Since 2017, new merger control thresholds have been in effect in Germany and Austria which do not depend on the revenues generated by the parties but, rather, on the value of the transaction. It is now also the case that the acquisition of target companies generating no revenues, such as start-ups, may require a notification under the new rules where: (i) the value of consideration exceeds € 400 million (Germany) or € 200 million (Austria); and (ii) the target has ‘substantial domestic activity’ (for an explanation on this point, see our recent blog article here).
However, assessing the value of consideration or determining domestic activity can, in practice, often cause considerable problems. For example, would earn-out clauses for biotech companies form part of the consideration? Would a company be adjudged to have substantial domestic activity even if it generates annual revenues of less than € 5 million?
The German Federal Cartel Office (FCO) and the Austrian Federal Competition Authority (AFCA) aim to answer these and other questions with their draft joint guidance on the new transaction value threshold which was published on 14 May 2018.
The 2017 German transaction value thresholds
In 2017, the German legislator introduced a new, albeit subsidiary, criterion for the notification requirement and thus closed a perceived gap in the national merger control system.. According to the amended provision, a transaction has to be filed in Germany even if one of the parties involved does not meet the € 5 million domestic-turnover threshold, provided that: (i) the value of consideration for the transaction exceeds € 400 million1; (ii) at least one of the parties meets the € 25 million domestic-turnover threshold; and (iii) the target has substantial domestic activity. This is aimed mainly to cover the acquisition of highly rated start-up companies (so-called “unicorns”) that do not already generate revenues exceeding the domestic thresholds at the time of the merger. The merger review of such acquisitions aims at preventing a company with market power from buying up aspiring competitors at an early stage of development and, as such, potentially threatening innovation and innovation competition in technology markets. The new thresholds are also of relevance in the life sciences and biotech sectors.
The draft guidance published for public consultation intends to create a level playing field for the companies involved on the basis of experience gained by the FCO and the AFCA in the first year of the new thresholds being in force. In particular, the guidance discusses: (i) the assessment of the value of consideration; (ii) the interpretation of the undefined legal terms “substantial domestic activity”; and (iii) deviations regarding the existence of a concentration in the case of asset deals.
Assessment of the consideration
Because of the variety of possibilities in designing a contract, assessing the relevant value of consideration can be problematic. It is clear that the consideration of a transaction comprises all assets and other monetary benefits as well as the assumption of liabilities, irrespective of whether they are due pre-merger or post-transaction. According to the German and Austrian competition authorities, this also includes all future and variable components of the consideration, which usually leads to uncertainty especially in the case of earn-out clauses, stocks or cash funds in foreign currencies. This may lead to a situation in which it will be difficult to be determine whether the notification requirement is triggered or not. Although the notification requirement does not revive post-transaction in the event of a later change in the value of considerations already taken into account, parties involved are nevertheless well advised to document in detail their assessment. This requires an analysis and forecast for the date of the closing. The assessment should comply with the methods set out in the guidance so as to prepare the parties in the event of a review initiated by the competition authority.
The value assessment has to be plausible. For this purpose, an independently outlined and explained value assessment, both by the purchaser and the seller, may be required. Uncertainties relating to the transaction value fall are the responsibility of the parties. The guidance states that the company management’s written confirmation of the assessed value of consideration contributes to its reliability and may even trigger an assumption regarding the validity of the value assessment. Such written management confirmation should also cover the methods of the value assessment.
Eventually the amended provision also applies to the establishment of ‘greenfield JVs’ (including shelf companies). In this case, the transaction value is calculated as the sum of all considerations transferred to the JV.
In case of doubt, the FCO and AFCA encourage precautionary notifications in order to prevent infringements of the standstill obligation.
Substantial domestic activity
The phrase “substantial domestic activity” of the target raises many conceptual issues. Determining a domestic nexus for the target’s activity causes fewer difficulties (the activity solely has to be ‘current’ at the time of filing; future or prospective activities are insufficient). The key issue, rather, is when to consider the respective activity to be ‘substantial’. The law avoids quantitative limits. The lack of (sufficient) revenues is no suitable criterion for distinction.
The authorities build on the target’s economic and competitive potential. Accordingly, a key point is whether the target’s revenues generated so far reflect its market position and competitive potential (para. 79). Thus, the turnover may nevertheless be relevant for a rule of thumb: if the target has generated (low) turnover (under € 5 million) for a sustained period, it is less likely that these revenues do not adequately reflect the competitive potential. The situation is somewhat different when a start-up company has just started operating on the market and there is, as such, no relevant turnover.
Standardised criteria to measure the extent of activity are not available. One needs to recognise the fact that for every industry and activity, there will be different criteria applicable. However, the authorities stress that appropriate criteria for determining jurisdiction have to be customary in the respective industry and should not be easy to manipulate. As for the digital sector, such criteria might be seen in user numbers or the frequency of access. Where the target is active in research and development, the respective budget or the number of assigned employees may be suitable proxies. In addition, the number of patents or patent applications within a given pharmaceutical field might constitute appropriate factors.
Assuming an existing market position
Finally, under the amended provisions the transaction must also constitute a ‘concentration’ within the meaning of the law. In the case of an acquisition of shares, this is rather uncomplicated. It is, however, questionable whether a concentration is established where only single assets are being acquired in the course of an asset deal or a license agreement (as is often the case in the pharmaceutical industry). Past German practice inter alia required the acquired asset to provide an opportunity for assuming the target’s existing market position. Otherwise the concrete asset would not be e considered ‘essential’ and, therefore, the acquisition would not constitute a ‘concentration’ pursuant to the relevant provision.
If, however, the target does not yet generate any revenues, there is no basis for the assumption of an existing market position. The guidance states that, following the 9th amendment to the ARC, it should be sufficient that the transaction affects the purchaser’s future market position. In order to protect innovation potential in technology markets, the possibility of the purchaser building a strong market position through the acquired asset is subject to merger control to protect innovation, even if the acquired asset is not being used.
Procedural matters and outlook
Whilst the guidance is currently only in draft form and subject to consultation, it is to be expected that it will ultimately reflect, to a large extent, the FCO’s and AFCA’s existing practice. In proceedings before these authorities, parties will have to provide details concerning the value of the transaction as well as its assessment in the event that the turnover thresholds are not met. The guidance provides that parties should prepare their value assessment in a standard spreadsheet application – an assessment which may have to be presented to the authority. Furthermore, details on the nature and extent of domestic activity would also need to be provided.
The guidance provides examples of situations where application of the rules was unclear. The explanations provided on assessing the transaction value are, in particular, valuable, in understanding the authorities’ likely expectations. However, developing and applying criteria in order to determine a ‘substantial domestic activity’ will require some attention noting that he guidance only deals with rather unproblematic example and leaves open other more complicated factual constellations.
The new transaction value threshold should not be interpreted too extensively and should not be considered a catch-all element for cases in which the target remains under the turnover threshold of € 5 Mio. According to the legislative grounds of the amended provision, the legislator expects only three additional notifications annually under the new thresholds. Taking into account the vast number of transactions in which the purchaser alone already reaches the two German turnover thresholds and in which the transaction value exceeds € 400 Mio, the ‘substantial domestic activity’ requirement for the target should be interpreted narrowly in order to ensure that only ‘unicorn deals’ are caught. Hopefully the FCO follows this interpretation and applies the new threshold not too broadly.