M&A Report 2022: United States
Robert Katz and Charles Ruck, Latham & Watkins
The US M&A market remains strong following a record setting year in 2021. The market experienced unprecedented transaction volumes and values in 2021 and many of the underlying market dynamics remain in place for 2022. There are, however, factors that could moderate the pace, breadth and depth of the M&A market in 2022, including increased scrutiny from regulators, rising interest rates, global tensions and stock market volatility.
The extent to which the war in Ukraine, the imposition of sanctions and export controls on Russia, and related geopolitical, financial, and commodity volatility will impact the global M&A outlook is hard to predict. Some geographies, sectors, and businesses have seen immediate effects, while for others the implications will become clear in time.
The global regulatory environment received increased attention from dealmakers in 2021 and will continue to do so in 2022. Regulators in the US and around the world have signalled through both actions and public statements that a transaction’s impact on the competitive landscape will receive increased scrutiny and oversight.
Sustainability and organisations’ and institutions’ commitments to, and ability to improve, their environmental, social and governance (ESG) positions remains a key priority. Dealmakers and C-suite executives will likely demand increased attention as to how a transaction may be viewed and positioned from an ESG perspective.
The market continues to be driven by both private and public M&A transactions, although private M&A is more prevalent because there are many more private than public companies. Ready availability of financing (despite recent upticks in interest rates) is a driving factor, particularly for private company and private equity deal-making where acquirer stock is not available as transaction consideration.
For public companies, increased levels of cash on their balance sheets, together with an ability to use stock as an acquisition currency, remain key drivers for strong deal volume in 2022.
Transactions involving special purpose acquisition companies (SPACs) accounted for more than $600 billion in transaction value in 2021 and were a key component in fuelling increased deal activity. The outlook for 2022 is less certain based upon, among other factors, increased scrutiny from US regulators, investors taking a more cautious approach both in terms of private investment in public equity (PIPE) investments and shareholder redemptions.
So-called de-SPAC transactions and their evolution through 2022 and beyond continues to be discussed by dealmakers within the US.
Rising levels of scrutiny and evolving models of antitrust enforcement and review continue to be a topic of conversation amongst M&A participants within the US and throughout the globe. The potential for new legislation within the US with respect to both horizontal and vertical mergers that could alter long-held views on antitrust review and enforcement will continue to be top of mind for dealmakers.
The pace of regulatory review together with an increased appetite to enjoin or otherwise re-shape transactions was seen in 2021 and has and will impact transactions in 2022.
Economic recovery plans
Covid-19 caused a sharp decline in deal volume and deal value in the first half of 2020. Even with a strong rebound in the second half of 2020, M&A activity still ended down 21% by value compared to 2019, according to Mergermarket.
Global deal volume enjoyed unprecedented activity in 2021 topping $5 trillion for the first time ever, up approximately 64% from the prior year. The US was a key driver of this record setting pace, accounting for nearly half of transaction volume and value.
Generally, market participants expect strong deal flow to continue in 2022. Private equity (PE) buyout funds continue to maintain high levels of uncommitted capital for M&A transactions. In addition, strategic acquirers continue to remain focused on growth, both with a focus on M&A and organically.
There are moderating factors that could present a drag on the market, including less accommodative monetary policy from the US Federal Reserve Bank, challenges posed by antitrust regulators and the Covid-19 pandemic. However the US M&A market is expected to remain strong overall.
“The current exit environment remains robust, and was substantially boosted throughout 2021 by de-SPAC transactions, i.e., mergers between SPACs and private companies”
Transaction participants have been more keenly focused on the scrutiny regulators will apply to M&A transactions and how such risks are allocated among the parties to transactions. Regulators in the US have explicitly signalled a heightened sensitivity to the competitive effects of certain transactions and have taken more aggressive actions, including prohibiting the consummation of certain transactions based upon the presumed anti-competitive effects.
This increased regulatory scrutiny has and will continue to impact transaction strategies in the global markets. In particular, certain industries – including technology, industrials and healthcare – will remain under heightened oversight.
2021 also saw a dramatic surge in the volume and size of SPAC deals, an alternative path to taking a private company public whereby a SPAC is formed to raise cash in an initial public offering (IPO), and the proceeds are subsequently used to complete a business combination with a private target, typically within two years of the SPAC’s IPO.
SPAC transactions accounted for approximately 10% of the global deal volumes in 2021. Through the latter half of 2021 and early 2022 the SPAC alternative became less prevalent, as the performance of many companies taken public through SPAC structures came under pressure in the public markets.
