Stricter federal antitrust reviews pose added risks for VC-backed M&A exits

The effect of more careful antitrust reviews will likely cascade through the investment chain and affect valuations and willingness to do deals.

Stricter review of proposed deals by the Federal Trade Commission and Department of Justice is expected to slow deals involving VC-backed companies and could put deals in greater jeopardy of not closing, according to a partner at law firm Wiggin and Dana, which advises on such deals.

US antitrust laws require that companies file a pre-merger notification to both agencies for any proposed transaction valued at more than $101 million. The purpose of the filing is to ensure the deal won’t harm competition and have an adverse impact on customers.

Last July, an executive order by President Joe Biden articulated a broader “whole-of-government” approach to preserving competition. The order directed antitrust agencies like the FTC to step up enforcement to prevent increases in consumer prices and competitive harm in labor markets, among other ways to preserve competition.

While venture-backed M&A deals typically involve smaller, less mature companies than private equity deals, they can’t help but be similarly affected by the stricter rules, said Paul Hughes, a partner at Wiggin and co-chair of its emerging companies and venture capital practice.

“It already is having an effect on deals on the ground,” he told Venture Capital Journal. “The increased costs and delays add uncertainty and risk to deals and they’ll affect deals at the market.”

Healthcare and technology are the sectors of greatest interest to the FTC and DOJ, but the agencies are paying close attention to any highly consolidated sector, Hughes noted.

The downturn in public markets caused IPO exits for VC-backed companies to all but dry up in the first half of 2022, making M&A exits more desirable. But public market volatility has also taken a toll on venture-backed mergers, which were down 11 to 30 percent in 1H 2022 from a quarterly average of 290 in 2021, according to VCJ’s analysis of PitchBook’s latest exit data. Acquisitions were more stable but were skewed toward smaller and earlier-stage deals.

Cash-out deals are still closing amid plenty of M&A activity, but the deals are going slower. This is causing HSR filings to be done earlier in the process, based off a non-binding Letter of Intent instead of a definitive, binding purchase agreement, adding more risk to proposed deals, Hughes said.

Once an HSR is filed, it becomes discoverable and ultimately gets published in the federal register. Making a deal public before it’s binding entails heightened risk.

If a deal doesn’t close, “now everyone knows you were for sale and that it didn’t close, [which] makes them question why. You could be damaged goods,” Hughes said. M&A sponsors are also rethinking whether they’re willing to spend up to hundreds of thousands of dollars to gather the information needed for an HSR filing when it’s uncertain if the deal will close.

Last year, Wiggin filed a notification for a venture-backed deal valued at $115 million off an LOI with a 30-day window and didn’t ask for early termination because the FTC had already announced it was no longer doing that, Hughes said.

“[Wiggin] planned the 30 days into our deal. And very late in the process they came back and basically informally said, ‘We need you to fold your filing and refile so we can give it its due. And if you don’t that, we’ll issue a second request,’ which is a very onerous request,” said Hughes. “So we picked our poison and folded and refiled, which restarted the clock, which meant another 30 days to get the deal done.”

A second request within 30 days typically triggers a full-blown investigation by the commission, which can last between three months and a year and is viewed by lawyers advising on such deals as drawn-out and burdensome, according to an earlier report from affiliate publication Buyouts.

Wiggin had advised on a similar deal in the same industry a decade ago, which resulted in no review and early termination by the FTC.

Downward dug

With last year’s deal, however, the FTC “dug down to the level of the effect of the deal on hiring within the geography,” Hughes said. Although the agency was satisfied with Wiggin’s accounting of the consumer-related issues, it “still wanted data on hiring practices to know that we wouldn’t be the only hirer in town, which would have a downward effect on wages. So that’s a change.”

Although the transaction ultimately was approved and the deal closed, it took 45 days longer than planned, Hughes noted.

The pace of FTC reviews has been hindered by the new regulatory approach and a sharp increase in HSR filings, as well as staffing constraints. Fiscal year 2021 saw more than 3,500 filings, up 59 percent from 2,200 in 2007, which represented the next highest volume, said Jonathan Kanter, assistant attorney-general of the DoJ’s Antitrust Division, in a January 24, 2022 speech. Not only does the pace of filings show no signs of slowing, but the Antitrust Division has more than 350 fewer employees now than it did 43 years ago, he said.

The stricter HSR process is of greater concern now than it would have been a year ago, when market conditions were more robust, Hughes said.

“It’s an added risk in a deal among many, but deals are more precarious now. Dislocations in the market generally are making deal volume [go] down,” he said. “That reflects lower risk-taking behavior on the buy side. So this is an increased risk in a risky environment versus an increased risk a year ago in a low-risk environment.”