This article is taken from GTDT Practice Guide: Germany M&A. Click here for the full guide.
Current political and economic parameters
Germany remains an attractive market for foreign investors. The M&A market in Europe’s largest economy experienced a new boom starting in 2016, which was interrupted by the covid-19 pandemic in 2020. Prior to this, other factors such as Brexit or international trade conflicts had already dampened market sentiment. In 2021, the market recovered significantly and so far the outlook for 2022 has also been positive, especially since the pandemic in Germany seems to have peaked for the time being. However, the consequences of Russia’s war against Ukraine, which was ongoing at the time of going to press and to which the West has responded with far-reaching sanctions, are not yet foreseeable. It is certain that the German economy will also be hit by the effects of the war. The German government is trying to reduce its considerable dependence on raw material imports, especially natural gas, from Russia in the medium and long term through the accelerated expansion of renewable energies, the construction of liquefied natural gas terminals, massive investments in hydrogen technology and a comprehensive restructuring of heat supply infrastructure. Furthermore, the defence sector will be strengthened in the coming years: as a result of the Russian aggression, the German government has announced the creation of a special fund of €100 billion for the modernisation of the armed forces and to substantially increase the future annual defence budget. These fundamental political decisions in Germany are likely to foster M&A activities in the mentioned sectors.
The majority of transactions in Germany are private acquisitions by way of share deals or asset deals. This applies equally to the acquisition of small businesses as well as to takeovers of large companies. Public takeovers are much rarer due to the smaller number of listed companies. It is mainly companies from the German Mittelstand (small and medium-sized enterprises (SMEs)) that arouse the interest of foreign investors. Here, both strategic and financial investors find attractive target companies with high profitability, solid financing and a strong market position. Often, these are owner-managed companies for which the necessary business succession within the owning family is not an option, and that are therefore looking for external buyers. Large companies, on the other hand, are increasingly coming under pressure from activist shareholders to dispose of business parts that are not profitable or do not belong to the core business, and are thus driving carve-out transactions in Germany.
Germany is considered a liberal market that does not provide for any specific barriers to entry for foreign investors. For acquisitions of German companies by foreign investors, specific regulatory requirements may arise from the Foreign Trade and Payments Act2 and the Foreign Trade and Payments Ordinance3. In addition, the general merger control regulations (the Act Against Restraints of Competition (GWB))4 apply. The provisions of the German Securities Acquisition and Takeover Act5 only apply to public takeovers and therefore do not play a role in private M&A. In the case of a direct or indirect acquisition of real estate in Germany by foreign investors, certain transparency obligations must be observed.
Investment screening procedure
Following a worldwide trend, the control of foreign investments has also increased in Germany in recent years. Under certain conditions, the direct or indirect acquisition of 25 per cent or more of the voting rights in a German company by purchasers who are not EU or European Free Trade Association (EFTA) residents, or who have a non-EU or EFTA resident shareholder holding at least 25 per cent of the voting rights in the acquirer, may be restricted or prohibited by the Federal Ministry for Economic Affairs and Climate Action. This is the case if an acquisition will likely affect public policy or the security of Germany or another EU member state or relates to projects or programmes of EU interest. It applies irrespective of the sector in which the target company is active (cross-sector screening). The screening procedure likewise applies to asset deals and acquisitions of definable parts of the operations of a domestic company (eg, carve-out transactions). If the German target company is active in a sector that is particularly relevant to national security, the threshold is set at 10 per cent of the voting rights (eg, for operators of critical infrastructure, the media and the healthcare sector)6 or at 20 per cent of the voting rights (particularly for emerging technologies such as semiconductors, artificial intelligence, additive manufacturing and quantum technology).7
Sector-specific screening applies to acquisitions of at least 10 per cent of the voting rights in a German company by a foreign company, including entities from other EU or EFTA member states, if the company is active in particularly sensitive sectors. This predominantly concerns certain military goods and IT security products.8 The screening considers whether the respective acquisition poses a threat to the essential security interests of Germany. The acquisition must be reported to the ministry if the relevant thresholds of 10 per cent or 20 per cent (depending on the sector) are met. The ministry may review the transaction during a two-month period (Screening Phase I) after having obtained knowledge of the transaction. If the ministry does not initiate a formal review procedure during Screening Phase I, the acquisition shall be deemed to have been approved. Under the law, the formal review procedure (Screening Phase II) may last up to eight months, depending on the relevant sector and other circumstances. After completion of the review, the ministry can approve or prohibit the acquisition or impose certain restrictions. Deals subject to mandatory reporting obligations must not be closed prior to the completion of the screening procedure or lapse of the relevant screening period. Outside the scope of mandatory reporting obligations, investors may apply for a binding certificate of non-objection from the ministry prior to the planned acquisition. The certificate of non-objection confirms that the acquisition does not raise any concerns related to public policy or security.
