After two subdued years, global M&A activity is showing signs of recovery. Though large-ticket M&A and private equity deals have been suppressed, Q1 2024 recorded the highest number of large deals per quarter in nearly 24 months¹.

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The launch of OpenAI’s ChatGPT in November 2022 took a flamethrower to the last AI winter. As users explored the chatbot’s wide-ranging generative AI capabilities to answer questions, draft copy, write code and more, it dawned on many businesses that this technology could be a game changer for how they operated. The challenge is pinpointing how, given the unprecedented frontier, to embark on the journey with eyes open to the risks associated with this new technology.

ChatGPT also lit a fire under leadership teams. After years of pitching AI as the future, suddenly they were under pressure to demonstrate they had been preparing for that future. A flurry of activity followed as companies raced to reassure investors they were on top of the issue and had their own revolutionary AI tech ready for deployment.

A wave of product launches, investment announcements and strategic alliance arrangements swept the globe, accompanied by a never-ending stream of media coverage on what AI could mean for the way we live and work.

After the NFT hype of 2021 and the metaverse dominating 2022, 2023 was certainly AI’s year. There were too many notable developments to mention exhaustively here, but to name just a few:

• Microsoft announced a $10bn investment in OpenAI to accelerate breakthroughs in AI technology¹.
• Google launched its own AI chatbot, Bard, and announced a $2bn investment in large language model provider Anthropic².
• Amazon launched Amazon Bedrock, a suite of tools to help users build generative AI applications under its AWS brand³.
• Demand for Nvidia’s AI chips saw a surge in its stock price, and in May it reached a $1tn valuation⁴.
• Professional services firms PwC and Accenture announced investments of $1bn and $3bn respectively into generative AI⁵.
• US President Joe Biden signed an executive order on AI to foster innovation while avoiding AI risks⁶.
• The EU agreed the EU Artificial Intelligence Act, the first-ever legal framework on AI that will come into force in 2025⁷.

It did feel like at one point or another, everyone got a little swept up in the AI wave.

Big money, low volume

Interestingly though, AI’s resurgence in popularity didn’t translate into M&A activity. Indeed, after a huge upswing in AI M&A between 2019-21, last year M&A dealmaking in the sector declined 31%, with only 190 deals compared to 276 in 2022 according to Crunchbase⁸.

There were a handful of big-ticket acquisitions last year. These included:

• cloud data platform Databricks purchasing MosaicML, an infrastructure company for training models, for $1.3bn in June;
• Thomson Reuters acquiring AI legal research tool Casetext for $650m in August; and
• Travelers Insurance announcing the acquisition of Corvus Insurance, a company which uses AI to predict and prevent cyber risks, for $435m in November (which completed in January 2024).

That said, overall, M&A activity in 2023 was significantly lower than previous years. Given the various macroeconomic factors at play – most economies were suffering rising inflation and increasing interest rates, as well as geopolitical uncertainty and conflicts – perhaps this is understandable. All of these components suppressed market confidence and valuations.

Now the economic outlook is stabilising and becoming more positive, we’re expecting an upswing in M&A activity later this year. As companies look to make strategic acquisitions to future-proof their business models and enhance product offerings, AI is going to be an increasingly active vertical within the tech sector, particularly as investors chase the elusive unicorn – both in terms of pure AI businesses, of which there are a limited number, and companies that create AI-enabled products and services.

Targets and risks

We expect AI-driven businesses focused on the following areas to be the most sought-after acquisition targets:

• productivity and the automation of software development;
• drug discovery and personalised medicine;
• predictive analytics and data analysis;
• content creation, recommendation algorithms and consumer engagement analysis; and
• agriculture and sustainable farming.

Many acquirers will be operating in unfamiliar territory though. AI and machine learning are not new, but the rapid pace of their development is. The explosion of chatter around AI technologies and the shift in development focus from a few big players to a much broader range of participants means it can be hard to assess which products and companies are actually going to have a positive impact vs which are well-polished (and expensive) vaporware.

There is a risk that in racing to make an acquisition to avoid being left behind, or to beat others to an in-demand target, businesses unfamiliar with AI technologies either don’t take the time to do proper due diligence or know what constitutes ‘proper’ diligence, meaning that they end up with a bad investment. Given the complexity of the technology, diligence providers are still learning what to look out for and what constitutes a ‘red flag’ issue. Demonstrating a track record may not be possible, and identifying what the threats to the future of the business being acquired might be (whether commercially, legally or regulatory) is harder to achieve.

