For those involved with the UK’s high-growth tech sector, 2021 was a stellar year and one of the busiest years in recent memory. The latest Government figures show that over £30 billion was raised by the sector with the vast majority of that cash flowing in from US investors: over 37% of funds came from across the pond, dwarfing even the 28% raised from domestic sources. Data from specialist growth company analysts, Beauhurst, also reflect the official figures showing that in 2021 US acquisitions of UK tech companies increased by 50% from 2020 to a total of 130. The previous record of 105 was achieved in 2018.
There is therefore no doubt in the current environment that founders and sellers reviewing exit and investment options should consider the likelihood of transacting with a Stateside buyer/investor. As is always the case with corporate transactions, it is crucially important to be as prepared and as knowledgeable as possible before any negotiations begin.
Governing Law – Which is best and how to chose?
English law and US law (often Delaware) are the two predominant laws for cross-boarder M&A transactions but there are some fundamental differences in approach that will impact on how the transaction is structured. Being aware of these and in particular being aware of buyer expectations can help smooth the transaction process and avoid the chances of a failed transaction.
In the US, acquisitions are often structured as a legal merger of the buyer (or a newly incorporated acquisition vehicle) and the target entity. This concept does not exist under English law (despite the term of ‘Mergers & Acquisitions’ or ‘M&A’ being generally used). In the UK, transactions are therefore structured as a sale of all the assets and business of the target company or, more commonly, a sale of the shares by all of the shareholders of the target.
Liability Caps
One other material difference in approach for US transactions is that the overall liability cap that the sellers incur can be far lower than in the UK. In the UK the overall limit on liability that sellers agree to under the purchase agreement tends to be higher. In the USA it is common practice for this to be much lower – nearer 20% of the purchase price or even less. One of the reasons for this is the prevalence of warranty & indemnity insurance in US transactions (more of which below). However, these thresholds tend to be hotly negotiated on each transaction.
There are also some more technical aspects that reflect the difference in approach between the jurisdictions. These include the different basis of calculating damages for a claim under the warranties in the purchase agreement – in the US these tend to be calculated on an indemnity basis (seen as more buyer friendly) which is not common in the UK. The disclosure process in the UK can be wider giving sellers greater opportunity to disclose against the warranties in the purchase agreement (seen as more seller friendly). For example, it is sometimes (although by no means always) the case that the whole contents of a data room can be disclosed against the warranties.
As can be seen each jurisdiction has its advantages and disadvantages over the other in different areas and, as ever, the bargaining strength of the respective parties tends to be the main driver as to which jurisdiction is chosen.
Warranty & Indemnity Insurance
A growing trend in both markets is the increasing use of warranty & indemnity insurance (W&I insurance) which provides insurance cover to buyers and/or sellers (although usually buyers) in relation to losses arising on a breach of warranty or indemnity under the purchase agreement. However, as with all insurance policies, the exclusions need to be carefully reviewed – known matters, for example, will be excluded. Although the UK market is catching up, the US market has been perceived as more sophisticated meaning, in most cases, there tend to be fewer exclusions under the policy. This does mean that premiums in the US tend to be higher. Parties should also bear in mind the overall cost of the policy as this can be high.
If W&I insurance is being considered this should be established early in the transaction process as underwriters tend to have certain specific areas that they require covered in the due diligence process and require a full due diligence process to have taken place.
Data Transfers and GDPR
Tech businesses are often heavy users of personal data. One point that will need to be considered at the very outset of the process is the impact of GDPR on the transaction, in particular if personal data is being transferred into the US at an early stage of negotiations or as part of the due diligence process. The transfer of personal data to the US without appropriate safeguards and contractual agreements (containing the standard contractual clauses required by the GDPR) can constitute a breach of GDPR opening up the target business (which following completion of the acquisition will form part of the buyer group) to the draconian regulatory penalties that such breach may incur.
New UK Government Powers to Scrutinise Transactions
The new National Security and Investment Act came into full effect in January 2022. This Act establishes a new regime for UK Government scrutiny and approval of acquisitions (and investments) that, amongst other things, result in the acquisition of more than 25% of the shares or votes of companies operating in certain sectors. The applicable sectors for tech companies include advanced robotics, artificial intelligence, computing hardware and data infrastructure. The sanctions for failure to comply with the new regime include that the transaction can be unwound.
Maximising Exit Value
As with any M&A transaction or investment, a deal with an US buyer will have its own issues that will need to be addressed through the process but the fundamentals remain for any founder of a tech business: exit value must be maximised. Ensure that the business is in good order and, in particular, ensure that the underlying IP is held by the target (and that this can be demonstrated by the company’s records and agreements), data protection policies and procedures are in place and are robust, and the target’s share capital is clean and filings are up to date.
For further information
Richard Pull is a partner in Goodman Derrick’s corporate team, representing clients on the full range of corporate M&A and capital markets transactions. Amongst other things, Richard has recently acted for Nasdaq listed Digimarc Corporation on its acquisition of UK software company, EVRYTHNG for a consideration of up to US$100 million in Digimarc stock, privacy tech start up Pimloc on its $7.5m funding round led by Zetta Venture Partners and for a North American based family office on its equity investment into a computing company as part of a US$45m funding round. Richard’s biography is available here. He can be reached on +44 (0)7788 340 797 and at rpull@gdlaw.co.uk.
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