Israeli M&A Activity - Market Trends Towards 2023

After two prosperous years in the Israeli M&A market, which can be generally categorized as having been a “pro-seller” market, it appears that the tide is changing into a “pro-buyer” market. This shift can be attributed in great part due to global and macro-economic changes, and is, naturally, affecting the terms and conditions and deal structure of the transactions today. We are starting to see fewer (successful) bids, longer negotiation and due diligence periods (including in connection with the company valuations), and a more frequent occurrence of asset-based transactions.

As investment and private equity funds still have significant ‘dry powder’ to invest, and there are many investment opportunities at more modest (and perhaps “realistic”) valuations, we foresee that towards the second half of 2023, investors will get back into the ring just as companies will be in need of financing, with their “Corona era” funds coming to an end. We anticipate that the Israeli M&A market, at least in the short term, will continue being a pro-buyer market, with one of its characteristics being a growing number of asset-purchase deals.

Essential Considerations for Choosing an Asset Purchase Transaction

When buying or selling a business, owners and investors may choose to structure the transaction as a sale and purchase of assets, or a sale and purchase of shares, depending on a variety of considerations and factors. Share purchase deals, by their very nature, result in the transfer of ownership of the entire business entity itself. When an asset transaction is contemplated, several factors come into play, as the sale of specific assets and the assumption of specific liabilities are at the heart of the transaction.

Here is a brief review of various aspects that may affect the decision of the parties to pursue an asset-based transaction or a share-based transaction.

General Structure of Asset Purchase Agreements

The basic structure of an asset purchase agreement will include the following provisions:

Purchased Assets and Excluded Assets. The parties should ideally specify (most conveniently in scheduled lists), which assets are acquired by, and which assets are not being acquired, and therefore remain with the seller. The excluded assets will remain in the sole ownership and responsibility of the selling company.

Assumed Liabilities and Excluded Liabilities. The parties should specify which liabilities are assumed and which liabilities are excluded by the buyer, and therefore remain with the seller. The exclusion of certain liabilities is important for protecting buyer from known and unknown exposures, e.g., obligations of the seller towards its customers; expenses incurred by the seller in the development or procurement of the purchased assets; obligations to employees and service providers for the pre-closing period; accounts payable; liability arising from the seller’s failure to perform agreements; and the like.

Purchase Price Allocation. It is advisable for the parties to agree on the allocation of the purchase price between the various acquired assets and assumed liabilities, so that there is alignment in the reporting to the tax authorities, and the correct calculation of the tax (where value added tax or purchase tax is involved). Accounting considerations should also be considered here (inter alia with respect to depreciation and amortization) and planning the “exit” taxes (in terms of the original purchase price).

Specific Israeli Issues in an Asset-based Transactions:

Transfer of employees

Specific attention should be given to the method of transfer of employees of the company, which can either take the form of ‘fire and (re)hire’ or ‘employee transfer in continuity’. In addition, where an employee union is involved, the transfer may likely involve negotiation and the execution of a new or amended collective bargaining agreement, which should be taken into consideration in connection with costs as well as delays in the transaction time.

The ‘fire and (re)hire’ method is comprised of the employment relationship between the transferred employees and the seller being terminated and pursuant to which the seller (being the employing company) must pay the transferred employees all payments they are entitled to upon such termination, and the transferred employees are thereafter rehired by the buyer. Employee transfer in continuity is essentially where the buyer hires the transferred employees but assumes the continuity of the employment of the transferred employees and all the entitlements, obligations, and exposures in connection with their employment with the seller.

The ‘fire and (re)hire’ method is typically preferred by buyers, as buyers avoid certain exposures with respect to the pre-closing employment period. This does not mean that buyer should be indifferent to the rights of the transferred employees, and it is in its interest to confirm that the hired employees are fully paid by the seller for all their pre-closing entitlements. It is important for the buyer to note however, that even under ‘fire and (re)hire’, Israeli law provides for the continuity of certain of the rights of the re-hired employees with their new employer (the buyer), such as acknowledging the transferred employees' seniority and service credit, considering their employment period with their former employer.

For example, Section 30)a( of the Wage Protection Law, 5718-1958 provides that a new employer may remain liable for wages, salary and provident fund payments (a liability which could be mitigated under certain circumstances); and Section 18 of the Collective Agreements Law, 5717-1957 provides that the new employer will take on the liability in connection with any obligations under a collective agreement. In addition, there are other laws and regulations which focus on the “workplace” rather than on the identity of the “employer” in order to determine the entitlement to certain rights, such as sick days, entitlement to annual leave, qualification period for pregnancy protection rights, etc.

By choosing the ‘fire and (re)hire’ method, the pension funds (which include all or part of the severance pay as well) are, in general, released to the employee, and the buyer will become the new employer and responsible for the contribution of pension and severance payments starting from the closing date. Also, in ‘fire and (re)hire’, employees are entitled to their severance pay, all or portion of which was accumulated in the pension funds (as described below), redemption of accrued and unused vacation days and accrued convalescence pay.