Buyers are also having to navigate the fact a lot of companies are being less than honest about their capabilities. There has been a surge in businesses positioning themselves and their products as ‘AI-powered’ in order to ride the AI wave when they don’t actually incorporate AI technology. This ‘AI washing’ has reached such a level that regulators have promised more scrutiny to ensure companies aren’t misleading consumers and investors.

In December US SEC chair Gary Gensler warned businesses against making false AI-related claims, and the SEC hasn’t hesitated to take action. In March it charged two investment advisers with making false and misleading statements about their use of AI, resulting in $400,000 in fines⁹. The US Justice Department’s top prosecutor in San Francisco, Ismail Ramsey, has also indicated he’ll be on the lookout for AI and other start-ups that defraud investors before they go public.

So… a transformative technology. But many potential pitfalls to avoid to take advantage of it. If you are planning to make an AI-related acquisition later this year, there are a number of areas you should pay particular attention to in due diligence to ensure you avoid a bad investment and are able to enjoy the benefits of innovation.

AI acquisition due diligence

Verify the technology

This may sound obvious – but then again, Theranos was able to raise $700m in funding after weaving a web of secrecy about its supposedly revolutionary tech – which didn’t actually work.

If you are planning to make an acquisition to gain technology that you think will give you the edge, make sure you are given an opportunity to actually thoroughly test it. A hands-on demonstration with testing conducted by your own or independent third-party specialists can be a very simple way to test if flashy promises are grounded in reality and avoid a potentially disastrous investment.

Assess the team

When making an acquisition, you are not just investing in the business but also its people. You should assess the quality of the target company’s leadership team to ensure they have a background in AI or relevant qualifications and to make sure there are no red flags or past instances of overpromising and underdelivering. Look for diversity wherever possible. Diverse development teams are less likely to develop AI-driven tools that create unintendedly biased or discriminatory results.

You should also identify key personnel you want to retain for business continuity and their knowledge of the business and ensure all employment contracts are up to standard and contain appropriate confirmatory assignments of intellectual property (IP) and sufficiently attractive related benefits. It’s also important you understand what options have been granted to employees and ensure all tax considerations related to these are in order.

If independent contractors or other third parties have been instrumental in the development of the technology, check that they have assigned their IP and waived other rights.

Review accountability

To ensure AI transparency and explainability are upheld, and that regulatory concerns around bias and discrimination don’t arise, make sure any company you are interested in acquiring has robust governance frameworks in place. These frameworks should include ethical guidelines, auditing procedures for algorithms, and mechanisms to track decision-making processes.

The reporting structure and responsibility for ensuring AI accountability within an organisation will depend upon its size and operational focus. But whether the individual responsible for accountability is the chief ethics officer, chief privacy officer or general counsel, they should have a direct reporting line into the board and ideally should be independent of the development or engineering team.

Monitor regulatory risk

As we’ve mentioned, AI is an area that regulators are paying increasing attention to. You need to stay informed on the evolving regulatory landscape and ensure you are prepared for regulations that might impact you, like the EU’s incoming Artificial Intelligence Act.

Although general (as opposed to sector-specific) AI regulation is relatively new on the scene, UK regulators are already investigating AI-driven businesses (and those claiming to be so) and have been for some time. In line with its innovation-first approach, the UK government has instructed a number of regulators including the Information Commissioner’s Office (ICO) and the Competition and Markets Authority (CMA) to direct their focus towards AI risks falling within their competence. As regulators consult and engage on the use of AI in areas within their purview, there may be advantages for businesses to seek positive regulatory engagement at an early stage.

As AI is one of the sectors classified as ‘high risk’ under the National Security and Investment Act, you may also need to inform the UK government of your acquisition to ensure compliance if it falls within the Act’s scope.

Consider competition law

It’s worth considering how antitrust authorities might view strategic acquisitions and consolidation in the AI sector. The European Commission has raised concerns¹⁰ about both AI facilitating collusion between algorithms and the AI sector itself raising competition concerns, as companies with cloud services facilities and vast amounts of data and unique data sets may be incentivised to favour their own AI systems.

In the UK, after launching a review of AI large language models last year, the CMA has published a set of guiding principles¹¹ relating to the development of AI technology which you’ll need to consider.

Understand intellectual property and patentability

Understanding the scope and protectability of AI-related patents requires a nuanced approach given the abstract nature of some AI concepts. You should work closely with intellectual property lawyers familiar with current trends in patent protection law as they pertain to software and algorithms to ensure you understand what you are acquiring the rights to. Patents, if sought in one jurisdiction, are likely to come at the expense of preserving trade secrets everywhere, since the trade-off for patent protection is publication of the details of the underlying invention. Careful consideration of the expected geographical scope of the business’s proposed operations should be undertaken before applications are filed.

