Technology M&A 2022: USA Chapter – Corporate/Commercial Law

Law and Practice

1. Trends

1.1 Technology M&A Market

COVID-19 significantly curtailed US M&A activity in the
second quarter of 2020 as many companies sought to boost their
liquidity and raise financing while simultaneously reducing their
spending on anything but their most necessary business needs.
M&A activity improved significantly in the second half of 2020
and into 2021. In fact, 2021 is on track to be one of the most
robust years ever for technology M&A.

1.2 Key Trends

COVID-19 has highlighted the importance of innovation as we move
towards a more contactless society and develop new ways to work
collaboratively from multiple locations. Cryptocurrencies are
disrupting financial transactions and the role of banks and
creating new markets, climate change is influencing the automotive,
transportation and energy sectors, and industrial companies are
adopting technology to better enable their businesses, products and
solutions.

The stock markets are rewarding growth. This, combined with low
interest rates and easy access to financing, has accelerated
M&A activity in the technology sector. In addition, the ability
to go public or add incremental investments at attractive
valuations has resulted in a sellers’ market and pushed
valuations higher.

Special purpose acquisition companies (SPACs) continue to impact
technology M&A as money continues to flow into these newly
formed companies, increasing the demand for M&A bankers and
lawyers to guide both SPAC sponsors and target companies desiring
to go public through de-SPAC transactions.

The significance of SPACs could change depending on whether any
of the new regulations being discussed by the US Securities
Exchange Commission (SEC) are adopted. Regulators and the US
Congress are also discussing regulation of cryptocurrencies and
related financial markets.

Antitrust scrutiny of technology deals has become heightened
under the Biden administration.

2. Establishing a New Company, Early-Stage Financing and
Venture Capital Financing of a New Technology Company

2.1 Establishing a New Company

Start-up companies in the US are typically formed in Delaware as
corporations. Delaware has adopted business-friendly laws and has a
large, well-developed body of case law that makes judicial
decisions predictable, which gives it an advantage over other
states. As a result, Delaware has largely become the default
jurisdiction in which to form entities for investors, potential
acquirers and counsel across the US.

Forming a corporation in Delaware is relatively easy and can be
done in a single day. New corporations file a Certificate of
Incorporation, adopt by-laws and issue equity to founders, which
can be a relatively fast process if there has been sufficient
pre-planning.

There is no initial capital requirement for forming a Delaware
corporation and founders typically pay for their initial shares of
stock with a de minimis amount of money for their “par
value” (often USD0.01 or USD0.0001 per share) and by
contributing any relevant pre-existing intellectual property to the
company.

2.2 Type of Entity

In choosing a type of entity, entrepreneurs are advised to
consider the tax treatment resulting from the entity choice,
whether the entity provides sufficient protection from personal
liability, whether the entrepreneurs plan to distribute equity
incentive compensation widely and whether the entity will seek
institutional venture financing in the future. For the reasons
described below, most technology and life sciences companies elect
to be structured as corporations that are taxed as a
“Subchapter C” corporation under the federal tax code
(the “Code”).

Tax Treatment

A “Subchapter C” corporation is subject to double
taxation, meaning the entity pays tax on any profit generated by
the corporation, and each stockholder also pays individual income
tax on any distribution the stockholder receives from the entity
but may not offset their personal tax burden with losses from the
business. Most venture-backed companies do not generate profits for
a long period of time, electing instead to increase spending in
pursuit of growth. As a result, venture-backed companies often
generate significant tax losses and rarely make distributions to
stockholders, so the double-taxation issue is often not a
concern.

In addition, Subchapter C corporations may be eligible to issue
qualified small business stock (also known as “QSBS” or
“Section 1202 stock”) if the company meets certain
criteria. QSBS is appealing to both founders and investors because,
subject to certain limitations and conditions, upon sale of the
stock, gains on QSBS may be taxed at a capital gains tax rate as
low as 0{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}, resulting in significant tax savings upon exit. The US
Congress is currently considering modifying or eliminating the
benefits of QSBS.

Limited liability companies (LLCs) and “Subchapter
S” corporations are “pass-through” entities for
tax purposes, meaning that income generated by the business is only
taxed once at the equity-holder level and equityholders may be able
to offset their personal income with losses from the business to
reduce their personal tax burden. Subchapter S corporations are
subject to strict ownership requirements and are generally not
permitted to have entity stockholders.

Personal Liability

Subchapter C corporations, Subchapter S corporations and LLCs
all generally shield equity-holders’ personal assets from
claims made against the company by creditors or other adverse
parties.

Other Considerations

The administrative cost of operating an LLC as a growing company
is significantly higher than the cost of operating a corporation
because of the additional legal and accounting costs resulting from
the accounting and tax reporting for an LLC. Furthermore, it is a
more complex process to issue equity compensation to employees and
service providers with an LLC or Subchapter S corporation as
compared to a Subchapter C corporation. Finally, venture
capitalists are generally more familiar and comfortable with
Subchapter C corporations and may be reluctant to invest in a
pass-through entity, which may further complicate their own tax
reporting, and have income and losses pass through to their
investors.

2.3 Early-Stage Financing

Early-stage financing is usually provided by angel investors,
accelerators and institutional venture capital funds.

Angel Investors

Angel investors may be wealthy individuals, consortiums of
investors that aggregate investment dollars together, or family
offices. Angel investors are typically the first investors in a
start-up company.

Accelerators

Accelerators provide services and mentorship to founders and
often have an industry focus. Depending on the programme,
accelerators may provide some initial seed funding to companies
participating in their programmes in exchange for an equity
interest. Accelerators often have extensive angel networks and
affiliations with institutional funds, which may give participating
companies opportunities to find investors.

Early-Stage Venture Capital Funds

Some institutional venture capital funds focus on providing
early-stage funding and typically lead a company’s first
equity financing.

Early-Stage Investment Documentation

Early-stage financing can take the form of convertible notes,
Simple Agreements for Future Equity (SAFEs) or preferred equity
investments. Convertible notes and SAFEs are designed to be
standardised so that companies may raise money quickly and
efficiently, and both include features that provide for investment
amounts to be converted into equity upon a future financing of the
company. A convertible note is a debt instrument that accrues
interest and has a maturity date that triggers a repayment
obligation of the company. In contrast, a SAFE is a contractual
agreement for investment but does not accrue interest, and a
company is generally not obliged to repay the amount after a period
of time. Convertible notes and SAFEs defer valuing the company
until a future financing. Angel investors and accelerators
typically use convertible notes and SAFEs for their early-stage
investments.

By contrast, most institutional venture capital funds prefer to
purchase convertible preferred stock at a set valuation, rather
than investing in a convertible note or SAFE.

2.4 Venture Capital

Typical sources of venture capital in the US are angel
investors, accelerators and institutional venture capital funds
(including corporate investors). Venture capital financing in the
US is easier to access compared to in many other jurisdictions, but
founders must still spend considerable time and resources engaging
with venture-capital sources in order to secure financing. In
recent years, foreign venture capital firms have increased
investments in the US. For example, Japan’s SoftBank has made
several high-profile investments in the US. Corporate venture
capital (CVC) has also substantially increased in recent years.
CVCs increasingly lead equity financing rounds and may be the sole
source of funding in a round.

2.5 Venture Capital Documentation

In the US, there are well-developed standards for venture
capital terms and documentation, which include customary economic,
control and contractual terms, such as those relating to dividends,
liquidation preferences, conversion rights, pre-emptive rights,
anti-dilution protections, voting rights, rights of first refusal
and co-sale, rights to designate members of the board of directors,
registration rights and information rights.

NVCA

The National Venture Capital Association (NVCA) is a trade
association for the venture capital community. The NVCA has
developed a well-regarded set of documents for venture capital
financing that are publicly available on the NVCA’s website  and
which generally reflect the terms described above. Because the NVCA
documents are well developed, many investors insist that companies
use those forms as the basis for equity financings, and companies
may find it more efficient to use the NVCA forms.

