PE firms’ acquisitions draw scrutiny on merger controls

Private equity firms need to keep in check with authorities for anti-competitive measures when making acquisition targets and combining them with existing portfolio companies.

Private equity firms have become industry giants, causing greater complexity over the years that has brought challenges on how to assess mergers. Today, large firms typically control many portfolio companies and tend to focus on investment in clusters or specific sectors. And that has drawn the scrutiny from regulators on anti-competitive concerns.

Usually, filing requirements requires a thorough assessment of the control structure of the fund to identify the relevant turnover for the merger filing analysis. However, CFOs must be aware of the complexities arising from the need to cover potential horizontal overlap and vertical links between the private equity portfolio companies and the targets.

An upfront merger filing analysis including the substantive review has become an essential part of the overall deal.

Transaction triggers

Transactions involving private equity firms often trigger merger control requirements because their turnover exceeds the relevant thresholds and there is a change of control of the target. To establish whether a competition authority has jurisdiction, turnover is totaled from the income of the PE firm and revenue generated by all its portfolio companies.

The PE firm could obtain sole control over a target by acquiring the entire capital, a majority interest, or a minority shareholding that confers veto rights over the target’s strategic decisions. Veto rights resulting in (negative) joint control relate to decisions on the target’s budgets, business plans, major investments or senior management appointments.

Joint control over the target can be acquired with another PE firm or institutional investor, existing shareholders or founders of the target. Acquiring joint control increases the likelihood of merger filing requirements, assessment of which is conducted on a case-by-case basis, particularly when the founders are still involved in the business. Even the acquisition of a minority stake without any controlling rights may trigger filings in EU member states (such as Germany) and in extra-EU jurisdictions.

The EU Commission’s Jurisdictional Notice provides guidance on transactions involving investment funds. As such, they tend to acquire shares and voting rights that confer control over portfolio companies in their capacity as mere investment vehicles. The investment company generally acquires at least indirect control over the portfolio companies held by the investment funds.

Different fund structures

Although the Jurisdictional Notice provides general guidance, the corporate structures that involve investment funds must be assessed on a case-by-case basis. Often, PE firms are organized through different funds and each of these funds controls several portfolio companies. By structuring each fund independently before competition authorities, private equity firms must carefully implement effective safeguards. This avoids any coordination and exchange of competitively sensitive information between the funds and portfolio companies controlled by the different funds.

State influence

Public sector organizations outside the EU have been known to establish investment funds by acquiring controlling stakes in European companies. Although legal, any link between fund managers and public authorities may raise questions about the possibility for the state to exercise decisive influence. Additionally, a public entity acting as a limited partner —   especially in cases with a large shareholding —  may raise questions as to the independent exercise of investment and strategic decisions. Analysis is needed to establish whether the investment fund should be viewed as a state-owned entity, to which merger control rules may apply.

EU developments

In October 2016, the EU Commission launched a consultation on procedural and jurisdictional aspects of EU merger control. For PE firms, there are two aspects worth noting:

  • The potential introduction of a deal-size threshold, complementary to the current turnover thresholds. A likely consequence this is that more transactions would be caught at EU level, resulting in additional burdens for PE firms, especially for those investing in technology businesses
  • The EU Commission is also considering extending the scope of application of the EU merger control simplified procedure. Broadening its application to transactions involving vertical relationships and acquisitions of joint control over a target with no activities within the EEA would reduce the burden on PE firms involved in transactions with no substantive issues. Parties acquiring control must notify the EU Commission and are subject to a standstill obligation barring them from implementing the transaction before clearance.

The EU Commission can impose fines of up to 10 percent of worldwide group turnover for intentional or negligent breaches. Competition authorities are cracking down on breaches of gun-jumping rules and the standstill obligation, so PE firms must carefully assess their filing obligations and obtain clearances prior to completing transactions. The Commission can impose fines of up to 1 percent of worldwide group turnover for supplying incorrect or misleading information in merger control filings, regardless of whether it impacts the Commission’s decision. Therefore, it is crucial for PE firms to ensure that information given by all parties involved in a transaction is accurate and complete.

Evolution

While the majority of transactions don’t present substantive issues, PE firms’ increasingly large portfolios may trigger competition issues. In the past, the absence of competition issues often gave an advantage to private equity buyers, but now, overlaps with other portfolio companies can give industrial bidders the advantage.

This evolution means PE firms must assess horizontal overlaps and vertical links between the target and the portfolio companies. Where the firm controls many companies active in the sector of the transaction, the data-gathering process may prove burdensome. Moreover, if the firm is contemplating joint control, the assessment must extend to the co-investor’s activities and portfolio too.

Therefore, CFOs must conduct analysis upfront and allow early stage remedies to be proposed. Competition authorities usually welcome informal remedies and discussions during the early stages. Such discussions increase the chances of obtaining conditional clearance in Phase I and mitigate the risk of Phase II investigations. Negotiating a remedy package in Phase II may also increase the risk for PE firms of having to divest certain assets, or an entire business, under time pressure and with limited bargaining power.

Ultimately, firms need to take a more strategic approach to merger control. CFOs must be pro-active in conducting analysis before initiating a transaction. A good understanding of filing requirements and substantive issues is crucial in addressing issues upfront, to avoid lengthy Phase II investigations and allow transactions to close without undue delay.

Pontus Lindfelt is a partner in the global antitrust and competition practice at global law firm White & Case.