When certain thresholds are reached, a proposed concentration is subject to merger control under German law (GWB)9 by the Federal Cartel Office (FCO)10. German merger control under the GWB only applies to the extent that the transaction is not subject to EU merger control. Particularly in the case of transactions in the SME sector,11 the high turnover thresholds of European merger control do not apply, so that merger control under the GWB is decisive. Under German law, a merger is subject to merger control pursuant to the GWB if, in the last financial year prior to the merger:
- the undertakings involved in the merger jointly achieved worldwide turnover of more than €500 million;
- one of the undertakings involved achieved more than €50 million in Germany; and
- another undertaking involved achieved turnover of more than €17.5 million in Germany.12
In 2017, a new threshold was introduced that subjects a merger project to merger control even with lower turnover thresholds if the value of the consideration exceeds €400 million and there is a domestic connection.13 The reason for the new regulation was, among other things, the Facebook/WhatsApp case, in which the relevant domestic turnover thresholds were not reached.
In 2021, a further possibility of intervention for the FCO was created to be able to take up ‘killer acquisitions’. According to the new provision, the FCO can oblige a company to notify of any merger with other companies in certain economic sectors if:
- the company has achieved a worldwide turnover of €500 million;
- there are indications that future mergers could significantly impede effective domestic competition in the named economic sectors; and
- the company has a share of at least 15 per cent in the named economic sectors in Germany.
However, the company to be acquired must have achieved more than €2 million in turnover worldwide and two-thirds of its turnover in Germany.14
If the relevant thresholds are reached, the proposed concentration must be notified to the FCO. If the undertakings concerned are domiciled outside Germany, they must designate a person authorised to receive official notification in Germany. The preliminary examination procedure (Phase I) begins with the submission of the notification documents. Within one month after receipt of the notification documents, the FCO must examine whether the main examination proceedings (Phase II) will be opened. Phase II proceedings shall only be opened if further examination is necessary. If the FCO does not open Phase II proceedings before the expiry of the one-month period, the project is deemed to be cleared. If Phase II proceedings are opened, the FCO must decide within a further four months whether the transaction is to be prohibited. Under certain conditions, the deadline can be extended. The FCO may also grant clearance subject to conditions and obligations to ensure that the undertakings concerned comply with any commitments they may have entered into with regard to the FCO in order to avert an otherwise impending prohibition. If the time period for Phase II lapses without a decision by the FCO to prohibit or to clear, the transaction shall also be deemed cleared.
A few days after receipt of the notification documents, the proposed concentration is published on the FCO’s website and thus becomes public. Therefore, the envisaged transaction is regularly notified to the FCO only after the conclusion of a binding acquisition agreement. It is, however, permissible to submit the notification to the FCO beforehand, for example, to trigger the deadline for the review to start earlier. A merger subject to notification may not be implemented before clearance (or expiry of the deadline without prohibition). In practice, it is possible to hold confidential talks with the FCO in advance if a planned acquisition is considered problematic under merger control law.
If applicable, both foreign investment control clearance and merger control clearance will usually be agreed as closing conditions in the relevant acquisition agreement.
