing contingencies while simplifying the deal negotiation process.

Private equity fundraising is seeing a healthy rebound

Global private equity fundraising dropped during the first part of the pandemic, following broad uncertainty in the market. Travel restrictions also had a quietening effect on deals, as it became difficult to create and nurture new deal pipelines. Capital funds remained healthy, however, and from the second half of 2020 into 2021, spending increased and private equity deal volumes increased. Private equity buyers have adapted to the restrictions, sometimes focusing on existing relationships for deal opportunities, and diversifying their asset classes. There was a pent-up demand for deals coming off the initial slowdown, and private equity funds in general have proved to be adaptable and resilient to the market volatility.

Going public with SPACs

As technology companies take advantage of the high investor appetite by going public, there is a trend towards the use of special purpose acquisition companies, or SPACs, for this purpose. SPACs offer an alternative to the traditional IPO through what is called a de-SPAC transaction.

SPACs are becoming increasingly common in the technology sector and beyond. As publicly listed companies designed for the purpose of merging with a private company, SPACs enable companies to go public without going through the traditional IPO process. This offers several benefits to investors in private companies in terms of higher valuations and a faster process than a traditional IPO. Venture capitalists and private equity sponsors are able to provide cheaper financing and get a quicker return on their investment than with a traditional fundraising and exit cycle.

Companies looking to go public are also choosing the de-SPAC route more often in order to take advantage of cheaper financing than they would find in the private markets. There is also the possibility of some earlier liquidity for shareholders.

SPACs are also a significantly faster path to the open market than a traditional IPO. Typically, the life cycle of an IPO from an investor’s point of view can be several years, from raising the funds, holding through the deal, and selling after a lock-up period. With SPAC IPOs, investors are seeing a return in as little as six months.

As SPACs are becoming more widely used, predictably enough, they are also being scrutinised more by regulators. In addition, some discerning investors still prefer traditional IPOs. That said, there continues to be a large number of SPACs seeking private companies with which to merge and technology companies interested in this route should have a lot of options.

Private companies and corporate investors are flush with cash

There is an abundance of capital in the private markets right now, which is encouraging some technology companies to stay private for the time being. At the same time, the increase in capital fundraising capabilities and the proliferation of technology solutions across sectors mean that many companies are deciding it is a smart time to buy.

A seller’s market like this one always has a lot of high-volume deal activity. It is an exciting time for emerging companies with smart technological solutions. On the buy side, companies are facing stiff competition. Sellers are setting tight timelines and buyers are under real pressure to meet those timelines and high-valuation expectations.

Regulators’ effects on deal activity

Governing bodies including the US Federal Reserve, the European Central Bank and the Bank of England’s Monetary Policy Committee have been setting interest rates low since the start of the pandemic, which is one factor encouraging deal activity in the technology sector.

At the same time, as technology transactions have increased in volume and amounts, regulators are increasingly scrutinising the deals for any potentially anti-competitive effects. In the US, the Department of Justice and the Federal Trade Commission (FTC) are understood to be focusing much of their efforts on consolidations in the technology sector, scrutinising transactions they deem potentially harmful to consumers. In the UK, the government is looking to increase the powers of the Competition and Markets Authority, giving it increased jurisdiction and lowering the threshold for inquiries. These potentially heightened-control efforts are also largely focused on the technology sector.

As governing bodies only conduct advance reviews of deals over a certain dollar threshold, currently set at USD92 million in the US, some technology companies are getting creative – often to the consternation of regulators. One tactic that garnered attention last year was the paying of dividends by a large cap company to investors ahead of a merger, reducing its assets below the threshold and thereby avoiding scrutiny. The FTC is, however, cracking down on this strategy, having announced late last year that it would consider special dividends a possible “avoidance device”, potentially triggering investigation.

There has also been increased co-ordination between regulatory agencies in the US, UK and Europe, which can slow down deals and make investigations more robust. Pushback from regulators is largely a reaction to the high volume of megadeals. Regulatory probes are often slowing down closings, but properly structured deals are ultimately making it through.