SAFEs

For convertible note financings, there is less standardisation
in the documentation, but convertible note forms tend to include
basic key terms such as interest rate, maturity date and conversion
mechanics. SAFEs were originally developed by Y Combinator, and the
Y Combinator form, which is publicly available on its website, is most
often used as the basis for SAFE financings.

2.6 Change of Corporate Form or Migration

A start-up company initially formed as a Delaware corporation
typically will not need to change its corporate form. If a start-up
company is initially formed as a Subchapter S corporation or an
LLC, or in a jurisdiction other than Delaware, the company may be
advised to convert into a Subchapter C corporation and/or
reincorporate in Delaware, particularly if it is raising venture
capital financing.

3. Initial Public Offering (IPO) as a Liquidity Event

3.1 IPO v Sale

In recent years, start-up companies were more likely to run a
sale process rather than take a company public. M&A sale
processes are attractive to investors because they may result in a
higher-value exit, provide a faster path to liquidity and are
generally easier to accomplish than going public, often in just
weeks or a few months. An IPO process is expensive and
time-consuming, and it can take several months to a year of
planning and preparation to accomplish.

3.2 Choice of Listing

If a US company decides to go public, it is more likely to list
in the US than on a foreign exchange, particularly if its
stockholders are primarily based in the US. The capital markets in
the US are robust, widely perceived as more investor-friendly and
fund a significant amount of worldwide economic activity, so
companies worldwide often choose to list in the US to take
advantage of its strong markets. Companies are also more likely to
be familiar with the accounting standards and other reporting
requirements of exchanges located in the US.

3.3 Impact of the Choice of Listing on Future M&A
Transactions

It is not common for US-based companies to list on a foreign
exchange.

4. Sale as a Liquidity Event (Sale of a Privately Held Venture
Capital-Financed Company)

4.1 Sale Process

Sellers often use auction processes to attempt to maximise price
and achieve the best possible terms. Structuring the sale process
as an auction provides the target company and its shareholders with
distinct advantages, including negotiation leverage based on
information asymmetry (eg, knowledge of the actual number of bids
and the depth of market interest in the target company). In
addition, a structured and competitive bid process can create
momentum by setting out a clear timeline for marketing and bidding,
forcing bidders to move quickly.

There are also disadvantages with an auction process,
particularly if a potential buyer has already been identified and
is seeking bilateral negotiations to pre-empt an auction process.
For early-stage companies, many sales happen as a result of a
strategic acquirer expressing interest in acquiring the target
company, and such transactions are bilateral negotiations. In
addition, an auction may lengthen the sale process timeline and may
require the target company to provide access to proprietary and
confidential information to a significant number of
competitors.

4.2 Transaction Structure

A sale of a privately held technology company is often
structured as a statutory merger but may also be structured as a
stock purchase or an asset purchase. These transactions typically
involve the sale of the entire target company, although many buyers
may require key employee shareholders (eg, the target
company’s management team) to retain equity in the business
or the acquiring company, to ensure a successful transition and
future growth following closing. Venture capital and other
financial investors would generally not continue to remain invested
in the target company following a sale process, particularly in a
transaction in which a controlling interest is being sold.

4.3 Form of Consideration

In acquisitions of privately held technology companies, the
consideration payable to target shareholders typically consists
solely of cash; however, it is also common, particularly in
transactions involving public company buyers, for the consideration
to consist of a mix of cash and stock or, less often, all
stock.

Where parties disagree on the value of the target business, or
in industries or economic conditions with high valuation
uncertainty (eg, life sciences), parties may employ an earn-out
structure to pay the target shareholders a lower price at closing
and additional consideration later if specified business results or
milestones are achieved. In addition to bridging a valuation gap,
an earn-out structure may also serve as a motivating factor in
transactions where the management team holds a significant equity
stake in the target company. However, earn-outs are generally not
favoured by venture capital and other financial investors and can
lead to disputes between buyers and selling shareholders when
implemented post-closing.

Alternatively, buyer stock may be used as a portion of the
consideration, so that selling shareholders may indirectly benefit
from the performance of the acquired business and selling employee
shareholders will still be invested in the continued success of the
acquired business.

4.4 Certain Transaction Terms

In acquisitions of venture capital-financed technology
companies, buyers will often seek to protect themselves from
unknown liabilities of the target company by negotiating seller
indemnification obligations into the acquisition agreement and/or
purchasing representation and warranty insurance.

Negotiation of Indemnification Provisions

Indemnification provisions are typically one of the most heavily
negotiated provisions in an acquisition agreement. These provisions
primarily benefit buyers by providing contractual recourse against
the selling shareholders for losses incurred following closing that
result from, among other matters, breach of representations and
warranties regarding the target company. In addition, a portion of
the consideration (generally 10–15{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of the transaction value)
may be placed in escrow (or held back by the buyer) at closing to
secure the selling shareholders’ indemnification obligations.
Generally, selling shareholders, and particularly venture capital
investors, will seek to minimise their post-closing liability by
negotiating limitations on their indemnification obligations,
including deductibles and caps, and will often seek to limit all
buyer recourse to the agreed escrow or holdback consideration.

Representation and Warranty Insurance

Consistent with the general trend in private equity
transactions, the use of representation and warranty insurance is
increasingly common in transactions involving the sale of venture
capital-financed companies, particularly in transactions with
higher values where the policy premiums are economically feasible.
Any issues that are identified during due diligence will generally
not be covered by the policy, so it is common for parties to
negotiate indemnification protection into the acquisition agreement
to allocate risk of such losses. Selling shareholders often refuse
to provide any post-closing indemnification in circumstances where
representation and warranty insurance is expected to be
purchased.

5. Spin-Offs

5.1 Trends

Spin-offs, which are a form of divestiture involving a dividend
of shares of the subsidiary conducting the divested business to the
divesting company’s shareholders, allow a company to focus on
its core business while unlocking the value of a business that may
be undervalued as a part of the diversified entity. There are many
reasons why a diversified company may decide to effect a spin-off,
including the following.

Management

A key motivation for spin-offs is to focus the management of
both the retained and divested businesses. A divested business may
not receive sufficient attention from the management of the parent
company or it may distract the management’s attention from
the core business. A spin-off also allows the management of the
spun-off business to receive equity compensation tied specifically
to the performance of the divested business.

Financial Metrics

A diversified company’s businesses may have different
financial metrics. A business with a lower growth rate may be a
drag on the value of a business with a higher growth rate.
Separating a high-growth business from a low-growth business may
allow the high-growth business to trade at a higher multiple while
allowing the lower growth business to trade at a multiple
appropriate to its own growth, rather than negatively impacting the
value of the diversified company.

Business Models

Different business units may have different business models that
appeal to different kinds of investors. A biotech company may
separate a successfully marketed drug from a drug discovery
business. Similarly, a technology company may separate a hardware
business from a software business, or a brick-and-mortar retail
business from an e-commerce business.

Motivation

A spin-off may be the result of an evaluation of a
company’s different businesses by its board or management, or
it may be initiated by pressure from activist investors who view
the spin-off as a means to unlock shareholder value.

Tax

Unless the diversified company has net operating losses, an
asset sale would generate taxable gain to the seller, while a
spin-off has the significant tax advantage of being tax free to
both the parent company and the shareholders receiving shares of
the spun-off business, as discussed in 5.2 Tax
Consequences.

Spin-Off or Asset Sale

An asset sale is a viable option for a wider range of
divestitures because the divested business does not need to be
capable of functioning as a standalone public company. An asset
sale also has the advantage of generating cash for the parent
company. However, unless the proceeds from an asset sale are
distributed to the parent company’s shareholders, the
proceeds from the asset sale may not translate into shareholder
value. A spin-off would unlock more shareholder value than an asset
sale if the divested business is expected to have a higher public
market value (after taking into account the increased operating
costs of two public companies) than its sale value. A spin-off has
all the complexities of an asset sale, plus the complexities of an
IPO, and the complexities described below to qualify the spin-off
as a tax-free transaction. A spin-off takes significantly more time
from planning to completion than an asset sale. Accordingly, while
spin-offs are customary in the technology industry, they are less
common and more difficult than other divestiture structures such as
asset sales.