The Transparency Register was established in Germany in 2017 to prevent money laundering and terrorist financing. It is kept in electronic form and contains entries on the beneficial owners of legal entities, trusts, foundations and similar legal arrangements. The beneficial owners are the natural persons who ultimately own or control a legal entity or legal arrangement. The legal entity or arrangement is obliged to disclose the beneficial owner to the Transparency Register and keep the relevant information up to date. This obligation also applies to entities domiciled abroad if they undertake to acquire ownership of real estate located in Germany (by way of asset deal). Since August 2021, the obligation also applies if the foreign entity acquires shares in an undertaking that owns real estate in Germany and, as a result of the acquisition, the foreign entity holds (directly or indirectly) at least 90 per cent of the undertaking. The foreign entity is exempted from this obligation if it has filed the relevant beneficial ownership information to another EU member state’s register on beneficial ownership.15 Unless the foreign entity complied with the above notification obligations, notarisation of the relevant acquisition agreement is prohibited.
Most common forms of business organisation
German target companies in M&A transactions are usually organised in the legal form of a corporation or partnership. In the M&A context, the most relevant forms of business organisation are the limited liability company (GmbH),16 stock corporation (AG)17 and limited partnership (KG),18 especially in the form of the GmbH & Co KG.
The most widespread company form is the GmbH. Every GmbH has a shareholders’ meeting and one or more managing directors as mandatory corporate bodies. In addition, a supervisory board or advisory board can be established. If a GmbH has more than 500 employees, a supervisory board must be established, the size, composition and competences of which are regulated by law. In principle, the management of the company lies solely with the managing directors. However, the shareholders’ meeting can issue binding instructions to the managing directors at any time, even to the extent that they directly concern the management of the company’s business (eg, whether to enter into a contract). Therefore, the GmbH enables the shareholders to exercise extensive control over the company. The law affords the shareholders far-reaching flexibility in shaping the articles of association of the GmbH. A GmbH usually does not issue share certificates. Even if share certificates are issued, they are not negotiable instruments and cannot be listed on a stock exchange. Shares in a GmbH are transferred by way of a notarised assignment agreement. Every change of ownership of the shares must be entered in a shareholders’ list to be submitted to the commercial register. The articles of association often provide for mandatory consent of the company, an affirmative shareholder resolution or even the consent of all shareholders for a share transfer. Tag-along, drag-along and pre-emptive rights may also be in place.
If only a partial shareholding in the GmbH will be acquired, the participation rights associated with the acquired stake should be examined. Unless the articles of association provide otherwise, a simple majority of the votes cast is required to pass resolutions in the shareholders’ meeting, whereas a majority of 75 per cent of the votes cast is required to amend the articles of association.
In a GmbH, the liability of the shareholders is limited to the contributions made. The minimum contribution is €25,000. A special form of GmbH is the entrepreneurial company with limited liability (UG)19 with a minimum contribution of only €1. The formation of the GmbH (and UG) must be notarised. The articles of association must be filed with the competent commercial register and are thus public. Therefore, the shareholders often enter into a separate shareholders’ agreement that serves as the contractual basis for their cooperation in the company. A separate shareholders’ agreement does not have to be submitted to the commercial register.
Most large German companies are organised in the legal form of an AG. Mandatory corporate bodies of the AG are the executive board, which can consist of one or more persons, a supervisory board and the general meeting. Unlike the managing directors of a GmbH, the executive board of an AG manages the company on its own responsibility. Neither the supervisory board nor the general meeting can issue instructions to the executive board on their own initiative. The minimum share capital of an AG is €50,000. The formation of the AG must also be notarised. Physical share certificates can be issued but do not have to be. The shares may be listed on a stock exchange, and their transfer does not require notarisation. For certain shares (registered shares), the articles of association may require the consent of the company for a transfer. The articles of association of the AG are also filed in the commercial register. Unlike a GmbH, an AG is designed for a larger number of shareholders. Under the statutory provisions, the shareholders’ flexibility to shape the articles of association is more limited than in the case of a GmbH.
