Will mid-market tech M&A buck the trend in a downturn?
Snapshot
- 2023 is the year for transformative deals and could be one of the biggest opportunities for private buyers
- 2022 bucked the trend despite the many challenges the macroeconomic landscape faced
- Trends include the changing regulatory landscape, the growth of the workforce solutions market and unabated digital transformation – with data being an essential element, even in a market slowdown
Rising interest rates, high inflation, the war in Ukraine, an energy crisis, increased regulation of foreign investments, midterm elections in the US, Covid-19 shutdowns rocking the supply chain, wellbeing and working habit changes leading to workforce shortages is an extraordinary confluence of events and factors that has led to almost three years of market disruption.
In 2022, the economic "kitchen sink" was thrown by governments around the world, with sweeping effects from the local petrol station to the supermarket and from the public markets to M&A activity. It's no secret that 2022’s unpredictable landscape ended up negatively impacting technology start-up valuations and venture capital investment but what does 2022 leave in store for tech M&A activity in 2023? Many are cautiously optimistic for 2023.
Changing regulatory landscape
In the tech industry, the turnover of a company does not necessarily reflect the competitive relevance or even the potential of a company. There are plenty of examples of companies with little to no turnover that have a huge impact on a market or the potential to become game changers, which many merger control regimes have been expanded to address.
For example, Germany and Austria introduced transaction value thresholds so that transactions can be caught even if the target only generates minimal turnover. The European Commission has revitalised a referral regime that allows Member States to ask it to review a transaction although the national filing thresholds are not met if the transaction threatens to significantly affect competition in that Member State.
In an attempt to catch so-called "killer acquisitions", the EU's new Digital Markets Act explicitly refers to this referral mechanism. It requires designated "gatekeepers" to inform about any intended transactions that involve a provider of core platform services or any other services in the digital sector or that enable the collection of data, irrespective of whether the transaction triggers a filing with the Commission or in a Member State.
In addition, Member States have expanded and tightened their foreign direct investment (FDI) rules significantly in recent years. The authorities take a great interest in tech transactions and are growing increasingly critical; for transactions involving non-European investors (even indirectly), it has proven helpful for a smooth and swift process to address FDI early in the transaction process.
Data-driven opportunities
Data could be considered one of the most important raw materials of the 21st century and it has been one of the main drivers for M&A recently; it is likely to remain so for some time to come, even in a market slowdown.
Many of the most valuable companies in the world have a data-driven business model and effective use of data can be beneficial to companies in relation to increased production and productivity, improvement of manufacturing processes, development of new customer segments and the expansion of product ranges to include new innovative services.
While processes are likely to take longer with higher market caution, increased data tools will enable due diligence teams to target analysis of financial and customer data more precisely (even more key in a slower market) to create a business case and allocate valuation and consideration structure in a carefully considered way.
Companies and processes that are data driven can aid buyers in finding a safer place to invest their cash and help future-proof business models as digital transformation and data become increasingly central to our world.
Workforce solutions opportunities
Businesses are increasingly looking to contingent workforce solutions to address talent shortages and support global growth by accessing resource via talent platforms and utilising so-called employer of record (EOR) services. Used extensively by tech companies, in particular, in recent years to support international growth plans, EOR services offer a quick and apparently compliant solution to the complex challenge of how to employ and pay talent in countries where the buyer has no HR presence or knowledge of local employment, tax and social security laws. As a result, EOR services have experienced huge growth and attracted a lot of investment, something that is likely to continue with workforce shortages.
The legal landscape surrounding workforce solutions businesses is complex and legal reforms are almost as fast paced as the industry itself. The European Commission announced in December 2022 its intention to provide platform workers with employment protections, setting out proposals for a European directive that will deem all "digital platform" workers as employees of the platform unless it can be proven otherwise.
This will have a significant impact on platforms that engage gig workers on a self-employed basis unless they can prove that such arrangements are genuinely self-employed. As we have seen with some ride-hailing apps and delivery platforms, employment status has become a key area for the courts and legislators and, of course, this isn't just about the need to comply with local employment law – worker status also affects tax, VAT and social security status, each of which will increase operating risk and ultimately, cost to consumers of these services.
As for EOR services, they "sell" full compliance with local laws, but it can be unclear how compliant these models are. Use of an EOR can create a permanent establishment risk for user organisations and in certain European countries EOR services may be operating in breach of local regulations by conducting employee leasing without a licence.
However, despite these uncertainties and growing legal challenges, investment and growth in workforce solutions businesses looks set to continue as, for many buyers, they provide a desirable solution to a challenging circumstance.
Resilience and dry powder
Opportunities in resilient industries, critical sectors and lots of dry powder: are these the perfect ingredients for transformative deals in 2023? We think so. There is still likely to be plenty of eagerness from dealmakers in the tech mid-market in 2023, and the growing digital adoption of technology and growth of businesses with software and infrastructure technologies, such as 5G and metaverse access, should only aid this uptake. That in turn could lead to a consolidation among privately owned tech companies and a rebound in valuations – a welcome sign for growth companies and start-ups that had to abandon hope of exits or initial public offerings in 2022. 2023 could well be a year where many private buyers adopt an active M&A strategy despite an overall slowdown.
Authors
Josephine Healy-Russell, Lead author Senior Associate, UK josephine.healy@osborneclarke.com +44 207 105 7710
Sebastian Hack Partner, Germany sebastian.hack@osborneclarke.com +49 221 5108 4210
Frances Lewis Consultant, UK frances.lewis@osborneclarke.com +44 20 7105 7032
Julian Baldus Associate, Germany julian.baldus@osborneclarke.com +49 221 5108 4224
Marta Lao Lawyer, Spain marta.lao@osborneclarke.com +34 93 419 18 18
Björn Hürten Partner, Germany bjoern.huerten@osborneclarke.com +49 221 5108 4200
Shaziya Kurmani Associate Director, UK shaziya.kurmani@osborneclarke.com +44 20 7105 7588