5.2 Tax Consequences

A distribution of appreciated property by a corporation to its
shareholders would ordinarily trigger taxable gain to both the
corporation and its shareholders. One of the advantages of a
spin-off is that it can be structured as a tax-free transaction at
both the corporate and shareholder level under Section 355 of the
Code. However, there are a several statutory and non-statutory
requirements that must be met in order for a spin-off to qualify as
a tax-free transaction under Section 355, including the
following.

Control

The subsidiary to be spun-off (the “SpinCo”) must be
under the control of the parent company immediately before the
distribution, and the parent company must then distribute control
of the SpinCo in the spin-off.

Valid Corporate Business Purpose

The substantial motivation for the transaction must be a
corporate business purpose (rather than a shareholder purpose),
other than tax avoidance. Examples of valid corporate business
purposes include avoiding harm to one business by association with
another business, compliance with laws and regulations,
facilitating borrowing or raising capital, providing equity
compensation to employees, and improving performance. A company
planning a spin-off transaction will often obtain a business
purpose letter from an investment bank to support this
determination.

Five-Year Active Trade or Business

The business to be spun-off must have been an active trade or
business (“ATB”) for five years prior to the spin-off.
In order to satisfy this five-year look-back, the ATB may not have
been acquired during the look-back period. However, expansion of
the ATB is permitted, as long as such expansion is “not of
such a character as to constitute the acquisition of a new or
different business”.

No Device

The spin-off transaction must not be used “principally as
a device for the distribution of earnings and profits” of
either the parent company or the SpinCo. A company cannot use a
spin-off to convert what should have been taxed as a dividend into
a tax-free distribution followed by a stock sale by the receiving
shareholders at capital gain rates. Satisfying the valid corporate
business purpose requirement also serves as evidence that the
transaction is not a tax-avoidance device.

5.3 Spin-Off Followed by a Business Combination

A spin-off may be followed by a business combination with an
unrelated entity if certain requirements are met, including that
both the spin-off and the business combination qualify as tax-free
transactions. If the business combination involves the parent
company, it is referred to as a “Morris Trust”
transaction, and if the business combination involves the SpinCo,
it is referred to as a “Reverse Morris Trust” or
“RMT” transaction.

Section 355(e) of the Code, known as the “anti-Morris
Trust provision”, limits the amount of equity of the parent
company or the SpinCo that can be acquired in the business
combination to 50{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}, and establishes other limitations and safe
harbours. As long as shareholders of the parent company or the
SpinCo own more than 50{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of the corporation resulting from the
business combination, and the other limitations and safe harbours
of Section 355(e) are satisfied, it is possible for the parent
company to transfer a business to a third party in a transaction
involving stock consideration that is tax-free to the parent
company and the SpinCo and their shareholders. The 50{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} limitation
effectively limits this to business combinations with smaller
counterparties so that the shareholders of the parent company or
the SpinCo own the majority of the stock of the combined
entity.

5.4 Timing and Tax Authority Ruling

Spin-offs are complex transactions that can take six to nine
months or longer to complete.

The key preliminary timing considerations for a spin-off are the
identification of the assets and liabilities to be spun-off and the
preparation of audited financial statements for the spun-off
business. Where the retained and spun-off businesses are already
separate, with clearly defined assets and liabilities and no
significant overlap or dependencies, and audited financial
statements already exist, this planning stage can be completed in
as little as two months. However, it can take considerably longer
if more work is required.

Implementing the spin-off can take another two to three months.
During this stage, the parent company would document the business
purpose for the spin-off, draft the definitive transaction
agreements to effect the separation of the businesses and define
their relationship post-separation, and prepare the SEC filings for
the transaction, including an information statement and a Form 10
registration statement.

It could take another three to four months for the SEC to
complete its review of the information statement and Form 10
registration statement and declare the Form 10 effective. During
the SEC review period, the parent company would continue to work on
the implementation of the spin-off and prepare for the launch of
the new publicly owned company.

A parent company contemplating a spin-off transaction may seek
to obtain a tax ruling from the IRS to provide comfort that the
spin-off transaction qualifies for tax-free treatment under Section
355, a process which generally takes approximately six months.

6. Acquisitions of Public (Exchange-Listed) Technology
Companies

6.1 Stakebuilding

The majority of acquisitions in the US are mutually agreed (a
negotiated transaction) and do not involve the buyer building a
stake in the target prior to the transaction.

Principal Stakebuilding Strategies

In a hostile or otherwise unsolicited offer, it is common for a
bidder to acquire a de minimis stake in a target for the purposes
of having the ability, in the capacity of shareholder, to pursue
litigation against the target or to seek to review its books and
records. However, acquiring a significant stake prior to launching
an offer for a US public company is less customary in light of the
following considerations.

• Firstly, the acquisition of voting securities of a US company
  having an aggregate value of greater than an amount set annually by
  the Federal Trade Commission (FTC) (USD92 million effective from 4
  March 2021) typically requires antitrust approval under the
  Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the
  “HSR Act”). Seeking that approval would result in
  disclosure to the target of the bidder’s intention to acquire
  the securities.




• Secondly, acquisition of beneficial ownership of more than 5{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}
  of a class of equity voting securities of a US public company
  requires public disclosure of the acquisition through a filing with
  the SEC.




• Thirdly, bidders who have engaged in negotiations with a target
  may be subject to confidentiality agreements which contain
  restrictions on acquiring the target’s shares, or may have
  obtained material non-public information regarding the target that
  prohibits the bidder from trading in the target’s securities
  under US insider trading laws.




• Finally, a number of states, including Delaware, have
  “anti-takeover” statutes that prohibit or restrict a
  shareholder that has acquired a specified amount of a
  company’s shares (15{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} in Delaware) from acquiring additional
  shares for a significant period of time (three years in Delaware)
  unless certain conditions are met (such as the approval of the
  acquisition by the company’s board of directors and by a
  super-majority vote of the shareholders).

Material Shareholding Disclosure Threshold

Federal securities laws require that any person who acquires
beneficial ownership of more than 5{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of the outstanding shares of a
class of US public company voting equity securities must report the
acquisition by filing a Schedule 13D with the SEC within ten days
of the acquisition. A beneficial owner of a security includes any
person who, directly or indirectly, has or shares either:

• the power to vote or to direct the voting of the security;
  or




• the power to dispose or direct the disposition of the
  security.

Filing a Schedule 13D results in public disclosure of the
acquisition, including the required disclosure of the purpose and
funding of the acquisition and the filer’s plans regarding
control of the target company. Once a Schedule 13D has been filed,
amendments must be filed promptly after the occurrence of any
material change in the facts set forth therein. Passive investors
meeting certain requirements who would otherwise be required to
file a Schedule 13D are permitted to file a Schedule 13G, which
contains less onerous disclosure requirements than a Schedule 13D,
but a stakebuilding strategy is not a passive investment
intent.

6.2 Mandatory Offer

Tender offers in the US are generally subject to regulation by
federal securities laws, which do not impose a requirement for a
shareholder or group that acquires a given threshold of securities
of a company to make a tender offer for the remaining shares of the
company. In addition, Delaware law does not impose any such
requirement. However, a small number of US states do have
“control share cash-out” statutes that require a
shareholder that gains voting power of a given percentage of a
company to purchase the shares of the other shareholders at a fair
price upon demand.

6.3 Transaction Structures

An acquisition of a public company is generally structured as a
statutory merger, often referred to as a “long-form” or
“one-step” merger, or as a combination of a tender
offer and a statutory merger, often referred to as a
“two-step” merger.