A KG is a commercial partnership established by two or more natural or legal persons for the purpose of operating a commercial enterprise under a business name. In a KG, there are two types of partners: at least one partner is personally liable, and at least one other partner (limited partner) must make a contribution and is only liable to the extent that the contribution has not been made. In the special form of the GmbH & Co KG, the personally liable partner is a GmbH, so that only the GmbH is liable with its assets. A limited partnership does not issue share certificates and its shares cannot be listed on a stock exchange (with the exception of the special form of a partnership limited by shares, KGaA). The limited partnership is entered in the commercial register, but its partnership agreement does not have to be filed with the commercial register and is therefore not public. Unless the partnership agreement provides otherwise, the partners must pass all resolutions unanimously and the transfer of shares also requires the consent of all partners. The partners have extensive freedom in drafting the partnership agreement. In the case of a KG, the management is assumed by the personally liable partner, and in the case of a GmbH & Co KG, it is thus assumed by the managing directors of the personally liable GmbH. The legal form of the GmbH & Co KG comes very close to that of a corporation in terms of limitation of liability, but is also recognised in principle as a partnership for tax purposes. This can be advantageous compared with a corporation (profit and losses of the partnership are accrued directly to the partners). At the same time, it can be structured flexibly. It is often used by family-owned businesses.
Types of transactions
In contrast to public takeovers, which are regulated by the German Securities Acquisition and Takeover Act,20 private M&A transactions are not subject to specific legislation (other than that which is mentioned above). Neither special provisions on the adequacy of the consideration offered apply, nor are there special publication obligations regarding the transaction.21 Only in particular industries, such as the banking sector, may special regulatory requirements also apply to private M&A transactions.
The acquisition of a company by way of a share deal is just as common as the acquisition by way of a purchase of the company’s assets. Combinations are also possible, such as in the case of some carve-out transactions, when certain business parts to be sold are first transferred from various companies within the seller’s group to a separate company by way of an asset deal and the company is then sold by way of a share deal.
In an asset deal, the precise specification of the assets to be transferred in the acquisition agreement (or separate transfer agreement, if any) is essential and a prerequisite for the effective transfer to the buyer. The transfer of assets is generally possible without any formalities. However, notarisation of the agreement may be required if the objects to be transferred include real estate or shares in a limited liability company or if all or a fraction of the seller’s entire property is sold.
Transfer of contracts generally requires the consent of the contracting party. If obtaining consent individually is not practicable, for example in the case of mass contracts, the parties may invoke the concept of implied consent. In this case, the contracting parties will be informed about the transfer of the contract. By continuing to perform the obligations under the contract, implied consent of the contracting party to the transfer can be inferred. Typically, the parties agree on how to deal with possible lack of consent to contract transfers in the acquisition agreement. Certain types of contracts are automatically transferred to the acquirer, for example employment contracts of the employees attributable to the acquired business (unless the employee objects to the transfer), leases of real estate and certain insurance contracts.
In principle, the liabilities in an asset deal remain with the selling company. However, under certain circumstances, liability can also be transferred to the buyer in an asset deal, for example, for inherited liabilities if real estate is acquired or for certain tax liabilities in the case of the takeover of a business. Since 2017, it equally applies to antitrust violations of an acquired business if it is carried on by the buyer in economic continuity. The buyer of a commercial business is also liable if the business is continued under the same business name; however, the buyer can exclude this liability by agreement with the seller if the agreement is entered in the commercial register or if the buyer informs the creditors thereof. It should be considered that certain public law permits required for the operation of the business do not automatically pass to the buyer in the case of an asset deal and may have to be applied for again (in time).
Since in a share deal only the owners of the company change through the transfer of the shares (or interests in case of a partnership), the company as an entity remains unchanged. There is no need to transfer individual contracts or assets. Licences and permits under public law held by the target company will generally not be affected by the change of ownership. Sometimes, however, a change of ownership may trigger termination rights of contractual partners of the target company, if agreed in the respective contracts (a change-of-control clause). Therefore, contracts that are important for the business of the target company must be reviewed under this aspect. There may also be unidentified liability risks in the company, for example from a previous business activity. This risk may lie in particular in shell companies that have ceased their business operations but remain in existence as a company and are later used for a new business purpose. Conversely, the use of a shell company burdened with liabilities may be desirable to use the company’s loss carry-forwards for tax purposes. Furthermore, the buyer may also be liable for outstanding capital contributions of the seller that have not been made or have been wrongfully returned.
If the buyer does not acquire 100 per cent of the shares, consideration should be given to what level of participation must be achieved to obtain certain veto or control rights in the company. As explained above, these rights depend on the respective corporate form and the individual provisions of the articles of association.