Whether the business wishes to rely upon trade secrets or patent protection, it must first have maintained the confidentiality of its IP. If the company has not been careful in protecting its developments, it may find its only real advantage will come from being first to market and you may find that it is a less appealing investment as a result.

Review data protection

Data is one of the essential components of any AI system, fed in so it can learn and deliver useful outputs. In many cases that data will be personal data. You should engage with legal counsel who specialise in data privacy to ensure that any acquisition target has adhered to data protection laws including the European GDPR/UK GDPR and that the acquisition doesn’t introduce risks concerning personal data, data protection governance and accountability.

Privacy compliance is as much about record keeping as it is about handling personal data properly. Any target company using personal data in its AI operations should be able to provide copies of data privacy impact assessments, records of data processing, policies and procedures, and evidence of privacy training for staff. The company should have a clear privacy notice which explicitly addresses its use of personal data for AI development.

Not all small businesses need to have appointed a data protection officer but if a company is processing personal data for AI training or development purposes, it is imperative that a senior member of the team takes the lead on privacy compliance.

Helping you make the right choice

We have a long history of advising clients on how to introduce AI into their business while steering clear of risk. We’ve helped developers create the technology in accordance with regulation, advised companies how to introduce it in their business, and helped investors sort the hype from the real opportunities.

If you are planning to make an AI acquisition or investment and need legal advice, please let us know if we can help.

Notes

1. www.bloomberg.com/news/articles/2023-01-23/microsoft-makes-multibillion-dollar-investment-in-openai
2. www.axios.com/2023/10/30/google-invests-2-billion-anthropic-openai
3. www.aboutamazon.com/news/aws/aws-amazon-bedrock-general-availability-generative-ai-innovations
4. www.theguardian.com/business/2023/may/30/nvidia-chipmaker-value-ai-chip-shares-artificial-intelligence#:~:text=Nvidia%20becomes%20first%20chipmaker%20valued%20at%20more%20than%20%241tn%20amid%20AI%20boom,-This%20article%20is&text=US%20chipmaker%2
5. www.consultancy.uk/news/34492/accenture-to-invest-3-billion-in-ai-over-next-3-years#:~:text=This%20investment%20from%20Accenture%20follows,collaboration%20with%20Microsoft%20and%20OpenAI.
6. www.whitehouse.gov/briefing-room/statements-releases/2023/10/30/fact-sheet-president-biden-issues-executive-order-on-safe-secure-and-trustworthy-artificial-intelligence/
7. www.taylorwessing.com/en/insights-and-events/insights/artificial-intelligence-act
8. www.news.crunchbase.com/ai/artificial-intelligence-startups-mergers-acquisitions-vc-funding-data/
9. www.fortune.com/2024/03/18/ai-washing-sec-charges-companies-false-misleading-statments/
10. www.competition-policy.ec.europa.eu/system/files/2023-11/20231108_VI-Lisbon-Conference_Olivier-Guersent_speech.pdf
11. www.gov.uk/government/news/proposed-principles-to-guide-competitive-ai-markets-and-protect-consumers

Why did you decide to become an M&A lawyer, and has it lived up to expectations?
M&A was the fourth seat of my training contract at King & Wood Mallesons. Until then, I was going to be a litigator.

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Multiple signs are pointing to an increasing momentum around M&A activity. If you’ve been holding out for better conditions to sell your business, now is the time to make sure you’re exit ready. Taylor Wessing’s Emma Danks, Suzy Davis After record highs in 2021, global M&A activity in 2022 and 2023 fell significantly, both in terms of deal volumes and deal values (with different sources recording varying degrees of the proportional drop, but some reporting up to half year-over-year). Though disappointing, this is understandable given the impact of macroeconomic factors at play, including: a sharp increase in interest rates (after many years of sustained low percentages), geopolitical uncertainty and conflicts, supply chain disruption, soaring energy prices, and high inflation.

All of these factors combined to suppress market confidence, leading to a drop in multiples which resulted in valuation gaps between sellers’ expectations and what buyers were prepared to pay (particularly given the stark contrast within certain sectors to the multiples that were being achieved in 2021).