One-Step Merger

In a one-step merger, the target company will merge with the
buyer (or a subsidiary of the buyer) and the target company’s
shareholders will receive the merger consideration in exchange for
their shares by operation of law. A one-step merger is implemented
pursuant to a negotiated merger agreement that is signed by the
buyer and the target company and must be submitted to the target
company’s shareholders for approval.

Two-Step Merger (with Tender Offer)

In a two-step merger, shareholders are first asked to tender
their shares into a tender offer in exchange for the offered
consideration. A tender offer is an offer made by the buyer
directly to the target company’s shareholders to purchase
their shares. In a negotiated transaction, the buyer and target
company will negotiate the terms of the offer and the target
company’s board of directors will recommend that shareholders
accept the offer. Tender offers do not, however, need to be
approved by the target company’s board of directors and,
therefore, they are often used in “hostile”
transactions. Tender offers are referred to as exchange offers
where the consideration includes equity securities of the
buyer.

The second step of a two-step merger is a statutory merger, used
to acquire any remaining shares held by shareholders that did not
participate in the tender offer (often referred to as a
“squeeze-out” merger). In a negotiated transaction, the
merger agreement will expressly provide for this second step and
shareholders in the merger will receive the same consideration as
those shareholders who tendered shares into the tender offer.

6.4 Consideration; Minimum Price

In acquisitions of publicly traded US companies, the
consideration payable to target shareholders consists solely of
cash in more than half of these transactions (particularly where
the buyer is not another publicly traded US company). In all other
cases, consideration consists of either all stock or a mix of cash
and stock (which may be fixed or subject to the election of each
shareholder). The stock component of the consideration may be
expressed as a fixed exchange ratio or a fixed value at closing.
With a fixed exchange ratio, the value of the consideration
fluctuates, and with a fixed value, the number of shares issued
fluctuates, in each case, based on changes in the buyer’s
stock price between signing and closing.

Unlike private company transactions, contingent consideration,
such as contingent value rights, are not typically used in
acquisitions of US public companies.

6.5 Common Conditions for a Takeover/Tender Offer

A tender offer will generally be subject to a number of
conditions, including:

• the tender of a minimum number of shares;




• the receipt or expiration of applicable regulatory approvals or
  waiting periods;




• there being no law or government order prohibiting the
  consummation of the offer; and




• the target not having suffered a material adverse effect.

An unsolicited or “hostile” offer will often include
the following additional conditions:

• the target’s removal of any structural defences (eg, a
  shareholder rights plan or poison pill);




• the receipt of sufficient financing; and




• the absence of a competing takeover offer.

While a bidder generally has significant flexibility in defining
the conditions to its offer, regulators require that conditions
must be based on objective criteria and not be within the
bidder’s sole control. They also require that conditions must
be applicable to the entire offer (as opposed to establishing
different conditions for different shareholders).

6.6 Deal Documentation

In acquisitions of publicly traded US companies, the target
company and the acquirer enter into a merger agreement which
contains representations, warranties and covenants on behalf of
both the target company and the acquirer, although once the closing
occurs there is generally no liability for target company
shareholders for breaches of the terms of the agreement. The target
company typically agrees to covenants to operate its business in
the ordinary course between signing and closing, to not solicit
third-party proposals and to make commercially reasonable efforts
to cause the closing conditions to the transaction to be
satisfied.

6.7 Minimum Acceptance Conditions

The minimum acceptance condition to a tender offer usually
corresponds to the number of shares required to effectively control
the target and to approve a subsequent second-step merger to
acquire any remaining shares held by shareholders that did not
participate in the offer (usually one share more than 50{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}). A
company’s organisational documents or the corporate law of
the company’s state of incorporation may provide a higher
threshold requirement.

If at least 90{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of outstanding shares are tendered into a tender
offer, the bidder has the ability under the laws of many states to
effect a “short-form” merger that does not require a
shareholders’ meeting and vote to occur.

In addition, amendments to Delaware’s corporate law in
2013 and 2014 eliminated the need to hold a shareholders’
meeting and vote to approve the second-step merger in situations
where the bidder has acquired enough shares in the tender offer to
approve the merger, but not the 90{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} required to enable the use of
the short-form merger statute.

6.8 Squeeze-Out Mechanisms

Shareholders that remain following a successful tender offer are
generally squeezed out by effecting a second-step merger. This will
be a short-form merger (if available), or a long-form merger where
the required shareholder approval is assured because of the number
of shares held by the buyer following the tender offer.

6.9 Requirement to Have Certain Funds/Financing to Launch a
Takeover Offer

A business combination in the US may be conditional on the
bidder obtaining financing; while this would typically be the case
in large hostile cash bids, most negotiated transactions do not
include this condition.

As financing conditions are rare, the focus in transactions that
include significant third-party financing tends to be on the level
of effort that the bidder must expend in order to obtain and
consummate the financing. In the US, it is common for a bidder to
have financial “commitments” from lenders at the time
of signing transaction documents.

It is not uncommon for the bidder to be obliged to seek to
enforce (via litigation, if necessary) the obligations of its
third-party debt financing sources to provide the bidder with the
agreed amount of debt financing at the closing of the transaction,
and to seek to obtain alternative financing on similar terms if the
original financing is unavailable.

In addition, bidders are often required to pay a “reverse
termination fee” to the target company in the event that the
transaction does not close due to the unavailability of debt
financing to the bidder.

6.10 Types of Deal Protection Measures

In the acquisition of a publicly traded company, a bidder can
seek a number of deal protections, including:

• “non-solicitation” provisions that prohibit the
  target board from soliciting alternative transaction proposals but
  allow the target board to pursue unsolicited proposals that may
  result in an alternative transaction that is superior to the
  pending transaction;




• “matching” or “topping” rights that
  allow the bidder the opportunity to improve the terms of the
  current transaction if the target receives a superior transaction
  proposal from a third party;




• break-up fees payable to the bidder in the event that the
  transaction agreement is terminated in favour of an alternative
  transaction proposal (these fees, based on guidance from the
  Delaware courts, tend to be in the range of 2-4{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of the transaction
  value); and




• “force the vote” provisions that require the target
  board to submit the transaction to its shareholders for approval
  even where the board is no longer recommending the transaction (eg,
  where it receives a superior alternative proposal).

Private transactions usually involve agreements with significant
shareholders of the target company to vote to approve the
transaction, thereby creating more closing certainty and
eliminating the need for the deal protection measures set forth
above.

6.11 Additional Governance Rights

This is not applicable in the US.

6.12 Irrevocable Commitments

Whether a buyer seeks to obtain an irrevocable commitment from
the principal shareholders of a target company to tender or vote in
favour of a transaction and not tender or vote in favour of an
alternative transaction (often called a “lock-up”) is
highly fact and transaction-specific. It will depend on, among
other factors, the identity of the principal shareholders and the
size of their holdings. Confidentiality considerations and the
target company’s willingness to involve the principal
shareholders in transaction discussions prior to a public
announcement may also be relevant factors.

While Delaware law generally permits the use of lock-ups,
current case law in Delaware generally prohibits a buyer from
obtaining lock-ups of a number of shares that would make
shareholder approval of a transaction a mathematical certainty.

6.13 Securities Regulator’s or Stock Exchange
Process

Merger Transactions

The SEC has the right to review proxy statements (for all-cash
mergers) and registration statements (consisting of a combined
proxy statement and prospectus for mergers where some or all of the
consideration is stock). Prior to distributing proxy/registration
statements to shareholders, companies file a preliminary statement
with the SEC and the SEC has ten days to inform the company whether
it intends to review or comment on the statement. If the SEC
comments on the statement, the statement may not be distributed to
shareholders until the company has cleared the SEC’s comments.
The SEC does not review all merger proxy statements, but where the
SEC does review and comment, such comments can typically be cleared
within 30 days. In the case of a registration statement, the SEC
will generally provide comments within 30 days of the filing date.
In some transactions, the SEC may not review (or may conduct a
limited review of) the registration statement. While a definitive
proxy statement may be distributed to target company shareholders
if the SEC does not inform the company that it intends to review or
comment on the proxy statement, the SEC must declare the
registration statement effective prior to it being distributed.

