M&A Report 2024: UK

The M&A environment continued to face headwinds in 2023, with subdued deal activity compared with the record levels seen in 2021. Steadily rising interest rates, inflationary pressures, geopolitical uncertainty, and regulatory actions have continued to shape the M&A market. This is underscored in deal value and volume data from Dealogic, with 2023 inbound UK M&A deal value (based on target nationality) dropping from £191 billion in 2022 to £109 billion in 2023. Despite market pressures, the 2023 volume figures demonstrated a greater overall market resilience, with inbound UK M&A deal volume (based on target nationality) at a similar level of 2,634 in 2023 compared to 2,739 in 2022.

Continued market pressures from the Ukraine–Russia war, tightening debt markets, and persistent inflation weighed heavily on financial markets for the majority of the year. However, a modest rise in activity was seen in the fourth quarter and driven by deals across the healthcare, technology, and financial services sectors, as cautious optimism led to companies seeking out new growth opportunities.

UK take-private transactions featured heavily in 2023 (i.e., when a publicly traded company returns to private company status as a result of a sale), accounting for approximately 53% in value of all UK transactions in 2023 (compared with approximately 46% in 2022, according to Dealogic). This activity was supported by UK-listed companies continuing to trade at a significant discount to their US peers.

In terms of M&A market drivers, public and private M&A transactions play an important part in the UK market, but private M&A deals make up a significant majority of UK-target M&A deals. Public takeovers have a prescribed process under the City Code on Takeovers and Mergers (the Takeover Code), as administered by the Panel on Takeovers and Mergers (the Takeover Panel), whereas the structure and process of private acquisitions are a matter of negotiation between the buyer and seller.

Latham & Watkins advised on a number of significant M&A transactions in 2023, including acting for Abcam, a global leader in the supply of life science research tools, on its acquisition by Danaher Corporation for approximately $5.7 billion (and having previously advised Abcam on its listing on NASDAQ).

Latham also advised Norsk Hydro on its agreement with Glencore, regarding the acquisition of Brazilian alumina refinery Hydro Alunorte, the world’s largest alumina refinery, and additional assets.

Furthermore, Latham advised on the multi-faceted cross-border strategic alliance between Lithia Motors and Pendragon, consisting of Lithia's acquisition of the UK motor and leasing business of Pendragon to create the UK’s second-largest car dealer group by revenue (with revenues of $5 billion), a subscription for shares by Lithia into Pendragon (to be renamed Pinewood) to result in Lithia becoming one of Pinewood’s largest shareholders, and the formation of a joint venture between Pinewood and Lithia to market and deploy Pinewood’s proprietary dealer management software in North America.

The M&A environment in 2023 remained subdued, with interest rates and recessionary fears compounding market uncertainty and making it harder for parties to agree on deal price. However, the market also demonstrated resilience in deal flow relative to pre-pandemic levels as UK M&A deal volumes remained comparable.

Looking forward to the next 12 months, the macroeconomic headwinds that hampered UK M&A in 2023 may recede with a normalisation of large-scale M&A volumes amid an increasingly supportive institutional leveraged loan market. The private markets have demonstrated a resilience, with many investors sitting on record levels of capital that needs to be deployed. It is anticipated that the M&A environment in 2024 will show improved sentiment, but the M&A playbook will also require buyers to readjust their valuation processes and prioritise greater investor protections through creative structures.

The most significant factors influencing deal structures in 2023 were the introduction of new regulatory red tape and the low availability and high cost of traditional debt financing. The new regulations that are having an impact on M&A activity are discussed in detail below.

In terms of debt financing, the challenges faced by firms in sourcing debt at reasonable rates have meant that private equity and venture capital bidders have struggled to put in place long-term financing arrangements in the post-completion phase, impacting bidder returns and capital availability. As a result, certain private equity and venture capital firms that could not fully fund transactions pressed the ‘pause’ button on investments. Strategic bidders with committed but undrawn capital, however, could afford to be more flexible in how they deployed capital and were therefore more active in this space.

Deal structures in 2023 were also influenced by a continued rise in shareholder activism. Activist investors are strategically using the inflationary headwinds to compel companies into action (including by way of strategic M&A), with US-based investors spearheading a significant proportion of public campaigns in 2023. In response, UK plcs are proactively enhancing activism defence strategies and focusing on ESG objectives in response to greater scrutiny.

Private equity acquirers continued to be active in the UK M&A market, albeit at lesser levels than in recent years. More challenging financing markets in 2023 led financial sponsors to look to non-traditional lenders and equity co-investors to finance deals.

The general partner-led secondaries market continued to experience growth as the range of accessible exit routes for funds narrowed across the IPO and M&A markets, compounded by the need of limited partners to realise liquidity.

Further opportunities to acquire high-quality assets at lower multiples are expected to continue to drive deal volume (particularly as interest rates begin to stabilise) and the related recovery of acquisition financing markets should further drive M&A activity in 2024.

