Although traditionally considered a roadblock for strategic buyers, antitrust regulators have increased their scrutiny of private equity deals in recent years. "Merger control" - the competition/antitrust review of M&A transactions - has become a critical element of successfully completing PE transactions. This bulletin shares insights from experienced PE and antitrust counsel who have collectively closed hundreds of PE deals in Canada.
- Is This Deal the First of Many?
Canny PE investors will often identify an industry or vertical in which attractive returns can be achieved through consolidation. The investment strategy may contemplate a series of acquisitions over the short- to mid-term, in order to build sufficient scale and efficiencies to generate a meaningful profit on exit. In these scenarios, it is understood from the outset that the first acquisition will likely not be the last.
Care must therefore be taken from the outset to develop credible and sustainable arguments around market definition, entry barriers, effective remaining competition, and efficiencies that will serve the final acquisition of a consolidation strategy as ably as the first. Consistency is critical - in subsequent merger reviews, the Canadian Competition Bureau will try to hold the buyer to the arguments it presented in prior merger reviews. Changing position on these key issues in later deals will harm the buyer's credibility with the regulator, and may create vulnerabilities if an acquisition is litigated before the courts or the Canadian Competition Tribunal.
With each bolt-on transaction, the PE buyer's market share will increase, the market will become more consolidated, and the antitrust risk will therefore rise. These factors should be considered when the investor is planning its exit timing.
- Limit the Purple Prose
Most PE investors will be well familiar with the U.S. merger control regime under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR"). Canada's regime, modelled on HSR, requires merging parties to provide a substantial volume of customer and supplier data with their merger notification filings. Additionally, parties are required to provide HSR-style "4(c)" documents, which are records prepared for or received by an officer or director that assess any of a range of qualitative factors (e.g., market shares, competition, competitors, markets, potential for sales growth, or expansion into new products or geographic regions).
These record productions are often the first stop of the Competition Bureau team reviewing a transaction. PE investors should exercise caution - and restraint - when preparing documents (including substantive emails) analyzing a proposed acquisition. They should avoid commenting on issues with particular significance to antitrust review, such as the definition (and particularly the narrowness) of potential geographic or product markets, either party's "dominance" in any "market", barriers to entry, or the ability to exercise market power (e.g., by increasing prices, reducing output, or unilaterally imposing key terms on customers or suppliers) post-transaction. Colourful language - "we will destroy the competition" or "customers will have no other option" - should also be avoided.
Resiling from such statements during the course of a merger review is difficult, and one can expect that such documents may feature prominently as "Exhibit A" in any challenged transaction.
This caveat applies with equal or greater force to PE investors divesting a portfolio company. Care and prudence should be taken in the preparation of confidential information memoranda. Notwithstanding the obvious desire to effectively market the company, some comments are best avoided in writing.
- How Much Confidentiality Is Too Much?
Pre-announcement, and occasionally pre-closing, confidentiality is an important consideration in virtually every PE transaction. However, for bolt-on acquisitions where a fund is already active in a sector, the knowledge and expertise of one's existing portfolio company(ies) in the sector may be invaluable. There may be value in bringing a select few members of management "under the tent" for a bolt-on deal.
First, management of an in-sector portfolio company are an excellent source of critical information - they will know the relevant market(s), the players, and the competitive conditions best. They will likely have a sense of how customers and suppliers will react to the new transaction. As the Competition Bureau conducts extensive market contacts, interviewing the parties' largest customers and suppliers, having a preview of their likely reaction can help to shape the antitrust strategy. The views of these marketplace participants exert significant influence on the Competition Bureau review team.
Even at a minimum, a high-level "no names" discussion with existing portfolio company management may provide valuable information about competitive conditions and give PE investors a better sense of the antitrust risk to the deal, which can inform a range of key elements of any purchase agreement (including risk-sharing provisions, timelines and long-stop dates, potential hell-or-high-water clauses, and cooperation covenants).
Second, the Canadian merger notification filing requires substantially more information than an HSR filing, including data concerning the top 20 customers and top 20 suppliers for any "principal category of products" which overlaps with the target's operations. Such granular data may need to be obtained at the portfolio company level in any case.
Third, where a transaction raises material competitive overlaps, the Competition Bureau review will typically involve one or more voluntary Requests for Information to the merging parties. Failure to answer such requests in a timely way may lead to a "pausing" of the service standard timeline for completing the review. Transactions raising serious concerns may be put into a Phase II review through the issuance of a Supplementary Information Request (akin to an HSR Second Request). Timely compliance with such information requests will often require the assistance - and preferably the willing and enthusiastic assistance - of the existing portfolio company.
- Questions, and More Questions, About Minority Shareholdings
Several years ago, a theme emerged among antitrust academics that questioned the role and impact of institutional investors with multiple minority shareholding investments in the same sector. The Competition Bureau has enthusiastically taken up this cause, and now routinely asks PE funds questions about minority shareholdings, including information concerning: (1) any 10% or greater direct or indirect shareholders in the fund; and (2) any 10% or greater direct or indirect downstream shareholdings of the fund. Once the Competition Bureau has information concerning these individuals/entities, further questions may arise concerning any 10% or greater interest held by these individuals/entities in any entity that competes with the target.
Where there are such overlapping minority investments, further information (including customer and/or supplier information) may be requested from those entities. Answering these questions can be a challenge for a minority investor with no role in the day-to-day operation of the business. Moreover, the majority shareholder may not wish to provide such confidential information, leading to delays in the Competition Bureau's review and possibly a "pausing" of the Bureau's service standard.
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