Tender Offers and Exchange Offers

Transactions structured as tender offers (for all-cash offers)
and exchange offers (for offers where some or all of the
consideration is stock) are also subject to SEC review, but they
have a timing advantage over merger transactions because the offer
documents can be distributed to target company shareholders at the
same time as they are filed with the SEC, allowing the offer period
and the SEC review period to run concurrently. While the offering
materials may need to be amended and the offer may need to be
extended if there are SEC comments, and in the case of an exchange
offer, the SEC would need to declare the registration statement
effective before the offer can close, all of this can occur after
the offer has commenced rather than before documentation may be
distributed to target company shareholders, as is the case in a
merger transaction.

6.14 Timing of the Takeover Offer

In the US, it is permissible to extend a tender offer via a
public announcement prior to the termination of the tender offer.
Generally, merger agreements will require that the tender offer be
extended in the event that the closing conditions, including
regulatory approvals, are not satisfied prior to the scheduled
expiration of the offer. For this reason, it is typical to commence
tender offers prior to receipt of regulatory approvals in order to
enable transactions to close promptly following receipt of the
relevant regulatory approvals.

7. Overview of Regulatory Requirements

7.1 Regulations Applicable to a Technology Company

There are no particular regulations that generally apply to
starting up a new company in the technology industry in the US.

7.2 Primary Securities Market Regulators

The SEC

The primary regulator of the US federal securities laws is the
SEC. The federal securities laws govern many facets of M&A
activity involving US public companies and the purchase and sale of
securities, including the information that must be provided to
shareholders being solicited to vote to approve a statutory merger
or to participate in a pending tender offer, as well as the
procedures that must be followed by both the buyer and the target
company in the conduct of a tender offer to the target
company’s shareholders.

Corporate and State Laws

The substantive corporate law of the state of incorporation of
the target company will regulate a wide variety of matters related
to M&A transactions involving both publicly traded and
privately owned companies, including the level of shareholder
approval that is required for certain transactions, the applicable
fiduciary duties of the directors of the target company in
considering and approving a transaction, and the mechanics relating
to the convening of shareholders’ meetings and providing
information to shareholders in connection with the transaction. In
addition, certain state laws (often referred to as “blue
sky” laws) govern issues relating to the sale and purchase of
securities in that particular state.

Stock Exchange Rules

Stock exchange rules (such as those of the New York Stock
Exchange and the Nasdaq Stock Market) can also be relevant to
M&A transactions involving US public companies, including
whether a vote of the buyer’s shareholders is required if the
buyer is issuing more than 20{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of its outstanding shares in the
transaction.

7.3 Restrictions on Foreign Investments

CFIUS

Transactions involving foreign investment in target entities
where US national security could be impacted are potentially
subject to restriction. Under US law, the US president is empowered
to review the national security implications of acquisitions of, or
investments in, US businesses by non-US persons and may impose
conditions on, or prohibit or even unwind, such transactions when
they threaten US national security. The president has delegated
these national security review authorities to the Committee on
Foreign Investment in the United States (CFIUS), an inter-agency
committee chaired by the US Department of the Treasury.

National security concerns can be implicated by transactions
involving a broad range of companies; however, technology companies
are of particular interest given the national security implications
of retaining control of strategically important technology,
intellectual property and access to personally identifying data. To
avoid the uncertainty imposed by the possibility that a transaction
may be prohibited or unwound, parties often voluntarily make a
filing to CFIUS requesting review of a proposed transaction. Once
cleared by CFIUS, a transaction is insulated from further US
national security review or from being prohibited or unwound.

Expanded jurisdiction

In 2020, the US Department of the Treasury issued regulations
that significantly expanded the jurisdiction of CFIUS to allow it
to review minority, non-controlling investments in certain US
businesses developing or producing critical technologies; owning or
operating US critical infrastructure assets; and possessing or
collecting sensitive personal data of US citizens (previously, only
investments that would result in foreign “control” of a
US business were reviewable). The regulations also mandate CFIUS
filings (which were formerly only elective) for many foreign
investments in US businesses producing or developing certain
critical technologies and for transactions in which a foreign
government-controlled entity acquires control of certain US
businesses.

Other Restrictions

Beyond CFIUS, there are also specific restrictions that can be
applicable to foreign investment in certain US shipping, aircraft,
communications, mining, energy and banking assets. There are also
restrictions applicable to foreign investment in certain US
entities that contract with the US government.

7.4 National Security Review/Export Control

US export control regulations are another area that can impact
foreign investments in US businesses. These regulations can
restrict the ability of US businesses to export, or otherwise make
available, certain US products, technologies or other items to
foreign entities.

EAR and ITAR

The primary US export control regimes are the Export
Administration Regulations (EAR) and the International Traffic in
Arms Regulations (ITAR). The US Department of Commerce is
responsible for enforcing EAR, which governs the export and import
of most commercial items, including those with defence or military
applications (so-called “dual use” items). ITAR governs
the export and import of defence-related articles and services, and
it includes a specific category for space-related products,
services and technologies. All manufacturers, exporters and
distributors of defence items and services and associated technical
data need to be registered with the US State Department’s
Directorate of Defense Trade Controls (DDTC) to be ITAR
compliant.

Export Licences

Export licences may be required before a US business may export
or otherwise make available dual-use or defence-related products
and technologies to a foreign entity, including a foreign acquirer.
Each business is responsible for determining whether any of its
products or services require a licence. It is therefore very
important for foreign acquirers or investors to understand the
implications that US export control regulations may have on their
acquisitions of, or investments in, US businesses.

7.5 Antitrust Regulations

Review of Business Combinations

The HSR Act enables the US Department of Justice (DOJ) and FTC,
which have concurrent general jurisdiction to enforce the antitrust
laws, to review business combinations for possible anti-competitive
effects before the transaction closes. This is accomplished by
requiring that parties to transactions that meet a specified
valuation threshold (USD92 million effective from 4 March 2021)
notify the FTC and DOJ and observe waiting periods prior to the
closing of the transaction. In the case of transactions that do not
require a lengthy review, the applicable waiting period will
generally be 30 days post-notification unless it is terminated
earlier by the reviewing agency. The FTC and DOJ announced a
temporary suspension of early termination grants as of 4 February
2021 and, at the time of writing, had not resumed or announced a
timeline for resuming early termination grants.

The initial HSR waiting period may be extended if the reviewing
agency issues a request for additional information or documentary
material, usually called a “second request”, which
begins a second-phase investigation. A second request may be issued
if, for example, the parties have overlapping product lines in a
concentrated market or if customers express concern about the
competitive effects of the acquisition. If a second request is
issued, the waiting period typically does not terminate until 30
days after all the parties have complied with the second request.
It typically takes parties two to four months to comply with a
second request, although the time period may be much longer.

Potential Actions by Reviewing Agency

At the conclusion of its investigation, the reviewing agency
will take one of three possible courses of action. Firstly, it may
close its investigation without taking any further action.
Secondly, it may allow the transaction to close while insisting on
certain structural remedies, such as divestitures of facilities or
product lines, or behavioural remedies, such as transparency or
non-discrimination requirements, to mitigate the anti-competitive
effects of the transaction. Thirdly, the agency may seek to
prohibit the parties from closing by initiating proceedings in a US
federal district court.

The DOJ and the FTC also have the ability to review business
combinations that are not subject to the notification and waiting
period requirements of the HSR Act, as well as business
combinations that have already been consummated.

7.6 Labour Law Regulations

In connection with M&A transactions, buyers should consider
regulations and other impacts with respect to employment, labour,
employee benefits and compensation matters. Both federal and state,
as well as local, laws can be implicated with respect to these
matters.

