Publication

The IBA’s 7th Mergers and Acquisitions in the Technology Sector Conference took place in Barcelona on 14–15 March 2024. It was generously attended by prominent deal makers and leading lawyers from all over the world. Below is a summary of key takeaways from the conference attended by Gints Vilgerts, M&A practitioner and partner at VILGERTS. The contents herein, is based upon statements or opinions expressed by the experts that are actively involved in M&A transactions on a daily basis in Europe and the US.

1) Overall commercial trends in Europe and US

The number of strategic acquisitions has increased compared to previous years, with a wider gap between valuations and expectations of the sellers. According to Goldman Sachs, multiples are down 2x if 2021 compared with 2024, based upon target revenues. Top SaaS company valuations are also down to 3x. In other words, consolidation is coming.

Large companies have a diverse range of risks, among which regulatory risks are increasingly prominent. Sales also being carried out through auctions, almost always.

US companies tend to be more direct when addressing risks in comparison with their European counterparts. Public and private companies never accept breakage fees for regulatory risks.  If there are breakage fees, those are capped at maximum 2%.

Virtual closing is standard now. Asset sales in M&A tech deals are on the decline due to data privacy issues and employee transfer complexity.

Very frequently, FDI and Antitrust issues go together. Unfortunately, those are time consuming. In some jurisdictions FDI is even more difficult as every country has its own rules and for lawyers it is not easy to determine whether FDI applies at all.

2) AI in current M&A transactions

There is no such AI law, unless there is a link to a particular industry. For law firms it is recommended they link practice areas to particular regulators.

Key risks in M&A tech deals are IP, data privacy, cybersecurity and now also the use of AI.

More and more AI is part of due diligence and R&W in the share purchase contracts. Ironically, there is denial of AI use by targets as it complicates the overall transaction. Some lawyers consider that AI is part of product liability questions.

In any deal team collaboration is critical, i.e., the legal team needs to quickly identify risks and what we can do to mitigate these risks. Most buyers agree risk management is better than a well drafted R&W. It is clear, penalties imposed on the target will affect the buyer.

In contract drafting alignment of definitions to include AI is underestimated and need to be taken care of by lawyers. During the due diligence, it is important to check whether the target has AI policy, and whether there is human oversight of AI produced product. AI policy is also required to avoid any leakage of information from the target, or breaches of copyright.

The unresolved question is how IP will be protected, if it is AI generated product, or some part of it is AI generated. The target’s and buyer’s management shall be on top of things and cannot ignore any risks related to potential copyright infringements. AI use supervision is a fiduciary duty of the director of the company. In practice, the question asked on ChatGPT or similar platform might be in breach of confidentiality already.

In an ideal scenario, an IT intense company’s executive board should include AI, GDPR, cybersecurity experts.

3) Asset deals in M&A tech sector

In asset deals the employees are the biggest risk. To transfer share options, licenses, cap tables. On top of that, comes the change of control and regulator approval (added risks that in too many instances can kill the deal entirely). Share swap is used as a risk sharing tool, but triggers tax risks that require review.

Also, in asset deals moving all IP to the target might be difficult. It starts with the simple question: who gets the money for IT services? Not always the person is linked with the actual payments.

Illumina – Grail case has opened pandora box for all M&A and competition lawyers. If there is too long a period before signing, or between signing and closing, then there shall be price negotiations in the middle.

If there is a cyberattack on the target before or after signing, then closing shall be optional.

Data lifecycle to be evaluated. A data breach before or after signing, may move a deal into an asset sale, but it may not help, it actually may kill the business due to limits for data transfer and missing contents from the users or customers.

An asset sale may kill customer marketing consents, but it depends on context and jurisdiction.

4) Non-compete undertakings

Non-compete varies, but in general it is typical to have a 2-year period from “closing”, not from “leaving the company” and it shall be combined with a “substantial payment” to a particular individual.

In Europe it is more regulated. If there is “good will” and “know how transfer”, then it is maximum 3 years non-compete, or 2 years non-compete if there is no such transfer. Controlling shareholder always gets 2 years, but when there is a post-closing consulting arrangement, it gets complicated as most likely the seller needs at least 50% compensation for the non-compete clause to remain valid once the consulting arrangement is over.

