Will tech M&A and venture capital investment return with a bang in 2021?
There are reasons for optimism that M&A and VC activity will hold up in the tech sector, although tax, regulatory and economic factors could affect transactions. In the face of extreme disruption in all areas of life, the private equity (PE) and venture capital (VC) investment and merger and acquisitions (M&A) dealmaking has remained strong in the technology, media and communications (TMC) sectors. While the pandemic has had an impact on certain aspects of deals – with parties agreeing how best to allocate the new and emerging risks between themselves – transactions otherwise continued on familiar terms. Deal teams and their advisers also largely adapted to managing transaction processes effectively while working remotely. The absence of in-person interactions meant more effort and time was needed to establish the strong personal connections that drive deals and which provide the basis for collaborative negotiations in later phases. Looking at the year ahead, we see a number of emerging trends and issues:
The return of IPOs
Over the past two years, public listings have become an increasingly viable option for TMC businesses, as equity capital markets investors increasingly look to the technology and innovation sectors for growth. While Europe has lagged behind the US in this respect, the success of recent initial public offerings, such as The Hut Group in the UK, suggests that more technology businesses will look to go public in the coming year. Market sentiment will have a significant influence on whether this trend continues, and the ongoing uncertainty of the pandemic and, in the UK, Brexit may cool things again in the coming months.
Deploying private equity "dry powder"
PE buyers have been a familiar feature of technology M&A in recent years. The pace at which PE investors made new acquisitions fell off noticeably during the initial months of the pandemic as investors focused on stablishing their portfolios. In recent months, however, PE investors have returned to the fray and are very active again. We expect this trend to continue in 2021 as funds fulfil their mandates to deploy "dry powder".
Venture capital backed investments and exits
Venture capital funds continued to invest in technology-driven businesses throughout the pandemic. During the initial phase, term sheets issued to start-ups with business models adversely affected by the pandemic – in sectors such as travel – were withdrawn and valuations of such companies suffered. As the year went on, large VC funds' closings, even larger public Covid-related investment facilities and the tailwinds of the pandemic for digital business models (particularly e-commerce businesses) supported high levels of VC activity and exits of VC-backed growth companies. In the coming year, we expect to see the number of larger, late-stage growth funding rounds in Europe continue to rise. VC funds will also drive M&A activity as they exit investments made during the wave of activity between 2010 and 2015 and return capital to their investors.
Due diligence, sustainability and diversity
As businesses focus more on sustainability and the social impact of their activities, we expect to see increased due diligence by VC and PE investors on environmental, social and corporate governance (ESG) policies, as well as diversity and inclusion (D&I) data, of their target companies. ESG and D&I as part of a fund's decision-making will not be limited to the growing number of impact investing funds, but will become a mainstream focus, particularly as more funds start to report and self-assess in this area.
Foreign investment concerns
In November 2020, the UK government caught up with many other Western governments by introducing the National Security and Investment Bill. This legislation will allow it to review and block acquisitions and material investments in companies and assets in areas of strategic importance. These include technology such as artificial intelligence, autonomous robotics, computing hardware, cryptographic authentication, advanced materials and quantum technologies. There are no turnover or share of supply thresholds, meaning that it will become far more common for venture and M&A transactions involving tech companies to be notified for review. This will need to be factored into deal timetables and will add an additional consideration from an execution-risk perspective. We expect a similar trend across Europe, as the EU's framework for screening foreign direct investment became fully operational in October 2020.
Taxes, taxes, taxes
It is widely expected that governments across Europe will increase tax rates this year in order to start paying for some of the unprecedented level of state support provided to their economies in response to the Covid-19 pandemic. In particular, capital gains tax rates are expected to rise. This may be a catalyst for both individual tech entrepreneurs and their institutional investors (where the favourable tax treatment of "carried interest" looks set to change), to pursue an early exit for their companies. As such, there may be a surge of M&A activity in the first part of the year before tax rate rises come into effect.