Employment and Labour

Employment arrangements in the US are generally “at
will”. Buyers need to consider worker classification (ie,
whether the service provider is properly classified as an employee
or a contractor), which may differ based on the state of
employment, and proper visa status of workers. Buyers should be
aware of the Worker Adjustment and Retraining Notification (WARN)
Act and similar state laws that may give employees the right to
early notice of impending lay-offs or plant closings (or salary in
lieu of notice). Buyers should also be mindful of sellers that
utilise the services of a professional employer organisation (PEO)
to provide certain human resources functions, as such arrangements
may create a co-employment relationship or trigger other analyses
regarding benefit plan compliance.

Buyers need to review employee equity plans and the impact of a
change of control on outstanding employee equity. Unlike many
industrial companies, most technology companies offer employee
equity to all levels of their workforce and equity can be a
material portion of an employee’s compensation.

Employees may be subject to restrictive covenants, including
non-compete and non-solicit agreements, either under agreements in
place prior to a transaction or under agreements that the buyer
intends to put in place in connection with a transaction. The
enforceability of such agreements is determined on a state-by-state
basis, with California being one of the most restrictive. Buyers
should also consider federal, state and local privacy and
non-discrimination laws in connection with implementing employee
on-boarding polices, such as background checks and drug-testing
policies.

Employee benefits

Buyers should be aware of the Employee Retirement Income
Security Act (ERISA), which governs the operation and terms of
certain employee benefit plans, including their treatment in
connection with transactions.

Health plans must be reviewed for compliance with the Affordable
Care Act (ACA), which includes certain benefits mandates. The
parties must also understand their obligations with respect to the
Consolidated Omnibus Budget Reconciliation Act (COBRA) and similar
state laws that provide benefit continuation coverage after
termination of employment. Certain states may also require the
payout of accrued leave or other benefits.

Employee compensation

Finally, buyers should evaluate the target’s prior
compliance with the Code and the tax impact of transaction
compensation. Section 280G of the Code regulates “golden
parachute” payments made to certain key employees in M&A
transactions. Section 409A of the Code regulates non-qualified
deferred compensation and imposes a steep excise tax on
non-compliant compensation. The Code may impact decisions on
post-closing employment arrangements, including employment
agreements, retention plans or agreements, and equity compensation.
Equity grants must also comply with federal securities laws and
similar state “blue sky” laws, which require securities
granted to be registered or to fit within an exemption.

7.7 Currency Control/Central Bank Approval

No currency control regulations or central bank approvals are
required for US M&A transactions.

8. Recent Legal Developments

8.1 Significant Court Decisions or Legal Developments

A significant recent legal development related to M&A
involved the first finding by a Delaware court that a material
adverse effect (MAE) had occurred in the time between the
announcement of a transaction and its closing, entitling an
acquirer to terminate its acquisition agreement. The absence of an
MAE having occurred with respect to a target’s business is a
customary closing condition found in agreements governing US
M&A transactions.

In its October 2018 decision in Akorn, Inc v Fresenius Kabi AG,
the Delaware Court of Chancery found that Akorn’s decline in
financial performance since the parties signed their merger
agreement was material, and that the underlying causes of the drop
in Akorn’s business performance posed a material,
durationally significant threat to Akorn’s overall earnings
potential. The Chancery Court’s decision, affirmed by the
Delaware Supreme Court in December 2018, confirms that an MAE may
be recognised in Delaware and provides helpful guidance as to the
quantitative and qualitative analysis of what constitutes an
MAE.

9. Due Diligence/Data Privacy

9.1 Technology Company Due Diligence

In an M&A transaction, a selling company would generally
disclose to bidders:

• the material contracts to which it is a party (including joint
  venture agreements, research contracts, and IP or IT
  licences);




• a schedule of patent, copyright and trademark registrations and
  applications and internet domain names owned by the company;




• a summary of pending and threatened litigations to which the
  company is a party; and




• the company’s template employment agreement, including a
  template employee invention assignment agreement. 

It is not uncommon for a company to withhold providing reports
or opinions of counsel relating to the company’s activities,
such as intellectual property opinions pertaining to infringement
or the company’s freedom to operate, on the basis of
preserving confidentiality and attorney-client privilege. A company
should also consider the protection of its trade secrets when
deciding what documents to provide throughout the diligence
process.

A company may be impeded from providing bidders in the US with
due diligence information to the extent that such information is
protected by data privacy laws or confidentiality agreements with
third parties. Information that is legally or contractually
prohibited from disclosure may be redacted, or consent of the
relevant third party may be obtained, to allow a company to share
documents that are otherwise material to the due diligence
process.

Public companies do not have an affirmative obligation to
disclose diligence information to bidders or to provide all bidders
with the same information. However, a board of directors should act
in accordance with its fiduciary duties to its shareholders when
deciding whether to disclose diligence information to bidders and
should have a reasonable basis to support providing different
levels of information to different bidders.

9.2 Data Privacy

There are both legal and contractual restrictions that could
limit the due diligence information provided by a technology
company in the US. Before providing due diligence information in
connection with an M&A transaction, a company should assess
which federal, state and non-US data privacy laws may apply to the
company’s business. US state and federal laws, as well as EU
laws, frequently apply to cross-border M&A deals. More
specifically, if applicable, the EU General Data Protection
Regulation (Regulation (EU) 2016/679) and the California Consumer
Privacy Act of 2018 restrict a company’s ability to share
certain personal data (ie, information relating to an identified or
identifiable data subject). In addition, a company should ensure
compliance with its published privacy policies and agreements with
third parties containing privacy-related requirements. There is no
comprehensive legislative privacy framework in the US. However, the
US government has enforced Section 5 of the Federal Trade
Commission Act – which prohibits unfair or deceptive acts or
practices – against companies that fail to protect personal
data or comply with published privacy policies. All of the
foregoing should be carefully assessed before sharing personally
identifiable information, such as client information or employee
details (including social security or bank account numbers), during
the due diligence process.

10. Disclosure

10.1 Making a Bid Public

The rules relating to disclosure of M&A transactions in the
US are generally the same for companies in the technology industry
as for companies in most other industries.

Negotiated and Hostile Transactions

In the context of a negotiated transaction, a bid would not
generally be made public until a definitive agreement has been
reached between the bidder and the target. At that time, the
transaction would be jointly announced by the parties. In a hostile
bid, the bidder usually issues a press release announcing an
intention or proposal to bid for the target.

In both negotiated and hostile transactions, bidders or targets
may sometimes disclose that negotiations are ongoing or that offer
letters have been sent or received, but this is less common. In
addition, it is possible for news of a potential transaction to
“leak” into the public domain through the media prior
to a formal public announcement of a transaction.

Publicly Traded Companies

If the target company is publicly traded, the material terms of
the transaction, including price, conditions to closing and any
special terms or break-up fees, must be disclosed on a Form 8-K
filed by the target company (and generally the buyer, if it is also
a public company) with the SEC within four business days following
execution of the transaction agreement.

Business Combinations

Depending on the structure of the transaction, shareholders
would then receive either a proxy statement from the target or a
tender offer document from the bidder and a recommendation
regarding the transaction from the board of the target, all of
which would be filed with the SEC. The substantive disclosure
required for business combinations is broadly similar, regardless
of structure, and would include previous dealings between the
target and the bidder, a summary of the material terms of the
transaction and certain financial information. Detailed disclosure
regarding any fairness opinion rendered by the target’s
financial adviser to the target board must also be included.

10.2 Prospectus Requirements

Issuance by the bidder of shares as consideration in a proposed
transaction requires the bidder to register the share offering
under federal securities laws, unless an exemption is available,
such as private placements to only “accredited
investors” satisfying requirements regarding their income,
net worth, asset size, governance status, or professional
experience. If required to register, the bidder must prepare a
registration statement containing a prospectus with additional
disclosure relating to the bidder and its shares, including the
bidder’s financial statements. When a registration statement is
required, it is generally combined with the proxy statement or
tender offer document into a single document.