PE firms remain a driving force of deal-making. Despite rising interest rates and increased market volatility, PE participants are expected to remain quite active in 2022, with uncommitted capital at PE firms remaining at record levels.
Shareholder activists are also expected to have a greater profile in 2022. While the pace of activist campaigns was relatively unchanged in 2021 compared to 2020 and 2019, market participants are anticipating a renewed level of activity.
Activists are expected to wage campaigns based not only on usual and customary grounds (such as asset allocation and sub-par returns on investment), but also on ESG platforms and ‘say on pay’. These activist campaigns are often M&A-related, with an underlying thesis that shareholders are better off with companies being sold or re-configured to drive maximum shareholder value.
Legislation and policy changes
US M&A transactions are subject to regulation by both the federal government and the target company’s state of incorporation.
The federal government primarily regulates the issuance and sale of securities through the Securities and Exchange Commission (SEC), antitrust matters through the Federal Trade Commission and the Antitrust Division of the US Department of Justice and foreign investment that may have national security implications through the Committee on Foreign Investment in the United States (CFIUS).
The laws, rules and regulations administered by the SEC are particularly relevant in the purchase or sale of a US public company. The laws of the target’s state of incorporation govern that company’s internal affairs and impose requirements for shareholder approval of mergers and the procedures for effecting mergers.
The Biden administration announced antitrust priorities in 2021 designed to address perceived shortcomings in antitrust enforcement. These evolving antitrust priorities will expand antitrust scrutiny going forward, consistent with changes practitioners are already seeing at the antitrust agencies within the US. The potential for new legislation within the US with respect to both horizontal and vertical mergers that could alter long-held views on antitrust review and enforcement will continue to be top of mind for dealmakers.
In negotiating transaction agreements, practitioners will need to be aware of these risks and how they are allocated, together with the time required to navigate the antitrust review process.
More deal parties have adjusted their transaction structures and used Covid-specific terms and conditions to allocate pandemic-related risks, including through the use of contingent pricing structures and carve-outs in material adverse effect (MAE) definitions and interim operating covenants to permit targets to take actions in response to Covid-19. Dealmakers and C-suite executives will likely demand increased attention as to how a transaction may be viewed and positioned from an ESG perspective.
The Biden administration has brought a renewed focus to antitrust enforcement. There are more than a dozen federal agencies within the US reviewing, analysing, and providing input on a renewed approach to competition/antitrust governance. The general US framework of protecting consumers, rather than competitors, is being re-visited writ large. Regulators are now more keenly focused on other constituencies, including labour, the environment and other ESG-related concerns.
This potential revised regulatory framework, together with time required to navigate regulatory review and the remedies that regulators may ultimately require, is something that all parties should consider thoughtfully when contemplating a potential M&A transaction.
Unlike the locked box approach that is more common in many non-US jurisdictions, in most US private acquisitions the purchase price agreed to at signing is usually subject to closing or post-closing adjustment based on the amounts of certain financial accounts of the target (e.g., cash, indebtedness, and net working capital) on the closing date. Under this approach, the parties generally must spend more time negotiating the adjustment mechanics and related accounting methodologies.
Under the laws of most states, public target boards must generally retain the right (commonly referred to as a fiduciary out) to terminate the transaction agreement after signing but before the target’s shareholders approve the transaction to accept a higher offer. Shareholder litigation is common in such transactions, and the buyer is generally liable for related costs.
Representations and warranties insurance (RWI) and transaction structures that provide for no post-closing recourse by the buyer against the seller except for fraud are increasingly common in private company transactions.
As a result of the pandemic, dealmakers have had to adjust to a virtual environment where almost every aspect of an M&A transaction relies on technology, necessitating a keener focus on cybersecurity issues in the deal execution process.
Data privacy and cybersecurity have also become critical elements of the business and operations of most companies and thus should be a key focus of due diligence in any M&A transaction.
In light of the fiduciary duties of public company directors that generally require them to maximise shareholder value in a sale, target boards often conduct some form of a pre-signing market check. However, in some deals, the target board will forego a pre-signing market check in exchange for a go-shop right to solicit competing offers for a limited period of time (usually 30-60 days) after signing the transaction agreement.
While state law generally requires target boards to preserve a fiduciary out to accept a higher offer under certain circumstances, buyers usually negotiate for a prohibition on the target’s right to affirmatively solicit competing offers (except in the case of a go-shop right), and the right to receive a break-up fee if the target’s board terminates the transaction agreement to accept a higher offer.
