2023 was a reasonably subdued year for M&A activity in the UK, but how is 2024 looking? In this newsletter we will look at the current corporate environment and any trends that are becoming evident.
How is the market generally?
The challenges faced in 2023 remain largely consistent in 2024. Inflation may be easing but it is still a factor in pricing and forecasting. Geo-political tensions continue to cause some international buyers to adopt a more cautious approach, although this has less of an effect in the more domestic M&A market. Investors looking at the UK as a self-contained market are certainly less concerned by the war in Ukraine or the risk of a change in government in the US.
The London Stock Exchange is not seen as the automatic destination for listing of UK companies. This is largely due to the increased valuations that can be achieved in the US capital markets. However, with increased valuations comes increased risk and the recent collapse of Cazoo, together with a number of UK companies listed in the US not trading significantly above (or even at) the initial listing price, indicates that an initial higher valuation may not always be good for long term growth.
Is the M&A activity restricted to listed company transactions?
The UK has two public markets, the Main List on the London Stock Exchange (LSE) and the LSE’s junior market AIM (Alternative Investment Market). Corporate activity on these markets generally takes the form of listings or IPOs (initial public offerings), when a company first lists its shares and offers new shares to the public, secondary share issues, takeovers and public-to-private transactions (where a company delists, often after a sale).
However, private M&A deals have always been a fundamental driver of UK activity and are significantly more numerous than public transactions, albeit at transaction values that range from very large to very small. Private M&A deals are ones that relate to companies that are not listed but may nonetheless be substantial international businesses.
How is the purchase price in private M&A being structured?
The majority of private M&A deal prices include a price adjustment mechanism. The two most common ones are completion accounts and locked-box mechanisms.
In a completion accounts mechanism, the parties agree a provisional purchase price based on what they believe to be the value of the target company at completion. Completion accounts are then drawn up to confirm the accuracy, or otherwise, of the provisional price. To the extent the provisional price is incorrect, an adjustment is then made to the purchase price. Often, an amount of the purchase price is retained pending sign off of the completion accounts, to reflect what the parties accept may be a reasonable amount of the adjustment.
A locked box mechanism, on the other hand, is an agreement by the parties of the final purchase price based on the latest audited accounts with no post-completion adjustment. However, the buyer seeks comfort on the agreed value by seeking an indemnity for any leakage or extraction of value in the period from the last accounts date to the date of sale.
What about earn outs?
Earn outs in M&A deals are a further means of a purchase price adjustment. Often, they are based on the target company’s EBITDA. EBITDA is a measure of a company’s profitability that shows earnings before interest, tax, depreciation and amortisation.
Earn outs are often linked to the target company’s post deal EBITDA. In other words, if certain EBITDA targets are met, then a further amount of purchase price is paid. These are often used in high growth companies, where the seller wants a higher price to reflect where the company will be in the next 12 or 24 months but a buyer is reluctant to pay a price based on potential future value.
Has the National Security and Investment Act 2021 (NSI Act) made a difference?
The NSI Act empowers the secretary of state to screen a broad range of transactions on national security grounds and allows them to block or impose conditions on deals. This relates to 17 sensitive areas of the economy, such as defence and critical infrastructure. Since coming into force in 2022, the UK government has reviewed over 1,700 notifications and made 20 final orders under the NSI Act to protect national security in the UK.
Under the NSI Act, 93% of notified transactions were approved within the initial 30-working-day review period (according to the UK government’s most recent annual report), but dealmakers must now routinely factor in potential NSI Act processes at the early stage (particularly if national security concerns are foreseeable).
The UK Government has recently carried out a consultation on the impact of the NSI Act and we are expecting updated guidance on its application shortly. This is likely to cover the types of transactions to which the regulations apply and transactions in the academic and research areas. We also expect further guidance on the sensitive sectors that are subject to the regulations.
How 3CS can help
Our team of corporate and commercial lawyers and consultants have both domestic and international expertise and offer a full range of corporate and commercial legal services. If you need any assistance or have any other questions in relation to M&A, please get in touch with your usual 3CS contact.