10.3 Producing Financial Statements

Requirements in respect of bidder financial statements are
complex and a case-by-case analysis of the financial information
requirements of each transaction should be undertaken by bidders
for US public companies. Unless the bidder’s financial
condition is not material to the target’s shareholders (eg,
in an all-cash offer for all outstanding shares that is not subject
to a financing condition), the bidder’s audited financial
statements are generally required for the last two fiscal years
(for an all-cash transaction) or three fiscal years (where bidder
shares are offered as consideration), and unaudited but reviewed
financial statements are required for the most recent interim
period. Pro forma financial information may also be required for
the most recent interim period and fiscal year.

The bidder’s financial statements must be presented in
accordance with US Generally Accepted Accounting Principles (GAAP)
or International Financial Reporting Standards (IFRS), or
reconciled to one of these standards.

10.4 Disclosure of Transaction Documents

A US public target company is generally required to file with
the SEC a copy of any material definitive transaction agreement
reached with a buyer within four business days of its execution on
a Form 8-K or with the target’s next quarterly report on a
Form 10-Q (or, if earlier, its next annual report on a Form 10-K).
These documents become publicly available immediately upon
filing.

In addition to the definitive transaction agreement, any other
agreements that are material to the transaction, which could
include voting agreements or agreements relating to the financing
of the transaction, must be described in detail in the relevant
disclosure document provided to shareholders and filed with the SEC
(and a copy of the agreement may also be required to be filed as an
exhibit to the disclosure document).

Although the SEC can grant confidential treatment for portions
of transaction documents that are required to be publicly filed,
this is not common. Nevertheless, parties are permitted to, and
typically do, omit from their public filings any schedules and
similar attachments to transaction agreements if the contents of
those schedules or other attachments do not contain material terms
of the transaction or other information material to the
shareholders’ investment decision; however, parties may still
be required to provide such materials confidentially to the SEC
upon request.

11. Duties of Directors

11.1 Principal Directors’ Duties

Directors of Delaware companies owe two principal fiduciary
duties to the company and its shareholders: a duty of care and a
duty of loyalty. These fiduciary duties are generally not owed to
any other constituencies, except in unusual circumstances, such as
a company insolvency, where duties may be owed to company
creditors. Certain other states have “other
constituency” statutes, which permit directors to consider
the impact of a potential business combination on constituencies
(such as employees) other than the company and its
shareholders.

The Duty of Care

The duty of care requires directors to exercise reasonable care
in making decisions for the company. This duty requires directors
to inform themselves of all available material facts and
circumstances, devote sufficient time and deliberation to the
matters under consideration, participate in board discussions, and
ask relevant questions before making a decision or taking a
particular action related to a potential business combination.

The Duty of Loyalty

The duty of loyalty requires directors to be loyal to the
company and its shareholders, to act in good faith and to not act
out of self-interest or engage in fraud, which includes a
prohibition on self-dealing and the usurpation of corporate
opportunities.

11.2 Special or Ad Hoc Committees

It is not uncommon for boards to establish special or ad hoc
committees to negotiate and evaluate potential business
combinations. A committee of independent directors is often formed
in situations where the potential transaction involves a
controlling shareholder or management participation, or where the
majority of directors are conflicted. In these situations, the
forming, empowering and effective functioning of a special
committee of disinterested and independent directors can be an
effective part of demonstrating that the directors have discharged
their fiduciary duties in evaluating and approving the
transaction.

11.3 Board’s Role

Board’s Role in Negotiations

Negotiation of an M&A transaction is usually conducted by
the management of the companies, with regular updates to and input
from their respective boards of directors. A company’s board
of directors must ultimately approve any sale of the company and
the material terms of the sale.

Shareholder Litigation

Shareholder litigation is very common in connection with the
acquisition of US public companies, but the overall levels of such
litigation have fluctuated in recent years. The fluctuation is tied
to at least two developments in the laws concerning merging
litigation:

• firstly, decisions by state (principally Delaware) and federal
  courts have attempted to curtail the use of “disclosure
  only” settlements used by shareholder plaintiffs to extract
  additional information and legal fees from target companies in
  M&A transactions; and




• secondly, Delaware courts continue to extend the application of
  the business judgment rule (ie, the most lenient standard of
  judicial review) to decisions by boards of directors of target
  companies in certain merger transactions approved by a fully
  informed, uncoerced shareholder vote, making it more difficult for
  shareholders to challenge such transactions and easier to obtain
  dismissal of such challenges early in the proceedings before
  shareholder plaintiffs can seek discovery.

However, the measures taken by states such as Delaware to reduce
shareholder litigation have resulted in plaintiffs seeking
alternative means and jurisdictions to resolve merger-related
disputes and seek money damages.

In addition, appraisal actions have been prevalent in M&A
related litigation, particularly in Delaware. However, recent
decisions by the Delaware Supreme Court may reduce the frequency
and outcomes of appraisal actions in that state. In those cases,
the Delaware Supreme Court held that significant, if not
dispositive, weight should be placed on market-based indicators of
value, including the target’s stock price or the transaction
price, where the shareholders seeking appraisal fail to demonstrate
that the market for the target’s stock is inefficient and/or
that the transaction price did not result from a robust sale
process.

Although litigation challenging M&A transactions continues
to occur routinely in the US, it is relatively uncommon for it to
result in a meaningful delay in the transaction or personal
liability to the target company directors that approved it.

11.4 Independent Outside Advice

A board considering a possible business combination transaction
will generally engage outside legal and financial advisers and may
also seek the advice of outside accountants and consultants.

Directors are permitted to rely upon the advice of outside
professionals (as well as internal management and other employees
within the scope of their expertise), and the receipt of robust
advice from outside advisers is an important aspect of the
discharge of a director’s fiduciary duties.

Boards of publicly traded target companies will almost always
request that their financial adviser deliver a “fairness
opinion” to the board, which will opine that the
consideration to be received by the target company’s
shareholders is fair from a financial point of view.

Trends and Developments

The Surge in Technology
Transactions

Transactions in the technology sector have been on a hot streak,
with an increase in mergers and acquisitions, capital funding, and
initial public offerings and de-SPAC transactions, fuelled by both
growing general optimism about the economy’s rebound as well
as the major transformative changes that the world is going
through. We are in a seller-friendly market with high valuations.
Corporate investors are flush with cash, and many are choosing to
invest in technology. It is a major growth segment of the economy
right now, and smart companies are looking to position themselves
accordingly.

Industry sectors such as energy, finance, healthcare,
automotive, transportation and real estate are experiencing
technology-focused disruptions in their markets. In the rush to
stay competitive, many companies are forgoing development of their
own technologies and opting to make strategic acquisitions to fill
their business needs. Low interest rates and high investor
appetites are adding fuel to this technology-deal fire.

In the past year alone there have been several
multibillion-dollar transactions in the technology space, including
Square’s USD29 billion acquisition of Afterpay,
Salesforce.com’s USD27.7 billion acquisition of Slack,
Microsoft’s USD19.7 billion acquisition of Nuance,
Zoom’s USD14.7 billion acquisition of Five9, Intuit’s
USD12 billion acquisition of Mailchimp, and Hitachi’s USD9.6
billion acquisition of GlobalLogic.

The pandemic is spotlighting the value of
technology

The widespread remote working environment that started with the
COVID-19 pandemic has put technological solutions front and centre
for many businesses. Technological innovations enabled companies to
carry on crucial aspects of their work, maintain operations, engage
employees and keep robust security protocols, all with workforces
outside of traditional office environments. Video-conferencing and
other digital working solutions helped keep productivity high and
minimised the disruptive aspects of the pandemic. Distributed
workforces are becoming more common, which is increasing reliance
on digital communication, collaboration apps and cloud-based
productivity tools.

