Lexology GTDT Market Intelligence provides a unique perspective on evolving legal and regulatory landscapes. This interview is taken from the M&A volume featuring discussion and analysis of legal developments, keynote deals as well as an insight into typical transactions within key jurisdictions worldwide.

1 What trends are you seeing in overall activity levels for mergers and acquisitions in your jurisdiction during the past year or so?

The German mergers and acquisitions market seems to be back in full swing after the first year of covid-19 in 2020. In fact, in 2021, Germany is expected to have the highest growth of mergers and acquisitions in Europe. In the first half of 2021, the number of transactions with German participation increased by more than 60 per cent compared to the same period last year. Even compared to the first half of 2019 there has been a significant uptrend. This does not just seem to be a catch-up effect; we believe the strong momentum will be maintained.

Nevertheless, the pandemic has left its negative and positive marks. On the positive side, the demand for digital solutions in all areas of life is reflected in an increased number of M&A transactions in the technology and IT sector. For many companies, the opportunities and challenges associated with digitisation are catalysts for mergers and acquisitions. For some German small- or medium-sized companies, for example, technology transfer is a tried-and-tested means of compensation for lack of digital expertise. We continue to observe steadily growing participation of private equity firms in German M&A transactions. While strategic investors are still involved in the majority of these transactions, most of the larger transactions in the recent past involved private equity groups, either as sellers or buyers, or at least as part of the bidder universe. There is still a lot of equity from financial sponsors that must be invested, combined with ongoing cheap debt capital. The continuing zero-interest-rate policy of central banks will extend this development. Private equity also plays an important role for German medium-sized companies. For owners of profitable medium-sized companies, the window for a successful company sale on attractive terms will remain wide open in the coming months.

In the venture capital space, we are currently seeing a sharp increase of large volume financing rounds with extremely high valuations of German technology companies. In June 2021, Celonis SE closed a series D financing round of €1 billion against a post-money valuation of more than €10 billion. Correspondingly, and in line with developments in the United States, there is an increasing number of special purpose acquisition companies (SPACs) looking out for targets to invest in de-SPACing transactions. Last but not least, in the wake of the covid-19 crisis, there has been a spike in carve-out and spin-off transactions in Germany.

2 Which sectors have been particularly active or stagnant? What are the underlying reasons for these activity levels? What size are typical transactions?

The M&A market is in full recovery mode in almost all sectors. Strengthened by the high liquidity on the stock exchanges, the technology, media and telecommunications sector was the driving force behind M&A activity in the first half of 2021. Deals in this sector were driven by financing rounds, which ensured unprecedented growth and record valuations for many young companies. Trade Republic, for example, raised one of the biggest Fintech C-rounds in European history after securing US$750 million in fresh funding in May 2021 at a valuation of US$5.3 billion.

The second strongest sector was mechanical engineering, followed by healthcare as the third strongest industry in the recent boom of M&A. The business support services sector, which includes, for example, personnel service providers, cleaning companies and facility managers, was the weakest segment in the first half of the year. These segments offered the most savings potential in the pandemic, which weakened demand considerably and was also reflected in valuations. Compared to the same period last year, this sector was perhaps the only sector with a decline in absolute number of transactions.

3 What were the recent keynote deals? What made them so significant?

Vonovia’s takeover of Deutsche Wohnen SE will probably be the largest single transaction by far in Germany this year, with a volume of approximately €17.9 billion. After Vonovia had narrowly failed in its initial takeover bid in July to meet the minimum acceptance threshold of 50 per cent, it has now waived all offer conditions, including the minimum acceptance threshold. Osram Licht AG, in which the much smaller Austrian technology group AMS had already secured a majority stake in 2019, has now been swallowed and delisted from the stock exchange through a successful delisting offer. AMS is said to have put up €1.38 billion for the transaction. The company will operate under the joint name AMS Osram.

Apart from this, transactions involving private equity investors have been characterised as having great momentum in 2021. Major transactions involving German targets include, for example, the takeover of eyewear manufacturer Rodenstock by British financial investor Apax Partners SAS for €1.5 billion. Interestingly, SPACs now also play a role in German M&A. For example, Munich-based electric aircraft manufacturer Lilium merged with US shell company Quell Acquisition Corporation and is thereby listed on the NASDAQ. Also, through a de-SPACing transaction, Berlin based Signa Sports United, the global leader in sports e-commerce, went public in the largest listing of a German-speaking company on the NYSE in years.

4 In your experience, what consideration do shareholders in a target tend to prefer? Are mergers and acquisitions in your jurisdiction primarily cash or share transactions? Are shareholders generally willing to accept shares issued by a foreign acquirer?