Lastly, according to Israeli labor laws, an employer cannot transfer its employee to another employer without his or her consent. This means that even in the ‘employee transfer in continuity’ method the employee needs to agree to be employed by the buyer. Also, it should be noted that no funds will be released to the employee, including severance pay, as all the funds will be transferred to the buyer as the new employer. The buyer will be responsible for the pre-closing employment period and therefore it should verify that funds and contributions were properly and timely made by the seller. The transfer of the employees’ pension funds requires specific notice to the tax authorities which should be provided prior to the closing.

Transfer of Knowledge

The transfer of intellectual property rights is generally realized through the asset purchase agreement itself. With the exception of registered intellectual property such as patents and trademarks which are administered by the Israeli Registrar of Patents and the Registrar of Trademarks, all other intellectual property rights, including copyrights, are not required to be registered in Israel.

This means that in terms of the transfer of intellectual property assets in technology-based companies, much more attention should be given in the due diligence phase, to identify the following risks and exposures:

With respect to the last point, in many transactions involving technology companies, one may encounter the IIA (or in its former name, Office of the Chief Scientist), which provides funding to technology companies through various R&D grant programs, which grants are generally repaid from revenues from sales of products. Many Israeli early-stage Hi-Tech companies obtain these grants, which have attractive terms, and as such, become subject to the rules and regulations of the IIA. These rules and regulations include several obligations, processes, obtainment of approvals, or sometimes even fees, when the funded intellectual property is to be transferred.

Israeli Tax issues

A non-Israeli tax resident who sells shares in an Israeli company may be exempt from capital gains tax if several conditions are met. This exemption, however, does not apply to the sale of assets, so in most cases where non-Israeli shareholders are involved, the sale of shares is preferred by the sell-side.

In general, selling assets by an Israeli company is a transaction which is subject to value added tax in Israel (currently at the rate of 17%) on certain types of assets. If the buyer is not an Israeli company or a non-Israeli company registered for VAT purposes in Israel, one of the parties to the transaction will have to bear the value added tax without the possibility of offsetting the tax. Selling shares of Israeli companies, however, is generally not subject to VAT.

In Israel there are very broad withholding obligations. Accordingly, it is market standard for a buyer of assets or shares to require seller to present a certificate issued by the Israel Tax Authority that seller is exempt from Israeli withholding. Without such a certificate the buyer will have to withhold Israeli tax at the applicable tax rate.

Transfer of real estate

When one of the acquired assets is real estate, the buyer should examine the specific risks and associated real estate taxes (including purchase tax), and consider the resulting mechanics, such as the use of escrow, the release of (and registration of new) mortgages, payment of municipal taxes and the receipt of the necessary approvals for the transfer of the real estate with the Registrar of Real Estate. Where the real estate is owned by the State of Israel (which is the case in most transactions) its consent is required (mostly, but not all, through the Israel Land Authority).

Transfer of Personal Information and Databases

The Israeli Privacy Protection Law, 5741-1981 and the regulations promulgated thereunder regulates the collection and use of personal data, pursuant to which a collection of personal data processed by an entity should be administered as a “database” which may be subject to a registration requirement with the Registrar of Databases at the Israeli Privacy Protection Authority. This Authority oversees compliance with the privacy laws in Israel any transfer of a registered database should be pursuant to guidance issued in this regard and maintaining the data subject rights.

The main risk at hand here is the sharing of personal data collected by the seller for certain purposes with buyer, which may give rise to the need in providing disclosure to the data subjects, and in some cases, even obtaining their consent, whether opt-out or on an opt-in basis.

In some asset-purchase deals, the purchased assets do not contain an entire database but rather only certain parts of it, and this requires special attention to data mapping, listing the information systems, and analyzing the privacy risks involved therewith. In other deals, the buyer may need the seller to keep processing the purchased information for a designated period following closing, due to operational or regulatory need.

In all of the foregoing scenarios, the parties will need to identify the databases and categories of personal data involved, to define the lawful basis for sharing the data, and to determine the relations of the parties until closing or thereafter in terms of controller-processor relations (or in Israel, a database manager – holder relations).

Public Registrars

When purchasing assets that are registered in a public registry, it is important to complete the process by updating the applicable registry. It should be noted that in some cases the registry is constitutive as to the rights of the registered owner. Common registries include the Registrar of Real Estate, the Licensing Registry of the Ministry of Transport and Road Safety, the Patent Registrar, the Trademarks Registrar and the Registrar of Databases. Buyer should also check with the public registers administering pledges and charges which may be imposed on the purchased assets.

Summary

Asset purchase transactions are generally more complex for both the sell-side and buy-side, but have their advantages, mainly for the buy-side, and so they are likely to be more popular in a “pro-buyer” market, as currently seen in the Israeli M&A market. In light of the complexity and special characteristic of asset-based transactions, it is recommended to involve local counsel from the early stage of the transaction structuring, in order to make the process as efficient and short as possible, as well as to address the various factors set out above, which are for the most part, Israel specific.

Authors

Lior Etgar, Partner, leads the Data Protection and Privacy Practice

Shay Dayan, Partner, Corporate and M&A Department