Most states require shareholder approval (usually by a majority of outstanding shares) of most mergers. Certain regulatory approvals, including clearance under the Hart-Scott-Rodino antitrust statute, and for non-US acquirers, from the CFIUS, must be obtained before an acquirer can take control of a US company. Acquiring a US company in regulated industries such as financial services and energy may be subject to additional regulatory scrutiny at the federal and/or state level.
Public company acquisitions can be structured as (1) a one-step merger between the acquirer (or more commonly a subsidiary of the acquirer) and the target (typically requiring majority shareholder approval), or (2) a two-step transaction involving a tender or exchange offer by the acquirer for all the target’s outstanding shares (which is generally subject to a minimum tender condition requiring the tender of at least a majority of the outstanding shares) followed by a back-end merger. Both types of transactions are typically subject to the following conditions (among others):
Accuracy of representations and warranties;
Material compliance with covenants;
No MAE on the target; and
Receipt of regulatory approvals.
Nearly all public target M&A deals in 2021 included an MAE exception for changes, effects or conditions arising out of the Covid-19 pandemic and governmental responses thereto, according to Deal Point Data. Many agreements also provide for greater flexibility under the interim operating covenants to permit the target to take action in response to Covid-19.
Public company merger agreements generally require the target to pay a termination fee if the target terminates the agreement to accept a superior offer, or if the buyer terminates because the target changes its recommendation in favour of the deal. These fees are usually between 2% and 4% of the transaction’s equity or enterprise value, but may fall outside this range based on deal size and other factors.
In some transactions the buyer is required to pay the seller or the target a reverse termination fee under certain circumstances (e.g., the failure to obtain required regulatory approvals or if all the buyer’s closing conditions are satisfied and it nevertheless fails to close the transaction). These fees are highly variable but often range between 5% and 7% of the transaction’s equity or enterprise value.
2021 saw the continued use of earn-outs, under which the seller will receive one or more additional payments, contingent on the target’s future performance, in part to account for increased earnings uncertainty due to Covid-19.
Completion accounts (known as working capital or balance sheet adjustments) are common in private company acquisitions. Locked box transaction structures are much less prevalent in private company acquisitions in the US than in many other jurisdictions.
At the beginning of the pandemic, RWI carriers started including broad Covid-19-related exclusions in their policies. Over the last several months, these exclusions have narrowed to focus on the target’s Covid-19-related risks.
All the conditions listed for public M&A above (except the minimum tender condition) generally also apply in private M&A transactions. However, in the absence of RWI, representations and warranties usually survive the closing in private M&A transactions and may give rise to post-closing indemnity claims.
Agreements are typically governed by the law of the target company’s state of incorporation. If that state has sparsely developed corporate law, the parties sometimes provide that Delaware law will govern certain issues.
The current exit environment remains robust, and was substantially boosted throughout 2021 by de-SPAC transactions, i.e., mergers between SPACs and private companies. The market for IPOs and de-SPAC transactions remains strong, albeit with a renewed focus on quality and the underlying economics of the transaction. Trade sales and sales to financial sponsors are expected to remain strong and will likely increase as a result of stock market volatility.
There is continued confidence in the market that M&A activity will remain robust in 2022.
Among the factors likely to drive and sustain M&A activity in the near-term are the release of Covid-19 vaccines and the easing of pandemic driven constraints, continuing low interest rates, the general availability of credit, the amount of capital to be invested by private equity firms, the Biden administration’s likely support for infrastructure and renewables investment, a recovery in oil prices and the continuing popularity of de-SPAC transactions.
Latham & Watkins
T: +1 212 906 1609
Robert Katz is a partner in the New York office of Latham & Watkins and a member of the firm’s global Mergers & Acquisitions Practice. He represents financial institutions, public companies and private equity sponsors and their financial advisers in their highest-stakes M&A transactions across geographies and industries, including industrials, healthcare, technology, and media and communications.
Robert’s practice includes cross-border transactions, governance matters, joint ventures, leveraged buyouts, public and private acquisitions and divestitures, spin-offs, takeover and activist defence strategies and tender and exchange offers.
Latham & Watkins
T: +1 212 418 7625
Charles Ruck is a partner in the New York and Orange County offices of Latham & Watkins and serves as global chair of the firm’s corporate department.
Charles’s practice includes advising on M&A, capital markets, and general corporate and securities matters. He serves as primary outside counsel to a number of public and privately held companies and he often represents boards of directors and special committees in complex strategic corporate governance matters.