White & Case Technology Newsflash
Consolidation continues to increase across the technology sector with many tech companies throughout the life cycle acquiring or merging with similar or complementary businesses. This is driven by several factors including a more challenging funding environment, the opportunity to shore up balance sheets, improve economies of scale and hasten the path to profitability. We have set out five things these companies should be aware of when considering consolidation opportunities.
One
Structuring
Structuring is key to any consolidation. Consideration needs to be given as to whether the transaction will be a merger of equals or a controlling acquisition of one company by the other and whether a new structure will be implemented. Often these transactions are effected on a cashless basis with an agreed ratio allocated between the shareholders of each entity. Bridge financing may be required whilst the transaction is negotiated and a strategy for financing the consolidated group will be required.
Understanding the impact of existing liquidation preferences and key terms of all equity and debt instruments is essential. The transaction may also constitute a change of control for either or both of the companies and so the impact of the structuring on the parties' commercial contracts should be considered.
In addition, venture-backed companies often have broad shareholder bases so it may not be practicable to have every shareholder sign up to the transaction prior to announcement. Some shareholders may also resist the transaction. As such, careful consideration should be given to how the transaction can be implemented from a legal perspective, including the effectiveness and approach to exercising any drag-along rights. This will vary by jurisdiction and legal advice is essential.
Two
Tax
A parallel consideration is tax which can have a significant impact on transaction structure and returns for existing investors. If shareholders are rolling over into a new Topco structure or exchanging their existing shares for new shares in an acquiring entity, it will be important to consider a tax efficient structure so as to minimise the impact of any taxable events on existing investors. This will depend on how diverse the shareholder base is from a tax residency perspective and whether there are any particularly large shareholders whose position will drive the direction of travel.
Three
Incentives and Management Rollover
Approach to incentivising management and employees is important in any consolidation scenario. Consideration will need to be given as to how existing awards are affected, whether they will accelerate or roll forward into the new entity and what post-closing arrangements should be put in place to ensure that each party's management and employees are appropriately incentivised going forwards. This is likely to be a complex topic and will require careful planning with legal and management advisers.
Four
Future Governance
Whatever transaction structure is selected, the future governance arrangements of the combined entity will be a key topic. A shareholders' agreement for the surviving entity will be required and consideration will need to be given as to how investor protections in each party's existing governance documentation (such as consent rights, liquidation preferences and anti-dilution protections) are carried forward into the new governance arrangements (if at all).
Decisions will also need to be made as to which individuals from the existing businesses will sit on the board of the combined entity and who will take the key management and leadership roles. These negotiations will be sensitive and driven by the respective bargaining power of the parties.
Five
Regulatory and Antitrust
In a consolidation scenario, it is likely that the relevant parties will be operating in the same or similar sectors so antitrust considerations may be important. Additionally, if the businesses operate in a regulated sector, the transaction may need to be conditional on obtaining change of control approvals from relevant regulators. Foreign direct investment regimes should also be considered.
Appropriate legal advice should be sought at an early stage to understand: (i) whether the transaction is feasible from a regulatory perspective; (ii) whether any approvals may be required or advisable and how long they are likely to take (which could be a critical consideration for companies with short runways); and (iii) the regulatory restrictions associated with sharing business information with potential counterparties prior to an agreed transaction and whether "clean teams" should be used to assist with this.
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