Tech M&A: Buy innovatively, integrate intelligently

In recent months, the M&A market has witnessed a significant upswing, with technology companies at the forefront of this trend. M&A transactions within the tech sector present unique challenges that span various legal areas and topics. The fast-paced nature of the technology industry often demands flexibility, which the traditional M&A process may lack. To successfully navigate these transactions, it's crucial to understand the specific requirements of tech M&A across the entire transaction cycle, from structuring, due diligence, and negotiations to integration.

Structuring sets the course

The structuring phase is where crucial decisions set the trajectory for the entire transaction. It's important to mentally distinguish between a complete acquisition and a partial acquisition from the outset:

• Full acquisition: In a full acquisition, the decision between a share deal and an asset deal is significantly influenced by the unique aspects of the tech sector. Specifically, carryover restrictions on IT and software assets—which are vital in tech companies—can tip the scales. Such restrictions may arise from change-of-control clauses in key contracts. In some cases, universal succession in the context of transformational measures can overcome approval requirements.
   
• Tax considerations: The chosen deal structure is closely linked to tax considerations. Capital gains and potential increases in the book value of intellectual property often drive the decision in a certain direction. However, loss carryforwards from early phases are also typical for growth companies, which must be used efficiently..

In the case of a partial acquisition, clear allocation of essential assets through a carve-out is necessary. When certain components are shared by both the remaining and sold portions of the company, parties must determine whether separate structures should be developed in the medium term or if long-term cooperation is required. Licensing agreements are pivotal, especially when dealing with intellectual property and joint venture projects.

In some tech M&A transactions, a partial acquisition might serve to retain the involvement of company founders, preserving their knowledge and entrepreneurial drive—especially vital in early-stage start-ups. The structuring phase must address how founders' shareholdings transition to the new entity. An earn-out mechanism may also be implemented, linking the sale price to the company's performance within a defined period post-transaction, providing financial incentives for continued success.

Due diligence with a focus on data protection and IP

Due diligence is usually conducted parallel to the structuring phase, significantly influencing its course. This phase involves addressing specific regulatory requirements and the paramount importance of know-how, which entail special risks for both buyers and sellers.

• Data protection: Regulatory compliance in data protection is crucial, as past failures can lead to operational difficulties, unforeseen liabilities, and reputational damage. Depending on the industry—be it fintech, insurtech, or healthtech—certain industry-specific compliance themes require attention. The growing importance of artificial intelligence (AI) and its regulation under the EU’s AI Act is expected to further influence tech M&A due diligence.
   
• Intellectual property (IP): IP existence, including trademarks, patents, and licenses, is a priority. Commercially, the focus lies on evaluating the IP portfolio's value, while assessing the legal protection concept for intellectual property and the legal structure of essential licenses is critical. Ambiguities regarding self-developed software ownership and usage rights can hinder future value creation. IP developed with public aid might also face geographical marketing restrictions.

From a seller's standpoint, due diligence involves ensuring the confidentiality of information provided to prospective buyers. Beyond non-disclosure agreements, protective measures like multi-tiered data rooms and clean team agreements are implemented to safeguard sensitive data.

Should founders be involved in the company’s sale, they often personally guarantee part of the purchase contract. To mitigate personal risks and assure solvency against warranty claims, warranty and indemnity insurance becomes a strategic choice. This safety, however, relies on a thorough due diligence process to ensure comprehensive risk coverage by insurance providers.

Negotiations, employee retention, and antitrust filings

Post-due diligence, securing client interests through transaction documentation is essential. While guarantees and indemnities are common tools in tech M&A just like in any other transaction, addressing employee management and antitrust permits adds layers of complexity.

• Employee considerations: Key employees, notably software engineers, are indispensable for successful tech enterprises as carriers of essential knowledge. Providing them stability amidst transactional uncertainties is often achieved through incentive programs with lock-up periods. Top management also require contracts that offer adequate protection of competition through non-competes, preventing their immediate shift to competitor companies.
   
• Antitrust filings: Specialised teams concurrently prepare antitrust applications to expedite necessary approvals right after negotiations end. Tech firms, under increased regulatory scrutiny, might face additional sector-specific requirements. A coherent forward-looking strategy across all jurisdictions can prevent delays or regulatory interventions. At this stage, attention to gun-jumping risks, referring to premature transaction completion, is crucial.

Rapid integration promises synergies

Once the transaction is complete, the realisation of the strategic goals can begin. The technology sector's inherently rapid market changes and innovation pressures make post-merger integration particularly challenging. However, if approached methodically, integration can yield substantial synergies, notably in labour and tax law contexts.

• Communicating with the workforce: A clear communication strategy with the workforce is crucial to minimise cultural tensions. Existing employee participation programs, which are standard in many technology companies, are regularly discussed. Subsequently, group-wide harmonisation can prove helpful in ensuring equal treatment within the workforce.
   
• Co-determination and structural measures: Increasing co-determination obligations in growing tech firms can constrain entrepreneurial freedom. Converting the relevant entity into a European Company (Societas Europea) offers a viable path to balance co-determination with shareholder interests effectively.
   
• Tax optimisation: Tax considerations provide multiple optimisation opportunities, such as avoiding unnecessary costs in intra-group IP transfers or licenses. Exploring potential benefits from income tax or VAT group arrangements can result in financial efficiencies.

Looking ahead: focus and prioritisation reduce complexity

Navigating tech M&A transactions requires an interdisciplinary approach to balance legal imperatives with clients' economic and technological ambitions. Through clear prioritisation and a strategic focus on essential areas of law within the different phases, the complexity of these deals can be reduced, and success can be secured in the long term. 

Flexibility in addressing the specifics of each transaction will help overcome the challenges of the dynamic technology sector, ultimately creating sustainable value.

A version of this article was originally published in German by Deutscher AnwaltSpiegel.