DMU Insights #6: What does the new regime mean for investments in UK tech companies?

Last month, the UK Government introduced the long-awaited draft Digital Markets, Competition & Consumers (DMCC) Bill (see our previous summary here), which introduces a new regulatory regime for digital markets as well as more general reforms to competition and consumer protection laws. This post considers the implications of the proposed reforms for funds and financial sponsors investing in tech companies.

Merger control: will increased scrutiny of SMS acquirers make funds more attractive buyers?  

The original Digital Competition Consultation proposed a mandatory merger control review for certain transactions and amended the legal threshold to block a merger in Phase 2. The Government has since rowed back on these proposals, highlighting in April 2022 the risk of introducing different jurisdictional thresholds for SMS mergers and the potential impacts that this could have on innovation and investment.

Instead, the DMCC requires SMS firms to mandatorily report transactions when the firm gains “qualifying status” (i.e., shares/voting rights triggering certain thresholds: 15% (or more), 25% (or more), or 50% (or more) in a “UK-connected body corporate” (i.e., an undertaking that carries on activities in the UK, or supplies goods and services to person(s) in the UK), for a consideration of at least £25m.

In practice, these conditions will be easily met in the vast majority of the transactions involving SMS firms, provided the target has some UK nexus. Once the transaction is reported, the CMA will have five working days to confirm if it requires further information, or if it wishes to open an in-depth investigation. While the CMA already has expansive jurisdiction to review deals, the new regime solidifies the CMA’s grounding to review acquisitions by SMS firms.

It remains to be seen whether these new merger conditions will impact investment in UK start-ups (and ultimately innovation). In the short term, there will be several implications for (most) acquisitions by SMS firms:

• No simultaneous signing and closing. The new regime deviates from the usual voluntary non-suspensory UK merger control regime. SMS firms will have to make their deals public, wait (at least five days but potentially more), and face the possibility of a full merger control review commencing prior to closing (and the imposition of a hold separate order).
• Administrative burdens. SMS firms (and their M&A targets) will have to provide the CMA with information relating to the transaction. This is likely to create a practice of “pre-report” engagement (i.e., in essence pre-notification) with the CMA, which will have to be factored into deal planning. The sheer number of reports and the, at least on paper, brief duration of the suspensory period might also strain the CMA’s resources. It remains to be seen if this could result in more deals following the route of full merger control review in cases where a five-day review cannot be determinative.
• Strategic investments will be covered. The SMS-specific regime is similar to the National Security & Investment Act 2021, in that it also applies to minority investments triggering certain thresholds. In other words, it deviates from the “control” test applied under traditional merger rules and even from the “material influence” test applied under existing UK merger rules (which assume material influence at 25% or more but are fact-specific at lower levels and "control" is rare at 15%). This will directly impact strategic investments that tech firms make in start-ups, including potentially venture capital rounds.

The new regime may as a result make investments by funds and financial sponsors more attractive for tech start-ups in the UK, compared to acquisitions or investments by an SMS firm. In addition, the heightened scrutiny by the CMA of practically all material investments and acquisitions by SMS firms could potentially make it harder for venture capital funds to exit tech start-ups, where a potential sale to an SMS firm could face a suspensory period and the possibility of detailed review. If various exit routes are foreclosed, this could in turn temper VC funds’ appetite to invest in tech start-ups. The potential impact of the new regime on investment and innovation will largely depend on the interplay of these competing forces and the way the new rules are in practice enforced by the CMA.

Conduct requirements: a substitute for antitrust enforcement? 

The CMA has historically been hesitant to resolve competition issues with commitments that require ongoing monitoring. This was one of the concerns raised by the CMA when rejecting the access remedy offered by Microsoft in its proposed acquisition of Activision. This is set to change with the DMCC – SMS firms will be subject to conduct requirements that require ongoing compliance and, potentially, the scope for greater acceptability of behavioural commitments as a result (or, indeed, to provide scope for argument that no commitments are required at all as codes of conduct under the DMCC will adequately deal with conduct concerns).

In the short term, although the CMA has indicated that it intends to continue to enforce antitrust law in addition to the DMCC, there are likely to be fewer antitrust investigations in digital markets (at least in relation to SMS firms) resulting in infringement findings and, consequentially, damages. Instead, as in the recent Google investigation, the CMA is likely to accept behavioural commitments that may be ultimately backed up in conduct requirements.

Conduct requirements will likely benefit smaller tech companies – particularly those that rely on services from SMS firms. Tech funds may be more willing to invest in start-ups if they are confident that they will not be exploited / squeezed out of the market by dominant companies. The actual impact will depend on the content of conduct requirements, and their enforceability.

Consumer protection

The DMCC introduces direct enforcement of consumer laws by the CMA and allows the imposition of very significant fines for breaches (up to £300,000, or 10% of a company’s annual turnover). The Government has indicated that particular attention will be paid to unfair practices such as “subscription traps” (i.e., contracts with auto-renewing features). It is also expected that the Government will use its powers to regulate practices relating to “fake online reviews”.

This is likely to have an impact on smaller / mid-sized tech companies, who can face significant penalties if they fail to comply with consumer protection regulation.  Tech funds or companies looking to invest in these companies, will need to intensify their due diligence on compliance with consumer protection to ensure they do not inherit significant liability post-closing.