After the US M&A market experienced record transaction volume and aggregate deal value in 2021, US M&A activity generally reverted to pre-COVID-19 pandemic levels in 2022. In 2023, it slowed even further, particularly in the third quarter, and at the end of that quarter was on track to match only the depressed pandemic levels of activity in 2020. Technology transactions have not avoided the general M&A slowdown. Through the third quarter of 2023, the volume of US tech deals was down by approximately 50% compared to the same period in 2022.

A top contributor to the slow M&A market has been higher interest rates imposed by the US Federal Reserve, which has sought to tame inflation.

A portion of the depressed deal making has also been blamed on regulatory uncertainty and delays caused by aggressive antitrust enforcement by the Biden administration, which was formalised by proposed revised merger guidelines released by the US Department of Justice and the Federal Trade Commission in July 2023. However, recent losses suffered by those agencies, in multiple merger enforcement actions attempting to push similar themes in court, make it unclear whether federal court judges will embrace the drastic shift in approach to merger review represented by the proposed guidelines.

One consequence of the past 18 months was a significant decline in earnings for many technology companies, which contributed to a large number of employee layoffs across the technology industry. In 2022, layoffs of more than 93,000 employees were reported. Through October 2023, nearly 180,000 additional employees were laid off. As of November 2023, however, there were signs that these mass layoffs may be nearing an end.

2023 has also seen a possible thawing of the “crypto winter” in the blockchain and cryptocurrency sector, which had been caused by the failures of several prominent market participants in 2022. As of November 2023, major cryptocurrencies, including Bitcoin and Ether, have seen a steady rebound in their prices since their lows at the end of the previous year, and some investors were hopeful that the US Securities and Exchange Commission (SEC) would soon approve the first Bitcoin spot exchange-traded fund (ETF) trading on a major US exchange.

The use of special purpose acquisition companies (SPACs) also continued to decline in 2023 following precipitous post-de-SPAC valuation declines across many newly de-SPACed public companies, regulatory scrutiny and several failed de-SPAC transactions in 2021 and 2022. Through October 2023, new SPAC IPOs were on track to be down nearly 70% compared to 2022 levels (which themselves were down more than 80% compared to 2021 levels), and SPAC liquidations were already more numerous than those seen in 2022.

See 1.1 Technology M&A Market.

Start-up companies in the USA 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 USA.

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 US 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 shareholder also pays individual income tax on any distribution the shareholder 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 shareholders, 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 both to founders and to 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 equity holders 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 shareholders.

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 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 invest in a convertible note or SAFE.

Typical sources of venture capital in the USA are angel investors, accelerators and institutional venture capital funds (including corporate investors). Venture capital financing in the USA is easier to access compared to many other jurisdictions, but founders must still spend considerable time and resources engaging with venture-capital sources to secure financing. In recent years, foreign venture capital firms have increased investments in the USA. For example, Japan’s SoftBank has made several high-profile investments in the USA. 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 USA, 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.

National Venture Capital Association

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. As a result of the NVCA documents being well developed, many investors insist that companies use the NVCA forms as the basis for equity financings, and companies may also find it more efficient to use those forms.

Convertible Notes and 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 have been 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 and 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 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 USA than on a foreign exchange, particularly if its shareholders are primarily based in the USA. The capital markets in the USA 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 USA 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 USA.

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 company 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 target company 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 among 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 on 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 for 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 elsewhere in 5. Spin-Offs), 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 several statutory and non-statutory requirements that must be met 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. 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” (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 for the parent company, 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 to 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 assurance that the spin-off transaction qualifies for tax-free treatment under Section 355 – a process which generally takes approximately six months.

Most acquisitions in the USA 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) (USD111.4 million since 27 February 2023) 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 that 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

US 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 (soon to be reduced to five business days following adoption by the SEC of amended rules on 10 October 2023). 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 (within two business days, following the effectiveness of the 10 October 2023 amended rules) 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 USA 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 company 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, is not typically used in acquisitions of US public companies.

See 6.4 Consideration and Minimum Price.

See 6.4 Consideration and Minimum Price.

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 USA 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 to obtain and consummate the financing. In the USA, 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 if 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 if 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 reducing the need for the deal protection measures set forth above.

This is not applicable in the USA.

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) or 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 USA, 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 expiry 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 regulatory approvals.

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

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; and
• 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 by requiring a vote of the buyer’s shareholders 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 affected 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 the CFIUS requesting review of a proposed transaction. Once cleared by the 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 the 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 the 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 affect 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 exportation and importation of most commercial items, including those with defence or military applications (so-called dual-use items). ITAR governs the exportation and importation of defence-related articles and services, and 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 (USD111.4 million since 27 February 2023) notify the FTC and DOJ and observe waiting periods prior to the closing of the transaction. For 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 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:

• it may close its investigation without taking any further action;
• 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; or
• it may seek to prohibit the parties from closing the transaction 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 on employment, labour, employee benefits and compensation matters. Federal and state laws, as well as local laws, can be implicated with respect to these matters.

Employment and Labour

Employment arrangements in the USA 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 onboarding 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 M&A transactions.

Health plans must be reviewed for compliance with the Affordable Care Act (ACA), which includes certain benefit 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 affect 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 granted securities 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 trade mark 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 USA 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 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 USA. 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 USA. 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 to 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 USA 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.

Both in negotiated and in 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 receive either a proxy statement from the target or a tender offer document from the bidder, as well as 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 be 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 definitive agreements for 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;
• act in good faith; and
• 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 a 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 USA, 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 of 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.