In terms of legislation and the regulatory bodies that govern M&A activity in the UK, the UK Companies Act 2006 applies to public and private companies registered in the UK. While the Companies Act 2006 does not govern M&A activity as such, its requirements dictate the way that deals by UK companies are effected.

The acquisition of private companies is a matter of negotiation between the buyer and seller, and no regulated offer process is required. In non-regulated industries (i.e., other than financial services, telecoms, media, and pharmaceuticals), deals are not typically subject to input from regulatory bodies, save for competition and foreign direct investment (FDI) matters. Public acquisitions are governed by the Takeover Code, a principles-based set of rules issued and administrated by the Takeover Panel.

The end of the Brexit transition period on December 31 2020 marked the end of the European Commission’s (EC’s) status as a ‘one-stop shop’ for the review of mergers relating to the UK meeting monetary thresholds. This means that if a merger satisfies the jurisdictional thresholds of the EU Merger Regulation and the UK’s Enterprise Act 2002, the Competition and Markets Authority and the EC may conduct parallel assessments of the same merger in their respective jurisdictions.

A number of recent regulatory changes have impacted M&A transactions – the introduction of the National Security and Investment Act 2021 (the NSI Act) in 2022 and the Foreign Subsidies Regulation (FSR) in 2023 continue to affect the structure and timelines of deals.

The NSI Act empowers the secretary of state to screen a broad range of transactions on national security grounds and allows them to block or impose conditions on deals. Under the NSI Act, 93% of notified transactions were approved within the initial 30-working-day review period (according to the UK government’s most recent annual report), but dealmakers must now routinely factor in potential NSI Act processes at the early stage (particularly if national security concerns are foreseeable).

Additionally, the FSR allows the EC to investigate and remedy distortive subsidies. Under the FSR, the EC has the power to review a wide range of M&A transactions (at specific concentration thresholds) involving any company that has received a subsidy from a non-EU country. This new regulatory layer applies in addition to existing merger control and FDI scrutiny, and effectively imposes an obligation on all companies operating in the EU to keep detailed records of all foreign financial contributions received by any entity of the group, taken as a whole.

In terms of upcoming policy framework changes that may impact M&A in the UK, merger control scrutiny is tightening. In particular, agencies are scrutinising the suitability of buyers and market dynamics more closely and imposing greater evidentiary burdens on merging parties; for example, buy-and-build transactions were a focus in 2023, a trend that the authors anticipate will continue in 2024. Strategic management of merger control from the outset is key to ensuring successful deal execution.

Furthermore, the Financial Conduct Authority (FCA) has published a consultation paper setting out detailed draft rules for a new UK listing regime. The publication represents the final stage of the journey to reshape the UK Listing Rules, which started with the launch of Lord Hill’s UK Listing Review in 2020. Key measures include the following:

• Single segment – the existing premium and standard listing segments will be merged into a new, single segment for equity shares in commercial companies.

• IPO eligibility – certain key barriers to listing (including the current premium segment requirements for a three-year financial and revenue-earning track record and a ‘clean’ working capital statement) will be removed.

• Significant transactions – Class 1 transactions will trigger only a requirement on the company to release a transaction announcement (but with no requirement to include a working capital statement or restated historical financial information), rather than a compulsory shareholder vote or FCA-approved shareholder circular.

• Related-party transactions – larger related-party transactions will no longer require compulsory shareholder votes or FCA-approved shareholder circulars. Instead, such transactions would require a transaction announcement and a fair and reasonable opinion from a sponsor.

M&A dealmakers should remain alert to these changes as the implementation process progresses.

A common misconception about the UK M&A market is that public transactions cannot be consummated by way of merger. The Companies Act 2006 does, in fact, provide for merger by absorption for UK public companies, but these provisions are generally not used and a scheme of arrangement is more commonly seen. This approach is in contrast to other jurisdictions; in particular, the US, where mergers are frequently encountered.

An area that is often overlooked by parties involved in M&A transactions is that buyers do not appropriately attend to the consolidation of group companies immediately after closing, resulting in continued administrative and financial burdens (for example, filing annual accounts) to correctly maintain newly acquired dormant or inactive subsidiaries.

Dealmakers are increasingly using artificial intelligence technology to conduct more efficient due diligence in M&A transactions. It is now routine for dealmakers to use virtual meeting technology and electronic signature platforms to negotiate and close transactions, and this looks set to continue. On the other hand, cybersecurity preparedness has become a paramount technological concern for companies, as sophisticated and costly attacks are on the rise.

The acquisition of control of a public company is regulated by the Takeover Code and the Takeover Panel. A bidder may choose to stake-build to obtain a toehold in a public company. However, depending on the timing of such acquisition and the form of consideration, stake-building may set a floor price and fix the form of consideration for any future offer. Furthermore, acquiring 30% of the voting rights in a public company will require a bidder to launch a mandatory cash offer for the remainder of the shares it does not own at the highest price it has paid.