Talent retention has become a tricky yet essential aspect to deals

The most valuable assets of emerging technology companies are often their people. Historically high valuations mean that founders and other key personnel at emerging technology companies are being offered life-changing amounts of money for the businesses they have created. For some, that may encourage them to cash out and retire. Buyers are getting smart to this possibility and building in retention packages for the most talented owners and employees, such as a requirement to reinvest their equity for a period of time, to ensure the long-term success of the acquisition.

The retention incentives need to take into account tax and accounting considerations in various jurisdictions. This is doubly true with companies operating on a more global basis, with, for example, headquarters in the US but operations and key talent in Asia. Deal structures need to be able to thread the needle of tax and accounting.

It is also crucial to consider the emotional or human component of this aspect of a deal. It can be a delicate operation to survey the talent at a start-up, many of whom have worked closely together for years on a possibly revolutionary product, and to put them all into categories of essential talent, or otherwise. Those deemed essential or “key” become subject to additional restrictions and need to negotiate their continued involvement in the acquired company. Those deemed inessential are free to cash out, but may walk away feeling injured or that their contributions were devalued.

Development for technology companies is increasingly global

Deal volume in the technology sector has been high across the globe – in the Americas, Asia-Pacific and EMEA. There is an ongoing trend towards cross-border technology transactions and investments, as companies search far and wide to fill their needs with the most innovative technology solutions.

Countries and regions that are currently seeing strong activity in this area are India, Eastern Europe, Israel and South America. Due to favourable tax laws in different jurisdictions, some companies are holding large amounts of cash offshore, which is also contributing to acquisition activity in the technology sector. At the same time, some countries are significantly increasing restrictions on foreign investments and acquisitions, which is hamstringing potential deals between, for example, the US and China, where there used to be a high volume of deal flow.

Cross-border deals, while increasingly common, are more complex for a variety of reasons. Deal teams need to be (or become) familiar with different deal structures, complex regulatory requirements relating to labour issues, currency controls, intellectual property, tax, executive and equity compensation, foreign direct investment and securities registration, among other things, as well as often significant cultural differences in deal-making.

The trend towards high-volume, high-value deals in the technology sector is expected to continue, as companies make strategic investments in smart innovations to grow their business and fill the needs of consumers in an increasingly digital world.

Shearman & Sterling LLP

599 Lexington Avenue
New York
NY
United States

+1 212 848 4000

www.shearman.com
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Shearman & Sterling LLP advises leading corporations, major financial institutions, emerging growth companies, governments and state-owned enterprises on complex strategic and legal matters. The firm has over 850 lawyers in 25 offices around the world, speaking more than 60 languages and practising US, English, French, German, Italian, Hong Kong, OHADA and Saudi law. Its long-standing M&A practice regularly represents clients in their most important transactions. Shearman’s lawyers focusing on the technology industry comprise several dozen practitioners based in the firm’s San Francisco, Menlo Park, New York, Washington DC, Austin, Dallas, London, Paris, Munich, Abu Dhabi, Dubai, Riyadh, Hong Kong, Beijing, Tokyo and Singapore offices. The firm’s clients include some of the world’s largest technology and software companies, promising venture-backed and privately held companies, as well as investment banks and private equity funds that focus on technology. Partners and counsel in Shearman’s technology group are thought leaders who frequently write and speak on technology industry specialisms to national and international technology development forums, financial institutions, academic and research facilities, and regulators.

Trends and Development

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Shearman & Sterling LLP advises leading corporations, major financial institutions, emerging growth companies, governments and state-owned enterprises on complex strategic and legal matters. The firm has over 850 lawyers in 25 offices around the world, speaking more than 60 languages and practising US, English, French, German, Italian, Hong Kong, OHADA and Saudi law. Its long-standing M&A practice regularly represents clients in their most important transactions. Shearman’s lawyers focusing on the technology industry comprise several dozen practitioners based in the firm’s San Francisco, Menlo Park, New York, Washington DC, Austin, Dallas, London, Paris, Munich, Abu Dhabi, Dubai, Riyadh, Hong Kong, Beijing, Tokyo and Singapore offices. The firm’s clients include some of the world’s largest technology and software companies, promising venture-backed and privately held companies, as well as investment banks and private equity funds that focus on technology. Partners and counsel in Shearman’s technology group are thought leaders who frequently write and speak on technology industry specialisms to national and international technology development forums, financial institutions, academic and research facilities, and regulators.

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