As the continually evolving M&A market adapts to a (hopefully) reviving economy, dealmakers are reflecting on recent deal processes, preparing to navigate hurdles, and strategising with legal counsel to optimise 2024 transactions. Following reduced deal volume in 2023, early signs of an M&A recovery are emerging, with dealmakers anticipating an improving interest rate environment and increasing deal finance availability. However, dealmaker caution, valuation and deal term gaps, and interventionist regulators remain key challenges, making transaction preparation critical to successful execution.
Addressing acquiror caution
Record levels of M&A activity, including compressed and highly competitive deal processes, resulted in more seller-friendly deal terms in 2021 and early 2022. Many deals were signed with fewer buyer protections and less information about target businesses than buyers have required at other times in the dealmaking cycle. This included tighter financial liability caps, shortened periods for claims, limited seller recourse, and frequent resistance to other protections, such as escrows and material adverse change clauses.
The aftermath of this M&A surge has seen a rise in post-closing discoveries of target company issues, and increasing M&A disputes, claims, and litigation – all compounded by ongoing macroeconomic and geopolitical challenges – making dealmakers reflect on their transaction playbooks and approach new deals cautiously.
While buyers have made gains in recent deals, a nuanced picture remains, with considerable variation in overall deal terms, based on deal size and target sector. Analysing data from more than 340 European deals signing or closing between July 2021 and June 2023 (inclusive), Latham & Watkins’ 10th edition of its annual European Private M&A Market Study (the M&A Market Study) provides insights into the trends and developments shaping the overall market.
As dealmakers prepare for new acquisitions, deal teams have worked closely with their advisers (internally and externally) to review previous acquisitions to pre-empt issues, implement improvements, and gain an in-depth understanding of current market dynamics. This collaboration encourages cross-practice information flows, which is critical in deal planning.
In recent deals, for example, this has included considering alternative deal structures and creative use of contractual provisions such as earn-outs. The growing prevalence of this contractual provision – in which additional post-completion consideration is paid based on the performance or meeting of targets by the acquired business – comes as parties seek flexibility to unlock valuation gaps and facilitate M&A deals, with 20% of deals making use of earn-out provisions.
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 downward trend for liability caps on commercial warranty claims also continues; however, the prevalence of transactions featuring W&I insurance has increased, after plateauing in previous editions. This increase reflects significant deal volume among private equity sellers, which typically favour W&I insurance, albeit W&I insurance now seems to be a commonly preferred route across the entire spectrum of sellers.
In the public M&A context, bidders have also been getting creative in an attempt to bridge valuation gaps. For example, 2023 saw five firm takeover offers announced that featured unlisted share alternatives, allowing target company shareholders the option to elect to roll into the bidder’s structure.
Ongoing creativity is to be expected in the year ahead as parties seek expert legal counsel for solutions to close deals while also managing risks.
Rising regulatory interventions
Dealmakers have a significant amount of regulation to contend with, including, most recently, the Foreign Subsidies Regulation (FSR), which empowers the European Commission to control subsidies that distort the EU internal market and places new filing requirements on dealmakers. As regulators and governments push to enhance and aggressively enforce a wide range of rules impacting investments in multiple sectors, dealmakers should expect to continue to feel the hand of government, even in sectors not traditionally viewed as ‘regulated’. Careful planning to manage and mitigate such interventions is essential.
Antitrust regulators remain particularly active. For example, the UK’s Competition and Markets Authority (CMA) is playing a more prominent role in reviewing global M&A deals, including a number of high-profile interventions in 2023, with more anticipated in 2024. Recent deals have also seen the CMA focus on buy-and-build transactions, as it looks to protect against perceived threats to consumers. It was perhaps this proactivity from the CMA that prompted the UK government to publish a “strategic steer” in November 2023 reminding the CMA that it was expected “to prioritise outcomes that promote competition, investment, innovation and boost economic growth”.
Foreign direct investment and national security concerns also remain a priority. As it currently operates, the UK’s National Security and Investment Act 2021 (the NSI Act) undoubtedly results in extra administrative steps for investors whose transactions are caught by the regime; in particular, the mandatory notification requirement. This is the case even when national security concerns are remote; for example, internal reorganisations, debt-to-equity restructurings, de-SPAC transactions in which no single investor acquires control of the target company, and acquisitions of companies whose activities are caught by the NSI Act’s wide scope.