In German private M&A, we rarely see sellers accept anything other than cash consideration. While the total cash payment is occasionally paid in full on closing, deferred payment schemes including escrows and holdbacks are more common. There also seems to be a renaissance of earn-out structures in an effort to bridge valuation gaps and pricing uncertainties caused by the ongoing covid-19 crisis. If shares form part of the consideration, we find that this is driven by unique circumstances, such as the desire to put in place a joint venture type structure.

From time to time, we come across stock-for-stock transactions in the public M&A arena. An exchange of shares in public companies is generally more attractive than an exchange of shares in closely held private companies. In Germany, the shares offered as consideration in a public takeover offer must be liquid securities admitted to trade on a regulated market in any EEA member state. While offering shares issued by a foreign bidder can help navigate the risks of shareholder challenges under German stock corporation law, this raises rather complex issues of legal equivalence between the foreign offer shares and the German target shares. Since the beginning of 2019, we are aware of three public M&A transactions that have been conducted by foreign bidders in the form of stock-for-stock acquisitions. For example, ZEAL Network SE, a European stock corporation then governed by English law, successfully offered its shares listed on the London Stock Exchange by way of exchange for the shares in German Lotto24 AG.

5 How has the legal and regulatory landscape for mergers and acquisitions changed during the past few years in your jurisdiction?

In Germany, there have been numerous changes to the legal and regulatory landscape for M&A in the past few years. Among the most noteworthy and most recent are the following.

Further to a number of revisions to the German foreign direct investment rules throughout 2020 (including a covid-19-related broadening of the scope of review, lowering the threshold to 10 per cent for mandatory reviews), 2021 saw yet another amendment to the German Foreign Trade and Payments Ordinance. The 17th amendment, which entered into force in May, completed the alignment with the EU Screening Regulation and further expanded the control intensity. The revised regulation expands the list of target activities, triggering a filing requirement and standstill obligation under the cross-sectoral review by another 16 sectors, including artificial intelligence, automated driving, aviation, biotechnology, cybersecurity, semiconductors and quantum mechanics. Following Brexit, the rules now also cover buyers from the United Kingdom, alongside all other non-EU and EFTA buyers.

There is now a 10 per cent threshold for mandatory filings for critical infrastructure and defence-related activities, whereas, for all other businesses, the relevant threshold for mandatory filings is set at 20 per cent.

Apart from mandatory filings, the new rules further authorise the authorities to review acquisitions of ‘atypical control’ of a German target (ie, acquisitions of voting rights below 25 per cent that are accompanied by specific rights or powers granted to the foreign investor).

On the competition law end, the 10th Amendment of the German Competition Act entered into force in early 2021. While the merger control thresholds have been substantially raised to relieve mid-sized companies from notifying transactions of minor economic importance, the German merger control authority may obligate a company, for a limited three-year-period, to notify every acquisition in a given industry, even if the domestic turnover thresholds are not met. The maximum duration of the Phase 2 review period has been extended from four months to five months.

Until 1 January 2021, distressed German companies wanting to restructure could only pursue the path of judicial insolvency (with or without self-administration) or seek an out-of-court settlement with their creditors, requiring the unanimous consent of all creditors. The Act on the Stabilisation and Restructuring Framework for Businesses (StaRUG) offers a new pre-insolvency restructuring proceeding with partial court involvement and the possibility of orders and regulations with binding effect for all affected creditors. In other European countries, such proceedings have long been established (such as the English scheme of arrangement). StaRUG can be expected to play an important role on future distressed M&A transactions in Germany, including in sectors directly affected by the covid-19 crisis such as aviation, industrials, sports, retail and leisure, tourism and hospitality.

6 Describe recent developments in the commercial landscape. Are buyers from outside your jurisdiction common?

Germany is often considered an extremely attractive jurisdiction for foreign direct investment. The country’s strengths traditionally comprise a powerful and diversified industrial network, a highly skilled workforce with a good command of English, reliable infrastructure, a favourable social climate, a strategic location at the heart of Europe and a stable legal framework. As a result, German companies in cross-border acquisitions have a long history of being favoured targets for investors across the globe, both on the strategic and the financial sponsor front. Although, owing to the covid-19 crisis, cross-border M&A diminished by more than 50 per cent in Q2 2020 compared with Q2 2019, German cross-border mergers and acquisitions are now extremely bullish.

In particular, transactions between Germany and the United States increased significantly in the first half of 2021. The change of administration in the United States at the beginning of the year made a positive contribution, as economic and policy events have become more predictable again. One of the larger transactions in Germany with US participation was the recent acquisition of the shoe manufacturer Birkenstock GmbH & Co KG by the French-American investment company L Catterton. Although there has been some appetite from Japanese investors in German targets over the past few years, the bulk of the M&A investments in Germany still come from the United States, the United Kingdom, the Netherlands and Luxembourg. Other significant players in German inbound M&A are from Switzerland, France, Italy, Belgium, Austria, Spain and Denmark.