From early on last year, where sellers had the ability to exercise discretion, many were opting to wait until market conditions improved. As the year passed, expectations for when those improvements would materialise kept being pushed out. Now (at the time of writing), at the end of Q1, it doesn’t feel like we are on the precipice of a ‘floodgate’ M&A moment. But green shoots are emerging and market momentum is building:

• Stabilising interest rates: though the US Fed declined to cut interest rates in March, it indicated that three rate cuts are coming this year as it expects inflation to continue cooling. Similarly, the Bank of England has indicated that there will be cuts to interest rates if inflation continues to fall – it is now at 3.4% in the UK¹, the lowest level in almost two and a half years. While we shouldn’t expect interest rates to drop back to where they were in 2021, the general consensus in the market is that we are past the peak. As the debt markets stabilise, buyers (particularly private equity sponsors) who rely on debt to part-fund transactions can put greater reliance on what the rates will be in the coming months and adjust their models accordingly.
• Political change: countries making up about half of the world’s GDP are holding elections this year. The threat of a change in government within the UK has, in the past, driven deal activity because of a fear of changes to tax rates (especially to capital gains tax (CGT)) or general uncertainty as to what the future would hold. That is not the case for the current impending election (the outcome of which is generally being treated as an inevitability) and it does not seem to be driving or stunting deal activity. Labour’s statement that it has noplans to raise CGT is likely salving sellers’ jitters. The geopolitical turmoil that may ensue following the US election outcome is of greater concern – but any fallout from that is likely to be less immediate.
• Supply chain re-establishment: while there are still ripples of disruption flowing as a result of the war in Ukraine, the initial shock factor has passed. The various supply chain issues have started to settle, companies have found alternative sources of goods or components, the increased costs have been passed on to customers and the spike in energy prices exacerbated as a result of Russia’s invasion has eased as markets rebalance.
• Record amounts of dry powder: after several years of burgeoning fundraising rounds, private equity investors are sitting on over $2tn of dry powder² which needs to be deployed. The drop in the number of assets coming to market, and the deal-doing hesitancy of the past couple of years, means that capital is burning a hole in sponsors’ pockets.
• Aged investments: private equity sponsors have held off on bringing assets to market pending improvements in market valuations and are reportedly sitting on a record 28,000 unsold companies worth more than US$3tn, globally³. The pressure to sell these aged investments and return capital to their investors is building. Furthermore, investors need to demonstrate their ability to deliver returns in order to raise further capital.
• Consolidated platforms: the lower end of the market has been less suppressed over the past couple of years. Companies have taken the opportunity to ‘buy and-build’ by acquiring complementary businesses to supplement their offering. Those that have effectively consolidated and integrated operations will have increased their overall value.
• Future-proofing: all businesses are looking at megatrends like AI and climate change, and working out how their models and plans need to change to future-proof their business whether organically or via acquisitions.

While we can anticipate an uptick in deal-doing activity, there is still a general hesitancy hanging over the market. Buyers have had time to reflect on the (at times, hasty) decisions they made two years ago and are likely to re-enter the market with greater caution. We can expect diligence to be more thorough, additional time taken to consider and assess the risks, and less vulnerability to getting swept up in the excitement.

That means sellers who have undertaken a fulsome vendor due diligence exercise, spent time getting their house in order and focused on, and can clearly articulate, what value their business can provide to a buyer, will be a much more attractive acquisition target for buyers. That will facilitate a much more efficient sales process and minimise the risk of process-failure.

Who’s looking to buy?

There are three types of buyer who are going to be most active in the UK market:

• Private equity: private equity buyers will be, and are, looking to make acquisitions. With the stabilising of interest rates and record amounts of dry powder to deploy as discussed above, private equity buyers will be keen to put their funds to work.
• Strategic corporates: trade buyers’ acquisition goals can vary, but typically include: securing new technological capabilities and integrating assets and operations with a view to realise costs or other synergies; gaining new customers, talent or intellectual property to enhance market position; expanding product lines and offerings; and/or accelerating growth in new markets. Trade buyers often make acquisitions for strategic rather than purely financial reasons, however as discussed earlier the stabilising of interest rates and the availability of aged investments will likely reignite their acquisition focus.
• US buyers: US buyers will be looking at the acquisition market for reasons similar to strategic buyers. Coupled with the relative strength of the US dollar and the perceived discount at which UK targets trade relative to their US peers, this means we will see increasing amounts of US acquirers taking an interest in UK companies, in particular ahead of this year’s US election.

Are you exit ready?

If you have been considering a sales process, and assuming you don’t have a functioning crystal ball to tell you when the best time to sell will be, the best we can advise is to ‘be ready’. It’s a time-consuming process to collate the necessary financial, tax, commercial and legal information required for a sales process and that needs to be balanced with ensuring sufficient time is dedicated to continuing to run the business.