It is therefore unsurprising that the prevalence of transactions featuring foreign direct investment approval conditions continues to increase – just 10% of deals included in the 2019 edition of the M&A Market Study featured such conditions, compared with 34% of deals included in the 2023 edition.
In late 2023, the secretary of state issued a call for evidence designed to solicit views on “how the system can be even more business friendly while maintaining and refining the essential protections we need to protect our national security”. As part of a wider pattern of the UK government showing a willingness to engage with investors, advisers, and other parties, the call for evidence has sought views on the scope of the mandatory notification obligation, including the definitions of UK economy sectors and the types of transactions covered by the mandatory notification obligation.
That said, the call for evidence is not restricted to reducing the NSI Act’s scope. The UK government has indicated that it is considering expanding the reach of some of the definitions of the sectors of the economy covered by the mandatory notification requirement, such as adding “generative AI” to the existing artificial intelligence definition, but potentially narrowing other parts of that definition.
With other regulators – including those in the US – voicing similar antitrust and foreign investment concerns, dealmakers need to consider the heightened risk and growing threat of enforcement action on multiple fronts. A key challenge has been navigating the nexus between regimes, and across different jurisdictions. As regulators can take divergent approaches to the same deal, proactive and early engagement with expert legal counsel is essential to navigate strategically the tougher and more complex enforcement landscape. Early diligence is required to assess and determine impacted entities based on the factual matrix of each deal.
With regard to the FSR, deal teams can also improve their chances of a successful transaction by planning ahead and assessing their relationships with governments and related entities across jurisdictions and corporate structures. In many cases, acquirors will need to engage upstream with specialists to prepare their notifications, which may be particularly challenging and time consuming for global corporations.
For acquirors seeking to enhance certainty in competition filings, employing risk mitigation by assessing available strategies (e.g., submission of a briefing paper or even a full merger filing to the CMA) may offer solutions. Where national security concerns are foreseeable, acquirors will need to ensure a comprehensive strategy is in place for engaging with government and addressing concerns, including potentially by adding a government affairs expert to the usual slate of advisers. But even when national security concerns appear implausible, severe sanctions for completing a transaction without first obtaining approval when required mean that notification analysis should form a key part of the deal preparation process.
Prepare for all transaction types
While traditional M&A was subdued in 2023 compared with previous years, joint venture activity, public-to-private deals (in the later part of the year), and carve-out transactions remained more robust. These deals are expected to remain prominent in 2024, and deal teams should remain agile and ready to engage in a range of deals.
Large corporates often operate ongoing reorganisation, carve-out, and divestment programmes to streamline portfolios, realign focus, and extract value from underperforming assets, and current market conditions are resulting in ramped-up preparations. There are plenty of issues for sellers to plan for as they look to maximise value; for example, deeply integrated businesses can make visibility on historical and forecast standalone performance difficult to obtain and measure. Corporates should:
Identify assets and entities within the deal perimeter (including when flexibility exists to respond to buyers’ requests);
Assemble a deal team covering all areas and jurisdictions;
Initiate early tax planning;
Consult legal advisers on regulatory filing requirements and HR issues; and
Consider corporate structuring.
Early planning and engagement with stakeholders is essential as there may be numerous third-party consents, employee consultations, and operational, technical, financial, legal, and taxation issues (among others) to consider to prevent business continuity and financial strength from being compromised, both in practice and in the eyes of an acquiror.
Such deal readiness is valuable for all companies but is particularly valuable for public companies as the UK continues to prove a fertile hunting ground for shareholder activism, with US-based investors spearheading a significant proportion of public campaigns during 2023. These seasoned investors with a track record of success are increasingly turning their attention to UK plcs, and corporates should expect more of this activity in 2024.
Heightened shareholder activist focus can introduce significant disruption to the day-to-day management and business operations of targeted UK companies. However, proactive preparation, including reviewing and enhancing activism defence strategies, can bolster UK plcs’ preparedness and uncover opportunities. In a welcome reduction to a source of friction in large-scale M&A, 2024 is expected to see the requirement for mandatory shareholder approval for significant transactions by UK premium listed companies (i.e., ‘Class 1 transactions’) removed, as part of the Financial Conduct Authority’s wide-ranging capital markets reforms.
Open for business
The next 12 months will likely present significant opportunities for dealmakers, but in a world increasingly difficult to predict, they will need expert legal counsel to help them to prepare for, and optimise, M&A transactions.
