M&A Report 2024: US

The deal environment in 2023 was subdued relative to prior years; however, the M&A market, much like the US economy, was more robust than many had anticipated. Many usual players in the M&A markets were active, providing transaction volume to top-tier advisers. The outlook for the US M&A market in 2024 is cautiously optimistic.

While 2023 incurred headwinds that muted the pace, breadth, and depth of the M&A market – including ongoing heightened scrutiny from regulators globally, a rising interest rate environment, global tensions, and challenging equity markets -- there are a number of factors that may lead to a more robust outlook for 2024. These factors include well-capitalised corporate balance sheets, the equity markets trading near record highs, and the resulting improved C-suite confidence, declining inflationary pressures, the end of interest rate hikes, financial sponsors with ‘dry powder’ at the ready and renewed access to bank debt, and a normalisation of valuation expectations between buyers and sellers.

A factor that may also impact 2024 activity is the availability of the IPO market. In the event that the appetite for new equity offerings is muted, the M&A market could benefit. Finally, event-driven/activist investors catalysing M&A opportunities may also prompt market participants to act not only in response to such investors, but in advance of unsolicited overtures.

Dealmakers both domestically and outside the US will continue to heavily consider regulatory enforcement. Transactions totalling in excess of $360 billion have been challenged since 2022. While most of these transactions were ultimately consummated – often with structural remedies – the environment seems no less rigorous. The policies of the US Department of Justice (DOJ) and Federal Trade Commission (FTC) are in line with the more aggressive approach of non-US competition authorities such as the UK Competition and Markets Authority, which have also stepped up enforcement actions.

In 2024, a new and expanded Hart–Scott–Rodino (HSR) form and recently finalised revised merger guidelines will take effect. The revised HSR form will require filings with greater disclosures regarding proposed transactions. Market participants should appreciate that the heightened disclosure will require more time to prepare the forms and provide more regulators with more information to probe.

National security concerns also remain a significant consideration, particularly in certain market sectors such as technology and energy. Similar to antitrust/competition enforcement, ‘foreign investment review’ in the US (including the Committee on Foreign Investment in the United States, or the CFIUS) and around the globe (including the EU foreign direct investment review) will require increased attention and analysis by market participants.

Importantly, M&A market participants must also consider geographies in which they are transacting. For example, China is a more charged political environment particularly as it relates to national security issues. Dealmakers and corporate boards must take these considerations into account when evaluating transactions.

The US market continues to be driven by both private and public M&A transactions, although private M&A is more prevalent because there are many more private than public companies. The cost of capital and the availability of debt financing is a driving factor, particularly for private company and private equity (PE) dealmaking where acquirer stock is not available as transaction currency. For public companies, well-capitalised balance sheets together with an ability to use stock as an acquisition currency remain key drivers for potentially stronger deal volume in 2024.

Increased scrutiny and evolving models of antitrust enforcement and review continue to be topics of conversation among M&A participants within the US and around globe. Particular industry verticals including technology, energy, and healthcare are receiving heightened scrutiny from regulators. In the US, governmental agencies challenged and sought to block a number of high-profile transactions within those industries, including Microsoft/Activision and Illumina/Grail. Regardless of the agencies’ win/loss record, regulators are undeterred, as the potential for new legislation within the US with respect to ‘horizontal’ and ‘vertical’ mergers may alter long-held views on antitrust review and enforcement.

M&A practitioners continue to discuss approaches opposite regulators to maximise outcomes. Such changes would include preparing to divest assets in advance of approaching regulators (‘fix it first’ approaches) such that settlement packages are part of the proposed transaction rather than provided by regulators.

Deal flow in 2023 was similar in many regards to what occurred in 2022. Overall, in 2023 the total M&A market by value dropped approximately 20%, with the number of transactions falling by approximately 15%. These levels were below the decade-long trend in M&A from 2011 through 2021. Generally speaking, the M&A market in the Americas was similar to that which was seen in 2023. The markets in Europe and Asia were slightly more subdued.

Themes that were apparent in 2022 continued in 2023. Specifically, monetary tightening by the US Federal Reserve Bank in the form of significant interest rate hikes and fears of a recession in the US, along with geopolitical tensions, and general economic uncertainty weighed on the M&A markets. In particular, the first half of 2023 was subdued. That said, the second half of 2023 saw an uptick in transaction volume. In the fourth quarter of 2023, five of the year’s 10 largest transactions were announced, including several large transactions in life sciences. That industry vertical is expected to remain active in 2024.

Market participants are growing more optimistic that deal flow will improve through 2024. PE buyout funds continue to maintain high levels of uncommitted capital for M&A transactions and, importantly for PE participants, bank lending appears to be rebounding. The revival of bank lending, together with continued access to ‘private credit’, is viewed as a harbinger of increased PE transaction activity. Strategic acquirors continue to remain focused on growth both with a focus on M&A and organically. Moreover, corporations continue to focus on their organisations and where they may be streamlined through divestitures and spin-offs.