Occasionally, in addition to the shares in the target company, other assets must be acquired that are needed for the operation of the company. Particularly in the case of family-owned companies, business premises, machinery or intellectual property rights sometimes belong to individual shareholders and are leased or otherwise granted to the company. These items must be either transferred to the company before closing or acquired separately by the buyer.
Comparison of transaction types
Overall, the asset deal is generally more complex and the contractual documentation more elaborate than in a share deal, as all assets to be transferred must be specified in detail. The preferred structure often also depends on tax considerations. Possible liability risks can play a role as well, for example if there are certain liability risks in a company that the buyer is not prepared to assume and therefore seeks the purchase of the assets rather than the shares in the company. An asset deal can also be considered if the buyer only wants to acquire certain assets or parts of the company, as well as in distress scenarios.
Both auction sales and trade sales are common in private M&A transactions in Germany. Auction processes are usually well prepared if experienced investment banks or M&A advisers are involved who set up the process according to international standards. This is now also common in M&A transactions involving larger companies of the German Mittelstand. It can be more difficult with smaller transactions in the SME sector, which can deviate from international practices. This holds especially true if the sellers have little M&A experience and do not involve professional advisers (in time).
A professionally managed auction process begins with the preparation by the mandated investment bank or M&A adviser and set-up of the internal project teams. The investment bank or M&A adviser then evaluates the target company to determine a potential purchase price range. At the same time, information is collected to provide potential bidders with an information memorandum and documents for later due diligence in a virtual data room. If flaws or risks of the company that could negatively impact the purchase price or even jeopardise the sale as a whole are already discovered at this stage, these may possibly be remedied before the actual divestment process begins. After the preparation phase, the identification of and approach to investors begin. Interested investors must then agree in a confidentiality agreement that they will treat the information provided about the target company as strictly confidential. On this basis, they receive the information memorandum and an explanation of the further process. As a rule, the bidders are requested to submit an initial non-binding offer (indicative bid) based on the information memorandum and to explain how the purchase price offered is derived. On this basis, the seller decides which prospective buyers will be admitted to the further process. These bidders will then be given access to the data room to conduct due diligence within an agreed time frame. Depending on the type and size of the transaction, due diligence is carried out in several steps. After an initial due diligence phase, a confirmation of the first offer is requested (confirmatory offer) before more sensitive data of the company is made available in the next phase. After that, the remaining bidders are asked to submit a final offer. The seller decides on the basis of the final offers with which bidders to start concrete contract negotiations. The bidder with the most attractive offer usually receives exclusivity for a limited period of time for the subsequent contract negotiations. Sometimes, however, negotiations are conducted with several bidders in parallel.
Outside of an auction process, the parties usually conclude a letter of intent (or memorandum of understanding) after establishing contact, in which the commercial key elements of the intended transaction are already set out and the further procedure is agreed. Even though the letter of intent is usually legally non-binding, its importance for the subsequent negotiations should not be underestimated. It should therefore be drafted carefully.
Signing and closing
If the negotiations (whether in an auction process or a trade sale) lead to an agreement, the acquisition agreement will be signed. As explained above, certain agreements must be notarised under German law to be effective. The notary’s fees for notarisation depend on the value and subject matter of the agreements to be notarised and are provided for by mandatory law. Often, certain closing conditions must be fulfilled (such as antitrust clearance, as described above) before the acquisition can be completed.
In transactions in the German SME sector, foreign investors should be prepared that not all principals have sufficient English language skills to be able to conduct negotiations fully in English or understand complex contract documents in English and, therefore, occasionally request the binding contract to be written in German. This is particularly true for the generation that is currently considering an age-related business succession and may have little international experience. In M&A transactions in the SME sector, especially in family-owned businesses, international investors must also take into account that it often matters to the sellers what the acquirer intends to do with the target company after the sale and what future prospects the change of ownership will open up for the company. A certain sensitivity for the cultural peculiarities and the interests of the sellers of family-owned businesses that go beyond the mere conclusion of the acquisition agreement can therefore be an additional success factor for acquisition efforts by foreign investors.