5) W&I Insurance

In W&I insurance most problems live around definitions in the insurance policy of “knowledge”, “damages”, “direct damages”, “punitive damages”, etc. Also, the scope of DD for W&I purposes shall be carefully crafted.

Typical premium of basic W&I insurance starts at EUR 50,000 and goes up depending upon the case with insured limits at 20% of the enterprise value.

Some lawyers consider that W&I is recommended for buyers more so than for sellers. A buyer will always have recourse against the seller if the insurer does not cover risks, and this should be properly reflected in the purchase agreement.

W&I insurers go deep into sensitive data, including notes from the target’s management interview.  Too often, insurance companies claim risk is not covered by the insurance policy terms.

The buyer shall take care of extra contractual claims against sellers: fraud and misrepresentation. For the buyer to claim “seller’s fraud”, it shall be based upon intentionally misleading statements during the LDD interview and statements shall include a lot of details.

When claims arise, insurers start with basic questions: was the seller acting in good faith when R&W were provided; was buyer acting in good faith when believed in the seller’s R&W? According to Marsh, most claims under W&I insurance are related to tax or financial losses.

6) Rise of uncertainty and trends

There is a rise in “Mexican deals” due to the prevailing overall uncertainty. The term “Mexican deal” typically refers to a specific type of transaction structure or arrangement. It involves a situation where the buyer and seller agree to a deal, but the buyer is not fully committed to completing the transaction until certain conditions are met. These conditions often include regulatory approvals, financing arrangements, or other contingencies.

Simultaneously, companies are pursuing so-called “dream deals” or “big transformative deals”. Parties wish to simplify these mergers and claim that it is worth doing including cash consideration.

As there are fewer transactions, there are shorter periods for deal making. However, some M&A advisors and lawyers disagree, due to lack of buyers deal cooking takes more time than before and the sellers should be patient. Extended deals may lead to losing employees as the longer the deal is not closed, then it is more likely the market knows about it and starts headhunting the target’s employees. Confidentiality is still important.

Due to falling valuations it is more difficult to structure purchase price allocations. VC funds have different exit pricing concepts depending on the stage they entered. In most cases VC funds have blocking rights.

Directors of target companies often find themselves in a conflict-of-interest situation when a deal arises, and handling this situation is more of an art than a science. The phrase “art, not science” was used a lot at conference to describe tasks reliant on creativity of legal team and the client in comparison with rigid rules. In law, it suggests applying legal principles with nuanced judgment. Legal practice involves interpreting rules to suit specific circumstances and client needs. Thus, the law is seen as more subjective and creative than purely formulaic. Practitioners use experience and intuition alongside the legal frameworks for optimal outcomes.

It is considered normal that the founder should receive additional compensation if they continue to work post-acquisition. If the founder or CEO does not want to continue after the acquisition, this may become a dealbreaker.

Negotiations on the basis of executed term sheet is mostly seen as “honeymoon period”. From a lawyer’s perspective, a very detailed term sheet is a valuable asset for the acquisition process.

Completion accounts approach is prevailing in the US. However, “locked box” purchase price dominates in auction processes and it is typical for European deals.

There have been some hybrid approaches used, as well in fairly large deals, being a mix between closing accounts and leakage restrictions to accommodate situations when the closing account preparation at end of month or quarter is the most convenient, but closing for various reasons cannot occur on such specific date, yet will take place after the closing accounts date.

Sellers and buyers sometimes disagree on the deferred revenue issues. It is a “liability” under GAAP, but the sellers see it differently. In most cases, the parties “split the baby”, i.e., the cost of services are applied to a 50% amount.

Earnouts are less and less popular, as in most cases it ends with litigation. Earnouts are not good for integration with the buyer’s team or systems.

However, alternatively, conditions precedent for the increase in purchase price post-closing are widely accepted and considered as a safer choice than earnouts.

The use of management incentive plans (MIP) is on the rise and have a wider impact on transactions than before including the purchase price.

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M&A is the core focus of our law firm, and we are highly praised by the market. Our team is highly specialized with remarkable capacity. We have successfully assisted clients in some of the largest Latvian transactions and pan-Baltic projects, our track record speaks volumes. Our M&A and corporate teams ensure a smooth transaction process with the best solutions for our clients.

For any enquiries, please contact M&A partner Gints Vilgerts (email: gints@vilgerts.com) or Reinis Sokolovs (email: reinis.sokolovs@vilgerts.com).