Ben Boissevain
Despite the war in Ukraine, accelerating inflation and increasing interest rates, the technology sector has still seen M&A happening in the United States. In the first half of 2022, large tech M&A transactions included Microsoft acquiring Activision Blizzard for $69 billion, Google buying Mandiant for $5.4 billion, and Elon Musk bidding for Twitter for $44 billion.
Private equity was also active in the tech sector, with Thoma Bravo purchasing SailPoint for $6.9 billion and Vista Equity Partners acquiring Citrix for $13 billion. Cross-border tech M&A included Deutsche Telekom’s acquisition deal with SoftBank Group and T-Mobile U.S. for $2.4 billion and Siemens acquiring Brightly Software for $1.8 billion.
European and Asian companies can compete effectively against both U.S. companies and private equity by offering greater target management responsibility post-transaction, flexible transaction structures and global distribution of the target’s products sold with the acquirer’s sales team. By understanding the key issues in cross-border tech M&A, an international acquirer can close a successful transaction and achieve its commercial objectives in the United States.
Acquisition criteria
Prior to approaching targets, it is important to establish detailed acquisition criteria.
Acquisition criteria can include the subsector, product set, revenue, profitability and customer profile. It should also include more intangible aspects, such as vision, culture and strategy. Management team strength is also important, particularly if the international acquirer is following the private equity playbook and acquiring a platform company with the intention of acquiring smaller add-on companies later. Finally, practical criteria should be considered, such as geographical location — if the international acquirer is in Paris, a flight to the East Coast is much shorter than a flight to California.
Target research
Once the acquisition criteria are established, in-depth target research is required. This research should include target financing, capital structure, leadership and industry reputation. Research should include databases such as Capital IQ, PitchBook and Crunchbase, as well as confidential discussions with industry leaders at other companies in the subsector and industry trade groups. This industry insider knowledge can be very powerful.
Acquirer’s presentation
The international acquirer needs to prepare a professional presentation describing the acquirer and its commercial objectives for a transaction. This will be helpful to convince the target’s management and board to proceed with a transaction.
This is particularly important if part of the consideration is swapping the target’s shares for an international acquirer’s shares. If the acquisition is to acquire a platform company, then this should be explained to the management team, who will welcome the additional responsibility post-transaction of acquiring other add-on companies in the future. The acquirer’s vision, culture and strategy should also be highlighted, since this will be important to the target’s management that plans to stay on after the transaction.
Target approach
Approaching the targets should be achieved through multiple vectors. This includes direct connections such as No. 1 connections on LinkedIn, industry analysts at firms such as Gartner and industry experts at Wall Street banks, who may be representing interesting targets on the sell-side.
One of the many benefits of an investment banker is they have many senior-level contacts in the sector. It is recommended to approach a number of targets at once, since this creates competition on the buy-side, which lowers the price and ensures that the international acquirer does not fall in love with a particular target and end up overpaying.
Once the initial dialogue has been established, then the acquirer should address critical issues such as ballpark valuation and the management’s desire to stay on after the acquisition. Leaving such issues for later in the M&A process wastes everyone’s time.
Valuation
Valuations in the technology sector have come down dramatically since 2021. Management teams, boards and shareholders have had time to adjust to the drop in valuations and will be more amenable to an acquisition at a reasonable price.
The acquirer, or its investment banker, needs to produce an in-depth valuation justifying the valuation put on the table. In addition, if the target’s product is expected to be sold through the acquirer’s sales team, detailed internal analysis should be undertaken to help determine the value of the target for the acquirer.
CFIUS review
The Committee on Foreign Investment in the United States (CFIUS) is an interagency committee authorized to review transactions involving the acquisition or control of, and certain non-controlling investments in, a U.S. business by a non-U.S. person to determine the effect of a transaction on the national security interests of the United States.
All companies proposing to be involved in an acquisition by a foreign firm are supposed to voluntarily notify CFIUS, but CFIUS can review transactions that are not voluntarily submitted. CFIUS’ primary concern in most reviews is that technology or funds from an acquired U.S. business might be transferred to a sanctioned country due to being acquired by a foreign acquirer. The vast majority of transactions submitted to CFIUS are approved without difficulty.
Structure
Transaction structures in Asia typically are minority investments, or “stakes,” in another company, and if this is successful, acquisition of more shares at a later date. Transaction structures in Europe typically are two-step transactions where a majority of shares are acquired, and the remaining will be acquired later. Both of these structures are also used in the United States, although the most popular structure is to acquire 100% of the shares, and then have an earnout payment if the target achieves certain goals.
International acquirers can use flexible transaction structures to their advantage by offering to make a minority investment or acquire a majority of shares. It is important to consider what transaction structures are prevalent in recent acquisitions in the sector.
For example, in the fiber-to-the-home subsector, certain transactions kept the original family that founded the telecommunication company on the capitalization table as minority shareholders — e.g., KKR and Oak Hill’s MetroNet acquired CTS Telecom for $100 million, which resulted in a capitalization structure that had KKR owning 42%, Oak Hill holding 27% and the Cinelli Family keeping 23%.
If a minority or majority investment is on the table, then the issue of control should be examined. There are various levels of control, including negative control, whereby a shareholder can block the sale of a company. This is a complex area, and technology companies often have class A voting shares and class B non-voting shares, preferences with anti-dilution rights, tag-along and drag-along rights, rights of first refusal and staggered boards. The complexity of control is one of the reasons why 100% ownership plus an earnout structure is popular in the United States.
Typically, the international acquirer will set up an acquisition vehicle in Delaware. If the transaction is a 100% acquisition, then the type of structure needs to be considered — asset purchase versus a share purchase. In the United States, acquisitions often take the form of a triangular merger, which can have tax benefits. The target will merge with a subsidiary of the acquirer. If the subsidiary survives, this is called a “forward triangular merger.” If the target survives, this is called a “reverse triangular merger.”
Taxes are an important consideration, and this requires examining the acquirer and the target’s corporate organizations and to determine the most tax efficient structure. Tax planning should consider not only the tax consequences of the transaction itself, but also the implications of operating the newly acquired U.S. business after closing — cross-border flows of goods and services, the repatriation of cash and other distributions and the availability of U.S. tax treaties.
Finally, it is important to structure a transaction with the acquirer’s employees in mind. In Asia and Europe, employee options are less common, but in the United States, technology sector employee options are expected, and the transaction needs to be structured accordingly.
It is also common to incentivize the management team to stay with the target after the transaction with a closing bonus and other incentives. Given that the management works for more than monetary incentives, selling the team on the acquirer’s vision, culture and strategy is particularly important. This can include global distribution of the target’s products sold by the acquirer, which is often a key goal for founding a technology company in the first place.
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