Significantly, there is a US presidential election in November 2024. Historically, election issues have not had material impacts on transaction volume; the election can serve as justification for participants to temper their M&A activities. In addition, market participants may evaluate whether a change in the White House may impact the regulatory agenda as a whole. Those considerations could impact when M&A market participants choose to pursue certain transactions.

Regulators in the US have explicitly signalled a heightened sensitivity to the competitive effects of certain transactions and have taken more aggressive actions, including prohibiting the consummation of particular transactions based upon the presumed anti-competitive effects. This increased regulatory scrutiny has impacted, and will continue to impact, transaction strategies in the global markets. In particular, certain industries – including technology, industrials, and healthcare – will remain under heightened oversight.

Participants in the US M&A market have also sought to work through valuation disconnects between buyers and sellers. In an effort to bridge the difference between the bid/ask spread in M&A transactions, the use of contractual provisions to mitigate pricing risks has become more common. Specifically, the use of earn-outs and ‘contingent value rights’ were a greater topic of discussion and influenced deal structures.

PE firms remain a driving force of dealmaking. With a halt to the rise in US interest rates and a decrease in economic uncertainties, PE participants are expected to be more active in 2024, with uncommitted capital at PE firms remaining at record levels.

Shareholder activism was more buoyant in 2023, with many campaigns focused on the common themes of asset allocation, sub-par returns on investment, board governance, and, importantly, M&A. Activists are expected to wage similar campaigns in 2024. With more robust equity market valuations, activists, as value investors, may be seen pushing for campaigns at those companies that have not participated in the market’s uptick and are struggling with operating performance.

US M&A transactions are subject to regulation by the federal government and the corporation’s state of incorporation.

The federal government primarily regulates the issuance and sales of securities through the Securities and Exchange Commission (SEC), antitrust matters through the FTC and the Antitrust Division of the DOJ, and foreign investment that may have national security implications through the CFIUS.

The laws, rules, and regulations administered by the SEC are particularly relevant in the purchase or sale of a US public company. The laws of the target’s state of incorporation govern that company’s internal affairs and impose requirements for shareholder approval of mergers and the procedures for effecting mergers.

The Biden administration, the legislative branch of the US government, and government enforcement and regulatory agencies have publicly spoken about antitrust priorities designed to address perceived shortcomings in antitrust enforcement. These evolving antitrust priorities will expand antitrust scrutiny and will continue to be top of mind for dealmakers. In negotiating transaction agreements, practitioners will need to be aware of these risks and how they are allocated and accounted for.

In addition, the SEC has also made changes to beneficial ownership filings in an effort to modernise such reports. Beginning in 2024, statements of beneficial ownership filed on Schedule 13D must be filed within five business days, rather than 10 business days, after a holder acquires more than 5% beneficial ownership. In addition, statements of beneficial ownership filed on Schedule 13G by “qualified institutional investors” (e.g., passive institutional investors) must be filed within 45 days after quarter end, as opposed to 45 days after year end. More accelerated filing date requirements can serve as an early warning signal to accumulations of an issuer’s equity securities.

In general, the US framework of protecting ‘consumers’, rather than ‘competitors’, is being revisited writ large. In addition, global developments regarding enforcement have been in lockstep with those in the US. Agencies outside the US are very focused on merger enforcement. For example, the UK’s Competition and Markets Authority has undertaken lengthy, time-consuming reviews of M&A transactions through the course of 2023. This potential revised regulatory framework, together with the time required to navigate regulatory review and the remedies that regulators may ultimately require, is something that all parties should consider thoughtfully when contemplating a potential M&A transaction.

Also in the US, reviews of M&A transactions related to national security issues continue to increase. The CFIUS has been subjecting more transactions to review. Similar to antitrust/competition enforcement, foreign investment regimes globally have been more active, with perceived increased protectionism on the rise.

The litigation profile as it relates to the US M&A market may sometimes be overstated. While it is true that ‘public’ M&A transactions have significant probabilities of being litigated, the large majority of all such cases are neither material nor time consuming. A well-run, deliberative, and thoughtful transaction process guided by informed and independent boards of directors will substantially reduce, if not entirely obviate, the risks of litigation. Market participants should not avoid transactions for fear of litigation.

In ‘public’ transactions it is often asked whether the buyer may pursue indemnity claims or escrow funds, or provide for representation and warranty insurance (RWI) to satisfy any post-closing claims for a breach of a representation or warranty. It is important to note that public M&A transactions are without recourse to the target company or the target company shareholders once the transaction has closed. In public company transactions, buyers should assume that once definitive transaction documents have been executed, the parties will be obligated to close, subject only to the receipt of required regulatory approvals or material adverse event (MAE) having occurred with respect to the target company.

An intuitive follow-on question and one that is often asked by non-US market participants is how an MAE is determined. Specifically, whether there are quantitative guidelines or whether it is entirely qualitative. In determining whether an MAE has occurred, there are no definitive guidelines. The question is whether the company in question has suffered a durationally significant, material diminution of its earnings potential not necessarily tied to macro market conditions but, rather, specific to the company in question.