Partly as a result of the covid-19 crisis, there is a strong continuing trend for large German listed companies with diversified portfolios to sell off or spin off entire divisions to focus on their core business. Recent examples include Continental AG’s September 2021 spin-off of its powertrain business, which is now separately listed and trading as Vitesco Technologies AG.

The commercial landscape will obviously be subject to major changes in the wake of the September elections for the German parliament. In the next few years, there will be a number of noteworthy legal and tax shifts after a 16-year era of relative continuity, which will, one way or another, influence the appetite for foreign direct investment into Germany.

7 Are shareholder activists part of the corporate scene? How have they influenced M&A?

In recent years, there have been many high-profile cases of shareholder activism in Germany, including thyssenkrupp AG divesting its elevator business upon initiatives taken by the hedge funds Cevian Capital and Elliott Management Corporation, and Active Ownership Capital initiating the restructuring of Stada Arzneimittel Aktiengesellschaft. As in many other jurisdictions, shareholder activism currently plays a role in Germany’s corporate scene, even though German-listed companies are traditionally more immune to shareholder activism than international companies by often having decisive shareholders and relatively low free float. Activists exert influence with regard to M&A matters in several respects, such as in connection with public takeovers when the activists buy shares to force the bidder to raise the offer price, a method used by Elliott in the context of Vodafone’s public takeover offer for the shares in Kabel Deutschland AG. In other cases, the activist investors push for specific acquisitions or divestitures of business lines by the listed companies in which they hold stakes. Only very recently, activist shareholder Enkraft Capital demanded that RWE AG divest of its brown coal business and focus solely on its renewable energies business. The newly permitted virtual general meetings may slightly curtail possibilities in Germany to take influence, especially if virtual general meetings will be permissible beyond the covid-19 crisis.

Take us through the typical stages of a transaction in your jurisdiction.

The phases of an M&A transaction in Germany largely conform to Anglo-American standards. Generally, everyone on the ground in Germany is comfortable with negotiating and documenting cross-border deals in English. In a bilateral deal, the parties frequently communicate with each other directly. Depending on the deal volume and company size, this can happen at all levels, including board level or the level of the internal business development teams. Financial advisers sometimes facilitate the initial contact and the overall process, especially when it comes to upper mid-cap or large M&A transactions. As a first legal document, the parties typically execute a non-disclosure agreement. Where parties are competitors, we are seeing an increasing trend to put in place clean team arrangements early on.

While the parties frequently prefer to initially summarise key terms of the envisaged transaction in heads of terms, others jump into the due diligence exercise and the negotiations of definitive agreements. By way of exception, we have also seen sales processes without any diligence review at all. This must be justified by the buyer’s board on a case-by-case basis and include measuring any advantages and disadvantages by applying the business judgement rule. Due diligence is now, in most cases, managed through virtual data rooms, and in larger international transactions with thousands of contracts, buyers increasingly apply legal technology tools to review the data efficiently.

The negotiation of the sale and purchase agreement often takes two to four rounds; however, we have also seen fast track negotiations and negotiations that have dragged on for several months. In Germany, the first sell-side draft of the sale and purchase agreement tends to be a little less ‘middle of the road’ than you would usually expect from a US or UK perspective. Before a deal can be signed, it is the seller’s job to prepare the disclosure schedules against the warranties – Germany’s answer to England’s disclosure letter. Originally used predominantly by private equity sellers, there are now more and more strategic deals that use warranty and indemnity (W&I) insurance. One German peculiarity is that the sale and purchase agreement must often be notarised, notably if the transaction involves the sale of shares in a limited liability company. Occasionally, foreign investors find it surprising that, in a notarisation, the documents must be entirely read by the notary in the presence of all the parties’ representatives. This exercise may take several hours or, at times, may be an ‘overnighter’ if the deal has not been finalised in all respects prior to the notarial session. Immediately after signing, the parties will focus on all regulatory clearances, which have to be obtained prior to closing. Similar to other jurisdictions, the German foreign direct investment control regulations have recently been enhanced. The practical significance of any foreign direct investment control clearance should, in these days of rising national protectionism, not be underestimated by investors from outside the European Union.

In an auction, a process letter will be provided with procedural guidance to all bidders. In preparation for auctions, German sellers often conduct a vendor due diligence review to provide all bidders up front with at least basic legal, tax and financial information on the target. Following the due diligence review – and sometimes subject to confirmatory due diligence – the bidders are asked to submit final bids, including a statement of the value they place on the equity and a mark-up of the sale and purchase agreement. Additionally, in German auctions, we frequently see ‘seller-buyer flip’ W&I insurance, where the seller begins to arrange for insurance with the preferred buyer, at some point in the process, then steps into the shoes of the seller to finalise the underwriting.