By the same token, technology companies were more insulated and
less affected by the uncertainties related to macro issues coming
out of the pandemic, such as industrial companies’ need to
staff sites that cannot be operated remotely, shifts in energy
production and consumption, and the uncertainties in sectors such
as hospitality and other service-related industries. Technology is
typically seen as an important investment area, but the pandemic
drove values into the stratosphere.

Growth itself has become a credo

As companies turn to technological solutions to stay relevant
and grow their market share, they are faced with a decision to
either develop the technology themselves or buy it. Technology is
also frequently the key to keeping up with shifting consumer
appetites and regulatory demands. Cryptocurrencies, self-driving
cars and green energy solutions are examples of technological
disruptors in different industries.

Deal structures are seeing pandemic-related
changes

The pandemic has also encouraged some widespread changes to deal
structures, many of which are likely to become standard. Most
M&A deals now include some relief or reduced contingencies in
regard to COVID-19-related market uncertainties, and these are
frequently being extended to include any government mandates that
may affect business. This is impacting the definition of
“material adverse effects” in definitive agreements, as
well as exceptions to covenants that require the company being
bought to operate its business in the ordinary course between
signing and closing.

There has also been widespread adoption of representation and
warranty insurance in many deal structures. Private equity
transactions have typically included representation and warranty
insurance in recent years, and it is now being increasingly adopted
by strategic buyers. The typically reasonable cost of this
insurance is enabling sellers to get more upfront cash and have
less exposure to post-closing contingencies while simplifying the
deal negotiation process.

Private equity fundraising is seeing a healthy
rebound

Global private equity fundraising dropped during the first part
of the pandemic, following broad uncertainty in the market. Travel
restrictions also had a quietening effect on deals, as it became
difficult to create and nurture new deal pipelines. Capital funds
remained healthy, however, and from the second half of 2020 into
2021, spending increased and private equity deal volumes increased.
Private equity buyers have adapted to the restrictions, sometimes
focusing on existing relationships for deal opportunities, and
diversifying their asset classes. There was a pent-up demand for
deals coming off the initial slowdown, and private equity funds in
general have proved to be adaptable and resilient to the market
volatility.

Going public with SPACs

As technology companies take advantage of the high investor
appetite by going public, there is a trend towards the use of
special purpose acquisition companies, or SPACs, for this purpose.
SPACs offer an alternative to the traditional IPO through what is
called a de-SPAC transaction.

SPACs are becoming increasingly common in the technology sector
and beyond. As publicly listed companies designed for the purpose
of merging with a private company, SPACs enable companies to go
public without going through the traditional IPO process. This
offers several benefits to investors in private companies in terms
of higher valuations and a faster process than a traditional IPO.
Venture capitalists and private equity sponsors are able to provide
cheaper financing and get a quicker return on their investment than
with a traditional fundraising and exit cycle.

Companies looking to go public are also choosing the de-SPAC
route more often in order to take advantage of cheaper financing
than they would find in the private markets. There is also the
possibility of some earlier liquidity for shareholders.

SPACs are also a significantly faster path to the open market
than a traditional IPO. Typically, the life cycle of an IPO from an
investor’s point of view can be several years, from raising
the funds, holding through the deal, and selling after a lock-up
period. With SPAC IPOs, investors are seeing a return in as little
as six months.

As SPACs are becoming more widely used, predictably enough, they
are also being scrutinised more by regulators. In addition, some
discerning investors still prefer traditional IPOs. That said,
there continues to be a large number of SPACs seeking private
companies with which to merge and technology companies interested
in this route should have a lot of options.

Private companies and corporate investors are flush
with cash

There is an abundance of capital in the private markets right
now, which is encouraging some technology companies to stay private
for the time being. At the same time, the increase in capital
fundraising capabilities and the proliferation of technology
solutions across sectors mean that many companies are deciding it
is a smart time to buy.

A seller’s market like this one always has a lot of
high-volume deal activity. It is an exciting time for emerging
companies with smart technological solutions. On the buy side,
companies are facing stiff competition. Sellers are setting tight
timelines and buyers are under real pressure to meet those
timelines and high-valuation expectations.

Regulators’ effects on deal
activity

Governing bodies including the US Federal Reserve, the European
Central Bank and the Bank of England’s Monetary Policy
Committee have been setting interest rates low since the start of
the pandemic, which is one factor encouraging deal activity in the
technology sector.

At the same time, as technology transactions have increased in
volume and amounts, regulators are increasingly scrutinising the
deals for any potentially anti-competitive effects. In the US, the
Department of Justice and the Federal Trade Commission (FTC) are
understood to be focusing much of their efforts on consolidations
in the technology sector, scrutinising transactions they deem
potentially harmful to consumers. In the UK, the government is
looking to increase the powers of the Competition and Markets
Authority, giving it increased jurisdiction and lowering the
threshold for inquiries. These potentially heightened-control
efforts are also largely focused on the technology sector.

As governing bodies only conduct advance reviews of deals over a
certain dollar threshold, currently set at USD92 million in the US,
some technology companies are getting creative – often to the
consternation of regulators. One tactic that garnered attention
last year was the paying of dividends by a large cap company to
investors ahead of a merger, reducing its assets below the
threshold and thereby avoiding scrutiny. The FTC is, however,
cracking down on this strategy, having announced late last year
that it would consider special dividends a possible
“avoidance device”, potentially triggering
investigation.

There has also been increased co-ordination between regulatory
agencies in the US, UK and Europe, which can slow down deals and
make investigations more robust. Pushback from regulators is
largely a reaction to the high volume of megadeals. Regulatory
probes are often slowing down closings, but properly structured
deals are ultimately making it through.

Talent retention has become a tricky yet essential
aspect to deals

The most valuable assets of emerging technology companies are
often their people. Historically high valuations mean that founders
and other key personnel at emerging technology companies are being
offered life-changing amounts of money for the businesses they have
created. For some, that may encourage them to cash out and retire.
Buyers are getting smart to this possibility and building in
retention packages for the most talented owners and employees, such
as a requirement to reinvest their equity for a period of time, to
ensure the long-term success of the acquisition.

The retention incentives need to take into account tax and
accounting considerations in various jurisdictions. This is doubly
true with companies operating on a more global basis, with, for
example, headquarters in the US but operations and key talent in
Asia. Deal structures need to be able to thread the needle of tax
and accounting.

It is also crucial to consider the emotional or human component
of this aspect of a deal. It can be a delicate operation to survey
the talent at a start-up, many of whom have worked closely together
for years on a possibly revolutionary product, and to put them all
into categories of essential talent, or otherwise. Those deemed
essential or “key” become subject to additional
restrictions and need to negotiate their continued involvement in
the acquired company. Those deemed inessential are free to cash
out, but may walk away feeling injured or that their contributions
were devalued.

Development for technology companies is increasingly
global

Deal volume in the technology sector has been high across the
globe – in the Americas, Asia-Pacific and EMEA. There is an
ongoing trend towards cross-border technology transactions and
investments, as companies search far and wide to fill their needs
with the most innovative technology solutions.

Countries and regions that are currently seeing strong activity
in this area are India, Eastern Europe, Israel and South America.
Due to favourable tax laws in different jurisdictions, some
companies are holding large amounts of cash offshore, which is also
contributing to acquisition activity in the technology sector. At
the same time, some countries are significantly increasing
restrictions on foreign investments and acquisitions, which is
hamstringing potential deals between, for example, the US and
China, where there used to be a high volume of deal flow.

Cross-border deals, while increasingly common, are more complex
for a variety of reasons. Deal teams need to be (or become)
familiar with different deal structures, complex regulatory
requirements relating to labour issues, currency controls,
intellectual property, tax, executive and equity compensation,
foreign direct investment and securities registration, among other
things, as well as often significant cultural differences in
deal-making.

The trend towards high-volume, high-value deals in the
technology sector is expected to continue, as companies make
strategic investments in smart innovations to grow their business
and fill the needs of consumers in an increasingly digital
world.

Originally Published by Chambers and Partners, 27 October
2021

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.