2022 has set certain trends in the structure of M&A transactions in the IT industry, and 2023 continues to follow them. Lawyers of the M&A in IT practice of REVERA law group have analyzed more than 30 M&A transactions made in the IT industry in 2022 and inferred several patterns that, in their opinion, will form the trends in IT M&A transactions this year.

Target is a group of companies

The transactions of 2022 showed that, more and more often, a target is not a single legal entity but a group of interconnected companies located in different jurisdictions and performing various functions within a single business. Usually, there may be:
(a) R&D centre
(b) Sales offices
(c) A company holding intellectual property rights
(d) And a general holding company.

It is also a common solution to create two branches within one business: B2B (which works with other businesses) and B2C (which works with end customers).

Accordingly, in M&A, purchasers usually acquire the entire group of interconnected companies. Combinations of connections in the group are very different: it can be a parent company, as well as several subsidiaries or sister companies (that is, companies with the identical composition of participants). Such connections are structured in each case individually, based on the needs of the business.

In most cases, such an extended target also means that the team is located in different countries. The founders, top management, and other specialists involved in the transaction are often located in different places and even different time zones.

As a result, the structure of M&A transactions becomes more complicated, and the timeframes for due diligence and document drafting are extended. Furthermore, since the companies are located in different countries, it is necessary to involve local lawyers. They will perform due diligence on the companies, as well as check the transaction documents for compliance with local laws and prepare the necessary corporate resolutions. Therefore, the costs of conducting M&A transactions for the client are increasing. In addition, the timeframes of M&A extend because it takes time to find local lawyers, and pass their onboarding procedures and conflict of interest check.

In such transactions which involve different jurisdictions and teams of lawyers, there shall be a leading counsel who coordinates the work of consultants from all jurisdictions because, usually, clients do not communicate directly with local lawyers. Leading counsels are responsible for the transaction at the global level: they engage local contractors, monitor compliance with deadlines by all involved persons, check the connections between the companies of the group, communicate with contractors, accumulate the results of due diligence for different companies in order to provide the unified result to the client. That is, leading counsels become the entry point for all requests and wishes of the client, form a team, transmit the client's wishes to the persons involved (including foreign contractors), collect feedback, and communicate it back to the client.

The document preparation process also becomes more complicated since all the provisions that may affect all the companies of the group shall be considered carefully (their management, conclusion of contracts with clients, etc.). If there is a holding company, which in turn owns all the other companies of the group, then usually two documents suffice:
(a) First, a share purchase agreement or a share subscription agreement - depending on who the investor pays the money to (shareholders or the target company itself)
(b) Secondly, a shareholders agreement that will regulate all issues at the holding level.
If the group structure is more complex and there is no single holding company, then in this case it may be necessary to prepare several share purchase agreements (or share subscription agreements) and shareholders agreements for different companies of the group.

Co-investment

It has also become common in 2022 when not one investor participates in M&A transactions but several at once. Investors seek to rely not only on their evaluation of the prospects of the target but also on the expertise of other investors in the industry. This, to some extent, mitigates the risk of investing. In addition, co-investment reduces the size of the check per investor.

Co-investors operate in several forms: venture funds, investment companies, business angels, and strategic investors.

Investors can divide roles among themselves in different ways. For example, there may be one lead investor whose investment exceeds the investments of the others. In this case, the lead investor largely determines the terms of the entire transaction. He conducts due diligence himself, prepares drafts of transaction documents, and co-investors rely on his expertise. There are also such transactions where the positions of co-investors are more or less the same, they are equally involved in the process, so it is impossible to distinguish one lead investor from them.

Co-investment is one more reason why transaction documents become more complicated. There are more interested parties with their opinions and positions which need to be considered in negotiations and then reflected in the transaction documents. In such cases, it is necessary to approach the drafting very carefully, clearly specify the rights and obligations of all parties, determine their degree of influence on the business, and consider whether the rights are exercised collectively or individually.

Strict bank compliance

The bank compliance requirements and the KYC (Know Your Client) procedures are getting stricter. Compliance can last for an extended period since banks regularly make additional requests, which are time-consuming as they require providing many documents and information.

Usually, in M&A transactions, the clients need to undergo bank compliance in the following cases:
(a) When an account for a new company is opened (for instance, when the new holding company is registered in which the investor will enter)
(b) When an investor enters the company
Any change of shareholders or beneficial owners in the company (including the entry of an investor) entails a new round of bank compliance. The bank will conduct a verification check of the new shareholders up to the ultimate beneficial owners.
(c) When sending investment, that is - when the investor pays for the acquired shares
Now such operations are also subject to close attention on behalf of the banks. It may take several weeks for the payment to be delivered because it will undergo bank compliance from the sending bank, correspondent banks, and the receiving bank. Thus, a delay can happen at any of these stages.

So that bank compliance does not slow down the work on the project greatly, it is worth starting it in advance:
(a) For example, while the investor has not yet become a shareholder of the company, the company can explain to the bank in advance that it plans to attract investments. In parallel, while, for example, an investor conducts due diligence or negotiates transaction documents, the bank will request documents for the investor and will conduct its KYC. This way, the process can be sped up.
(b) The same applies to sending payments. Before sending the investment, the investor can show the bank the contract under which he plans to make the payment and ascertain with the bank whether he will be able to make such a payment. This should also be done in advance, and not near the deadline for sending the payment. The bank will conduct its compliance procedures, request the necessary documents and give an answer. In case of denial, there will be time to consider and find alternatives.
(c) In alternative to the banks, it is possible to use different payment systems. As a rule, they have less strict compliance standards, so passing them is easier and faster. Another alternative to a bank account can be crypto exchanges and crypto wallets if investments are attracted in the form of cryptocurrencies.

Deferred entry into the company or investing

Investors are not always ready to enter a business immediately because they are not yet sure of its success. Before becoming a full-fledged shareholders, they want to ensure that the startup will be profitable. For such purposes, a convertible loan mechanism is used in transactions.

With a convertible loan, the investor provides financing and secures his right to become a shareholder in the future (when he decides to convert the company's debt into shares in its share capital). At the same time, the investor has a time range when he can observe the company and its development. Alternatively, the investor can demand repayment of the loan if he decides not to enter the startup.

Even if a standard mechanism is used in the transaction and the investor acquires shares immediately, without deferrals, the investment amount is often not provided in full. Instead, it is divided into several tranches, which are paid when certain KPIs are met. That is, investors play it safe and do not provide all the financing at once.

To sum up, the M&A transactions of 2022 have established their specifics and these patterns, most likely, will be relevant in 2023.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.