In addition, any dealing giving rise to speculation, rumour, or an untoward movement in the public company’s share price may mean an announcement is required (if the acquirer is considering making an offer for the whole company), while disclosures will also be necessary once certain thresholds of ownership are crossed.

A takeover offer will usually be subject to an extensive set of conditions, including:

• Securing acceptances carrying more than 50% of the voting rights in the target (or, in the case of a court-sanctioned scheme of arrangement, the requisite 75% target shareholder approval);

• Antitrust and regulatory approvals;

• The bidder’s shareholder approvals;

• Listing of consideration shares (when applicable); and

• Conditions dealing with the state of the target’s business.

A bid cannot be subject to conditions that depend on the judgement of the bidder. Additionally, bidders seeking to rely on a material adverse effect or similar bidder protective condition to not proceed with an offer require the consent of the Takeover Panel, which applies a materiality test with a high bar (requiring the circumstances to be of considerable significance and aiming to strike at the heart of the purpose of the transaction) before it will permit an offer to be lapsed.

In public takeover offers, break fees (when the target pays the prospective buyer) are now largely prohibited, whereas reverse break fees (when the prospective buyer pays the target) are not prohibited. Only in limited circumstances can a break fee be offered; for example, a break fee may be offered to a ‘white knight’ making a bid in competition with a hostile offer that has already been announced (subject to such fee being de minimis and payable only upon the first offer becoming, or being declared, wholly unconditional).

According to the tenth edition of the Latham & Watkins European Private M&A Market Study (the M&A Market Study), 55% of deals included a locked-box mechanism, 28% of deals included a completion accounts mechanism, and 17% of deals did not provide for price adjustment – broadly consistent with the 2022 findings.

The proportion of deals that included an earn-out increased in 2023 (and more significantly among private sellers) given the uncertain economic environment. The M&A Market Study noted that earn-outs featured in 20% of deals analysed, up from 14% in 2019. With a growing range of innovative earn-out metrics – and market dynamics in favour of cash-rich buyers – earn-outs are expected to facilitate M&A deals across sectors in the year ahead.

Escrows remain uncommon – only 15% of deals in the M&A Market Study featured an escrow, a notable decrease from earlier editions. This decrease is in part due to warranty and indemnity (W&I) insurance and sellers providing relatively limited covenants in the 2021–22 seller’s market. The decrease also suggests that despite buyers’ concerns about sellers’ ability to meet post-completion obligations, sellers are successfully resisting requests for a portion of the purchase price to be placed in escrow.

The prevalence of transactions featuring W&I insurance increased to 48%, after plateauing at around 32% in previous editions.

In private M&A, the conditions to closing included in a purchase agreement will vary based on the circumstances of each transaction. Historically, conditionality beyond regulatory and antitrust clearances have been uncommon, but the increasing role of regulation in dealmaking is having an impact in this regard.

The prevalence of FDI approval conditions continues to increase, corresponding with the increased number of jurisdictions with FDI regimes and the high-value, high-profile, and strategically significant nature of deals included in the M&A Market Study – 33% of 2023 deals analysed included FDI approvals as a condition (compared with 24% in 2022).

In the UK, it is not common practice to provide for a foreign governing law and/or jurisdiction in private M&A share purchase agreements. Such agreements relating to UK companies and assets are typically governed by English and Welsh law and are subject to the jurisdiction of the English and Welsh courts. In fact, for global transactions, depending on the location of the parties and their advisers, purchase agreements are also often governed by English and Welsh law, because it is viewed as stable, impartial, and commercial, with a developed litigation infrastructure.

The exit environment in the UK throughout 2023 remained subdued. The overarching effect of economic uncertainty, rising interest rates, and stock market volatility created hesitancy among many acquirers. These macroeconomic conditions played a major role in muting UK and global IPOs, among other strategies. The UK is specifically looking to promote its listing regime to maintain market share, and the introduction of new listing rules in 2024 should translate into greater exit opportunities.

Although it is difficult to predict how the current macroeconomic trends will play out in 2024, there are reasons to expect that some of the headwinds that impacted UK M&A activity in 2023 may give way. While UK M&A activity levels will likely continue to lag in the first two quarters of 2024, deal activity is likely to accelerate at the end of the year as investors continue to hold record levels of cash, and inflation and interest rates stabilise.

Nevertheless, factors that suppressed M&A activity in 2023 remain, and it is unlikely that the 2024 market will be as seller friendly as it has been in previous years. While investors will likely return to the market to attempt to take advantage of a reset in valuations and generally depressed competition for deals, they will likely proceed with caution and be particularly focused on the greater regulatory burdens when they target UK companies. Latham & Watkins expects that this will result in longer deal processes overall as the risks and benefits of potential transactions are more carefully considered, enhanced diligence is requested, and deal structures and terms are adjusted in response to perceived risks.