Public M&A transactions in Germany are, as in other jurisdictions, much more regulated than negotiated deals. It is customary to carry out substantially less due diligence. Notice periods and the prescribed contents of the offer document are set out in the German Securities Acquisition and Takeover Act.

8 Are there any legal or commercial changes anticipated in the near future that will materially affect practice or activity in your jurisdiction?

Following intense discussion, the German parliament passed the mandatory Supply Chain Due Diligence Act in June 2021. Scheduled to enter into force on 1 January 2023, companies will be under an obligation to ensure compliance with environmental protection and human rights in their national and international supply chains. This means that buyers in M&A transactions will have to increase their diligence efforts with respect to compliance with environmental, social and governance (ESG) criteria in future. Conversely, sellers will have to focus more on ESG-relevant facts and documenting compliance with ESG criteria when establishing exit readiness and preparing a sale.

The fallout from the pandemic – softened in 2020 by generous public financial support and regulatory leniency (eg, suspension of insolvency filing obligations) – will start to be felt in 2022, when the support measures run out. We expect to see more distressed M&A.

The overall outlook for M&A in 2022 and beyond is positive. Protection against foreign hostile takeovers involving core German patents and IP has high priority in several parties’ election manifestos, so a strict application of existing rules, some further amendments and tightening of foreign investment rules can be expected in the near future.

9 What does the future hold? What activity levels do you expect for the next year? Which sectors will be the most active? Do you foresee any particular geopolitical or macroeconomic developments that will affect deal sizes and activity?

At the end of last year, few would have expected the German M&A market to regain so much momentum, with a record number of transactions early in 2021. Entrepreneurs, corporations and investors have apparently become accustomed to a world with covid-19. Rising vaccination rates have boosted confidence and extensive fiscal measures have ensured that the German economy is recovering faster than expected. We firmly expect this trend to continue in 2022. As in 2021, increasing digitalisation, electrification and globalisation will be the significant drivers for M&A transactions in 2022. Although there are signs of slight inflationary pressure, which could have a longer-term impact on interest rates, for the time being, low interest rates will continue, which will encourage a willingness to invest. There will also continue to be huge cash reserves from private equity investors waiting to be deployed. On the part of large companies, the trend towards organisational restructuring and carve-outs will continue. Also, acquisitions will continue to be a key growth strategy for larger companies.

We are currently concerned about the continuing supply chain disruptions with sharply rising raw material and freight costs affecting important industrial precursors in Germany. The resulting shrinking value added in the manufacturing sector is putting a considerable damper on economic forecasts for Germany these days. The automotive industry, in particular, has suffered from the continuing chip shortage.

In terms of sectors, we expect that technology, healthcare and med-tech will continue to see high acquisition activity. In contrast, the travel industry and retail will be under pressure and subject to consolidation, which means that smaller businesses may continue to have a hard time. Some sectors face a degree of regulatory and policy uncertainty. Antitrust and competition policy for technology companies is likely to become contentious again, particularly given these companies’ strong financial performance during the pandemic but also their importance to the success of home working. The new normal is still being defined for many sectors. Shifts in post-pandemic travel patterns will drive and shape the recovery across various transportation segments. E-commerce and remote working trends could hurt longer-term prospects for retail and office real estate. ESG and climate change considerations are moving centre stage for many sectors. Carbon emission reduction targets are driving a transformation in the energy sector, requiring increases in capital spending.

The Inside Track

What factors make mergers and acquisitions practice in your jurisdiction unique?

The formalities of German corporate law give rise to a number of practical restrictions, which are not experienced in Anglo-Saxon jurisdictions. For example, it is sometimes required to use ‘limitation language’ to fit upstream loans into the requirements of German capital maintenance rules. Legal features integral to group structures, such as domination and profit pooling agreements, demand special provisions in sale and purchase agreements. In a nutshell, Germany has established a practice over the past decades to combine Anglo-Saxon legal concepts with mandatory German corporate law.

What three things should a client consider when choosing counsel for a complex transaction in your jurisdiction?

When facing a complex M&A transaction, a client should initially look for a truly cohesive external legal team with an experienced team lead who understands the commercial aims of the transaction and focuses on the key points. Secondly, the team should include expert lawyers with proven track records in the functional focus areas of the deal. Thirdly, the client should bear in mind that one important task for counsel will be to stay on top of the international aspects of the deal.

What is the most interesting or unusual matter you have recently worked on, and why?

Acting for an international consortium of bidders in an auction for a private company held by a governmental entity under the rules and regulations of European public procurement law. Combining traditional corporate and M&A issues with issues of large government contracts, public concessions and public procurement presented a unique set of challenges for the large cross-practice team in the auction process and the negotiations.