Increased scrutiny of M&A triggers contingency planning and exit strategies

The Federal Trade Commission (FTC) and Department of Justice (DOJ) are taking a stronger interest in stopping deals that limit competition — and making sure existing rules are sufficiently enforced. Previously, acquisitions of small companies fell below the radar of the Hart-Scott-Rodino (HSR) Act, which requires reporting of large transactions for antitrust review.

But recently, some experts have raised concerns about a pattern of “killer acquisitions”— those acquisitions designed to eliminate competitors before they pose a significant threat. The FTC responded with a comprehensive report, signaling increased appetite to control anti competitive behavior.

In the comprehensive report, FTC Chair Lina M. Khan notes, “While the Commission’s enforcement actions have already focused on how digital platforms can buy their way out of competing, this study highlights the systemic nature of their acquisition strategies.” She went on to say that the study, “Captures the extent to which these firms have devoted tremendous resources to acquiring start-ups, patent portfolios, and entire teams of technologists—and how they were able to do so largely outside of our purview.”

Meanwhile, Congress is looking at expanding oversight of merger and acquisition (M&A) activities to slow or limit acquisitions of start-ups by large tech companies. Many start-up founders have exit strategies that include being acquired by an industry incumbent, but they may need other options in case the acquisition path proves bumpier than they expected.

General counsel plays a crucial role in ensuring their leaders aren’t surprised by these changes. Many rely on Practical Law’s How Antitrust Agencies Analyze M&A for insights into what could go wrong and scenario planning.

Proactive merger assessments

On both sides of the transaction, senior leaders must understand the intensifying scrutiny from the DOJ and FTC. Buyers and sellers need to convince regulators that their strategy is not anticompetitive. Sellers will appreciate knowing that their assumptions may not bear out, particularly because sellers bear the brunt of the negative impact if a deal falls apart over antitrust concerns.

Companies can get ahead of regulatory changes by conducting preliminary merger assessments on potential buyers or deal targets. If no material competition or “killer acquisition” conditions exist, they may be able to proceed as planned. If a preliminary merger assessment shows that the deal could be blocked by the antitrust agencies or subject to unacceptable remedial conditions, small business leaders may want to diversify their exit options. The Practical Law resource Merger Control Overview: Presentation Materials helps bring business leaders up to speed on the merger control process.

Diversified exit options

The primary focus of the FTC’s report was acquisitions by Alphabet (parent company of Google), Amazon, Apple, Facebook, and Microsoft, because they are the largest in the U.S. in terms of market capitalization and are significant acquirers of technology start-ups.

Companies seeking acquisition by these tech giants or others like them should also develop contingency plans that are less likely to run afoul of regulators.

Build relationships with multiple buyers

To date, much of the antitrust scrutiny has targeted the largest companies, but as the focus expands, sellers are considering other buyers. Because it is wise for sellers to avoid locking in on one buyer early in the process, mid-size tech companies also have an opportunity to ramp up their own strategic acquisition activities.

Consider venture funding

While it isn’t a clean exit for the founder, venture funding could be a good option for shareholders. Founders who want to exit the business can also map out a management transition to the venture firm.

Check the management team

More mature businesses may have leaders who want to take over the business when the founder leaves. While shareholder value is a critical piece of the equation, the long-term company benefits may make this an appealing option.

In-house counsel can help founders, boards, and management teams think through these options to provide an appropriate Plan B. The outcome of a merger review process can be unpredictable and depends on the availability of credible and persuasive evidence of competitive market dynamics. Buyers and sellers alike will benefit from scenario planning that assesses risks and opportunities while also considering ongoing uncertainty from the DOJ and FTC.

Planning and preparation for merger review

Buyers and sellers that are in serious talks should prepare for a merger review, whether or not the deal is reportable under HSR. This includes the following steps:

1. Analyzing the need early in the transaction process for pre-merger filings in the U.S. and abroad
2. Performing a preliminary merger assessment to understand the transaction’s antitrust risks
   
3. Preparing for government inquiries and a Second Request, if likely
   
4. Drafting appropriate antitrust risk allocation language for the parties’ agreement
   

Outside counsel will likely be involved by the time an HSR review is needed or if the FTC or DOJ open an investigation into a non-reportable deal. Still, as the internal legal advisor, general counsel should ensure that the final agreement has appropriate antitrust risk allocation. Practical Law’s Corporate Transactions and Merger Control: Overview is an excellent resource for in-house counsel engaging in HSR review preparation.

A seller concerned about antitrust risk can use a covenant to place the risk of obtaining that approval on the buyer or to address scenarios in which regulators require the buyer to divest assets. Risk-shifting provisions can also require the buyer to defend against government orders that would prevent the closing through litigation. Practical Law's Antitrust Risk-Shifting Provisions: Overview helps guide lawyers through these and other common ways to allocate antitrust risk in deal agreements.

In-house counsel serve a critical business function for start-up leaders contemplating their exit strategy — they advise leaders on the antitrust landscape and how it affects their strategy. They also work with leadership teams to mitigate risks and maximize shareholder value.

Practical Law’s suite of up-to-date antitrust resources support in-house counsel in guiding businesses through uncertain M&A. Buyers and sellers access expertly written Practice Notes, Toolkits, Checklists, a database of public and private deal agreements, and more, to successfully plan their approach, despite increasing scrutiny from Congress and federal regulatory agencies.