Uncertain times and market volatility in 2022, following a best-ever M&A performance for Europe in 2021, are bringing about changes in deal terms and deal processes

At this point in 2022, we have analysed the trends emerging from a legal perspective in European M&A and have made predictions as to how the trends will pan out in the latter part of the year and into 2023. Our findings are set out in this report, and we summarise below its key findings. (For our forecasts on UK M&A trends, see our Insight.)

The year so far

2021 was a record-breaking year for European M&A as activity rebounded very strongly following Covid-19. Growth was particularly strong in the tech and financial sectors. Private equity also had a stellar year as sponsors looked to spend cash that they had accumulated during 2020.

It was anticipated that 2022 would also be an impressive year, and it began with huge optimism. With continued pent-up demand and available capital, dealmaking was forecast to maintain some of the momentum it had found the previous year.

But, with the invasion of Ukraine in February, the M&A market in Europe has become more volatile and fragile. After an initial material reduction of deals in Q1, Q2 has seen more deal flow, but volumes are well below the equivalent quarter in 2021 (though any comparisons with 2021 should be made with caution given the exceptional nature of that year).

Factors causing volatility

While the war in Ukraine and related sanctions of Russia and Belarus have been a major factor in volatility, not least by causing disruption to supplies of key goods such as wheat, oil and gas and metals, a number of other factors are also driving instability, namely:

  • Rising energy costs due to increased demand but reduced supplies.
  • Supply chain disruption and workforce shortages caused by, among other things, trade and geo-political tensions, China's Zero-Covid policy and Brexit.
  • Ongoing fallout from the Covid-19 pandemic – production backlogs and uncertainty as to whether there will be a more problematic resurgence.
  • Inflationary growth, the cost of living crisis and weaker consumer confidence.
  • Higher borrowing costs, and banks' increased barriers to borrowing.
  • Weakening currencies.
  • Global unrest and increasing challenges, such as cyberattacks and the climate emergency.
  • Governmental instability and regime changes.

Regulatory changes creating friction

In addition to political and economic uncertainty, regulatory changes are impacting deals.

In 2019, the EU adopted a regulation setting out minimum requirements for Member States regarding foreign direct investment (FDI) controls, requiring cooperation between them and the European Commission, and permitting the Commission to issue advisory opinions. In the last three years, Member States have been adopting the regulation's provisions, but also tightening FDI laws to protect key supplies in the pandemic, and to address other threats to their security. Measures intended to be temporary have become permanent and further enhanced.

In June 2022, the European Parliament and the Council (co-legislators) agreed on a regulation which will come into force by mid-2023, which will affect companies engaging in M&A in the EU that have received financial contributions from non-EU governments or non-EU state-owned companies. The co-legislators have also agreed the text of the EU Digital Markets Act which will require any M&A activity in the digital sector between "gatekeepers" (large digital platform providers) and other digital platform providers to be notified to the Commission before closing, irrespective of whether such activity is notifiable for merger control approval.

In addition to new legislation, regulators (including competition authorities) have tightened up their review and scrutiny of transactions using their existing and new powers, increasing the risk of challenge and enforcement action.

The European Commission has published guidance on the application of the referral mechanism set out in Article 22 of the EU Merger Regulation allowing for mergers falling below national merger thresholds to be referred to it, which previously it did not encourage.

It is anticipated that increased regulation and a more bullish approach to enforcement will impact transaction timetables and deliverability, and may act as a deterrent to cross-border acquirers.

Will there be a slowdown in H2 2022?

It is widely predicted that there will be a slowdown in M&A activity in the second half of 2022 and into 2023, though the volume of deals may still be comparable to that of the latter half of 2019.

Opportunities for M&A growth in 2022 and 2023

We predict that there are a number of opportunities for growth, despite the ongoing uncertainty in the market:

  • Cash-rich strategic acquirers, private equity sponsors and special purpose acquisition companies (SPACs) seeking to spend accumulated funds.
  • Roll-up acquisitions (acquiring and then merging several targets in the same market) and bolt-on acquisitions (of complementary services, technology or geographies to the original acquired target) undertaken by private equity sponsors, enabling them to make good aggregate valuation multiple returns.
  • Transactions not reliant on bank funding; or transactions using credit funds or accessing attractive loans due to their ESG credentials.
  • Consolidation of businesses in sectors with much fragmentation.
  • Deals expedited to be completed before bank rates rise, or the economy worsens.
  • Deals within sectors bucking the trend – technology, media and communications, renewables, fintech, biotech, oil and gas (where shelved local projects are coming back to life as governments look to supplies closer to home), and consumer and retail (where consolidation is happening).
  • Transformative acquisitions - some acquirers are responding to the need to be more agile, competitive and efficient to survive in today's economic climate and to decarbonise or digitalise, others are buying to bring their supply chain in-house or to improve their ESG credentials.
  • Carve-out transactions and reorganisations – companies are selling off non-core assets as they refocus their strategy and reorganising and rationalising their groups to cut costs and realign their structure to their revised strategy.
  • Distressed M&A – as in any uncertain economic times, we anticipate that there will be an uptick in business failures and sales of insolvent and struggling businesses and assets.

Key deal terms and processes trends

The economic background in which deals are being transacted always affects the trends in deal terms. We are seeing, and expect the continuance of, the following trends:

  • Non-cash consideration and consideration paid on deferred terms, so that purchasers can manage their cash flows tightly.
  • An increase in the use of completion accounts so purchasers can verify valuations, with locked box mechanisms still also being used, particularly in private equity and auctions.
  • Due to the difficulty valuing assets in a volatile market, greater use of earn-outs and performance ratchets, and not just in sectors where they have traditionally been used or targets with high valuations or earlier stage companies.
  • More conditional transactions to accommodate FDI control, merger and other regulatory approvals and to cover off other risks before closing.
  • Material adverse change (MAC) clauses referring to Covid-19 if it makes a resurgence in the winter or referring to other events such as the conflict in Ukraine.
  • Ever greater use of warranty and indemnity insurance (and more limited recourse arrangements) in strategic M&A as well as private equity, and even in jurisdictions which have been slower to adopt it as a risk mitigation tool.
  • Higher warranty and indemnity limits/caps to address the potential greater risk of claims.
  • New specific areas for warranty/indemnification cover: including cybersecurity and ESG matters, regulatory concerns and compliance.

The prevailing conditions also have a bearing on deal processes. We have noted the following trends, which we anticipate will continue:

  • More thorough and wider due diligence exercises to anticipate risks and consider increasingly complex factors rather than rely on a seller's financial covenant.
  • Deals taking longer to reach closing (due to conditionality and uncertainty, due diligence, planning activities and other lengthening processes) and more deals aborting or stopping and restarting.
  • Some deals being rushed through to avoid regulatory changes, or pre-empt adverse changes in the economy.
  • Digitalisation of processes, including e-filings, e-signings, artificial intelligence and automated processes for due diligence, automation of agreements, drones for site visits, digital payment platforms, consideration settled with crypto assets, and the potential use of smart contracts for escrow and other simpler payment obligations.
  • An increase in the use of auction processes, but with a smaller cohort of bidders than previously.
  • European jurisdictions legislating to simplify deal processes and increase attractiveness to inward investment.

Osborne Clarke comment

While the current economic and political backdrop means that M&A activity is harder to predict than it has been in a number of years, there are a number of reasons to consider that there will be a solid level of dealmaking in the next 12 months.

European jurisdictions are well placed to confront the challenges being faced, and dealmaking will adapt to the new market trends, ways of doing deals and the increasing complexity and challenges of M&A.