Legal due diligence

Here are a few of the key areas that you will need to focus on in terms of the daily business activities to get exit ready and ensure a smooth transaction process:

• Commercial contracts: ensure you have formally documented, and signed, contracts with commercial counterparties (such as suppliers, customers, agents and distributors). Familiarise yourself with the termination and amendment terms, and whether they require notification to the counterparty of potential M&A transactions. Do they permit your counterparty a right of first offer or refusal if a buyer takes control of the company? Are there any material/key agreements which are coming to the end of their term or have been terminated, which would impact the company’s value?
• Intellectual property, know-how, trade secrets and brands: can you evidence that the company either owns, or has the right to use, any IP necessary and/or relevant to the business? Also, confirm whether you have measures to manage and protect these assets from infringement or unwanted onward disclosure, and if not, consider whether such measures should be implemented.
• Disputes: monitor, assess and manage actual and/or potential disputes and investigations to minimise their impact on the value of the business. Resolution of a dispute before the sale process begins may not be possible but it’s important to conduct a proper assessment of relevant risks and to maintain clear records of decision-making processes.
• Employment: maintain good employee records, eg by regularly updating the company’s policies and employee handbook, and ensure detailed records are kept of any disciplinary and grievance procedures that are undertaken.
• Contractors and self-employed workers: do you have documentation and working practices in place to reflect the correct status of any independent contractors or self-employed workers (as misclassification presents a number of risks)?
• Immigration: do you have proper evidentiary records that your employees have the right to work in the jurisdiction they work in?
• Options: where tax-favoured options (eg enterprise management incentives or company share option plans have been granted and will be exercised in connection with a transaction, buyers will want to see that the company has followed HMRC rules and guidance in granting such options and operating the scheme. Any failures in this respect can affect, or result in the loss of, CGT treatment and/or other tax-favourable treatment for option holders, with their option exercises instead being subject to income tax and national insurance contributions on the full gain.

Transaction-specific considerations

As well as preparing for a due diligence process, there are a number of practical matters you will need to consider in order to get a deal over the line:

• Regulatory approvals: the global regulatory framework is multifaceted and becoming more extensive:
  • Antitrust/competition: regulating businesses to avoid a market dominance and preserve competition has been an element of M&A for many years. There are more than 100 countries with merger rules based on turnover, market share and asset tests. Analysis will need to be undertaken to determine whether your transaction will be caught or (subject to who the buyer is) may be caught.
  • Foreign direct investment (FDI) and national security: an increasing number of jurisdictions are implementing some form of FDI or national security regime, requiring transactions to be notified to regulators. Furthermore, several are now refining and adapting their requirements as their understanding of the application of the rules to transactions in practice changes.
  • Regulated businesses: those businesses whose activities are regulated will typically need consent from, or a notification will be triggered to, the relevant regulatory body in the event of a transaction. This will depend on the nature of the transaction, the rules of the body and the conditions attached to the authorisation.
• Shareholder communications: particularly relevant for a share sale, the timing for when to communicate the details of the transaction (and even the fact a transaction is proposed) is a delicate balancing act when there is a wide shareholder base. Enough time will need to be given to allow sellers to consider (and get advice on) the proposed terms of the sale and the negotiations will need to be sufficiently well progressed for the terms to be explained. If there are any shareholders with whom the company has not maintained contact, or with whom there has been past animosity, this can further complicate the process, both in terms of when and how to send the communications, and whether they will sign and deliver the documents necessary to implement the transaction.
• External lenders/debt providers: if you have any third-party lenders, it’s likely that their consent will be required for the transaction or the transaction will trigger a repayment obligation. Buyers typically expect an unencumbered asset to be delivered by the sellers, and co-ordinating the repayment of debt, the release of security and completion of the transaction to the buyer requires careful orchestration.

Help is at hand

An M&A transaction can be complicated, time consuming and daunting if it’s an unfamiliar process. We are here to help you get exit ready. We’ve released a new ‘Exit Guide’ which distils our experience from countless deals to help companies prepare and successfully navigate an M&A sale process. To get a copy, please get in touch.

Notes

1. www.bbc.co.uk/news/live/business-685815261
2. www.ft.com/content/079ccde6-3c3d-4791-953b-6e3e8203ef12
3. www.bain.com/insights/topics/global-private-equity-report/

Can you describe your expertise with M&A transactions within the Philippines? How does the Philippine legal and regulatory framework influence your approach?

Our firm, Gorriceta Africa Cauton & Saavedra, a top-tier full-service law firm in the Philippines, has extensive experience in providing legal and transactional advisory services for M&A deals, representing either the buy or sell side in all types of domestic and cross-border acquisitions, investments and divestments of businesses across a wide spectrum of industries.

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