As a result of the pandemic, dealmakers have had to adjust to a ‘virtual’ environment where every aspect of an M&A transaction relies on technology, necessitating a keener focus on cybersecurity issues in the deal execution process. Also, data privacy and cybersecurity have become critical elements of the business and operations of most companies and thus should be a key focus of due diligence in any M&A transaction.

In ‘public’ M&A, issues relating to obtaining control of a company are guided by the laws of the state in which a company is incorporated and the company’s organisational documents. Most states require shareholder approval (usually by a majority of outstanding shares) for mergers. Similarly, in the tender offer context, acquisition of a majority of a company’s outstanding shares is required to obtain ‘control’. This would be the case where the target company has recommended the tender offer and in the unsolicited/’hostile’ context, where an acquiror has launched a tender offer without requiring (or, in some cases, seeking) the target company’s recommendation. Certain regulatory approvals – including clearance under the Hart–Scott–Rodino antitrust statute, and for non-US acquirers, from the CFIUS – must be obtained before an acquirer can take control of a US company. Acquiring a US company in regulated industries such as financial services and energy may be subject to additional regulatory scrutiny at the federal and/or state level.

Public transactions are typically subject to the following conditions, among others:

• Accuracy of representations and warranties;

• Material compliance with covenants;

• No MAE on the target; and

• Receipt of required regulatory approvals.

In a transaction structured as a tender offer, the buyer will typically also require a ‘minimum tender’ condition to ensure that it may take control of the target company upon the closing of the tender offer.

Parties to public company merger agreements may employ various deal protection measures to deter third parties from interfering with the closing of an agreed-upon transaction. Parties may employ the following:

• A no-shop provision – a contractual provision that prohibits the target company (and its representatives) from soliciting competing proposals after the execution of a merger agreement.

• Termination fees (‘break-up fees’) – termination fees are payable by the target company to the buyer to reimburse the buyer for its costs and expenses in the event the target company terminates its merger agreement to accept a superior proposal from a third party. In practice, termination fees are in excess of the costs and expenses incurred by the buyer, but the quantum of the fee must not be so large such that courts find the termination fees coercive and in violation of the target board’s fiduciary duties. In the US, such fees typically range from 3–4% of the transaction value.

• Matching rights – merger agreements typically include contractual provisions that grant the buyer the right to match, within a number of days, any superior proposal that is received by the target company.

• Voting lock-ups – buyers may secure firm commitments from shareholders of the target company to vote their shares in favour of the proposed transaction.

• ‘Force the vote” provisions – merger agreements may include provisions, subject to compliance with applicable state laws, that require target companies to put the proposed transaction to a vote of its holders, regardless of whether a superior proposal exists.

The suite of deal protection provisions agreed to in a transaction are, typically, the most heavily negotiated terms.

2023 saw the continued use of earn-outs and other similar provisions under which the seller will receive one or more additional payments, contingent on the target’s future performance, in part to account for differences in valuation.

Completion accounts (known as working capital or balance sheet adjustments) are common in US private company acquisitions. Locked-box transaction structures are much less prevalent in US private company acquisitions.

A trend that continues is the use of RWI insurance in private transactions. The private market has reached a point where RWI is the norm rather than a negotiated point. Market participants, both PE and strategics, have become comfortable with the product and how it is employed.

All the conditions listed above generally also apply in private M&A transactions. However, in private company transactions, there is a greater ability for the acquiror to seek more bespoke conditions should the dynamics of the transaction allow.

Agreements are typically governed by the law of the target’s state of incorporation. If such state has sparsely developed corporate law, the parties sometimes provide that Delaware law will govern certain issues.

The exit environment in 2023 was, similar to the M&A environment writ large, muted. The IPO market was challenged as the appetite for equities was, generally, limited. The M&A markets were also challenging as buyers and sellers had gaps in their valuation expectations and overall confidence levels were low. Financial sponsors faced difficulties in exiting their own investments (‘private for longer’ was a common refrain) and in providing an exit opportunity for sellers. PE sponsors faced challenges related to valuations and the cost and availability of debt financing.

Market participants expect a more robust exit environment in 2024. The equity markets have been buoyant through the fourth quarter of 2023 and in the early days of 2024, which bodes well for the IPO market. There is an expectation that interest rates will be lower through the year, which, together with a greater availability of credit, bodes well for PE sponsors and the availability of credit.

There is growing confidence among market participants that M&A activity will be robust in 2004. Equity markets have entered the year trading at near-record highs. Corporate/strategic M&A players have strong balance sheets and there is confidence more generally regarding profitability through 2024. Financial sponsors are similarly well situated. With the US Federal Reserve having signalled that interest rates have likely peaked and that interest rate cuts could begin as early as the second half of 2024, together with more readily accessible credit markets, PE sponsors should see activity revert to pre-2023 levels.