Merger control for start-ups – Much ado about nothing?
In its 2016 Annual Economic Report, the German Federal Government announced that as part of the upcoming 9th amendment to the German Act Against Restraints of Competition (ARC), “merger control will be expanded to cover cases where, despite low turnover of the company acquired, the transaction value involved in a takeover (e.g. the purchase price) is particularly high.” As shown by the further explanations, with these plans the Federal Government is aiming in particular at big companies acquiring stakes in innovative start-ups. These transactions currently often “fly below the radar” of the German Federal Cartel Office (“FCO”) since the target company’s turnover is in most cases not high enough to meet the thresholds of German merger control. Under currently applicable law, transactions have to be filed with the FCO only if – in addition to an aggregate worldwide turnover of all participating undertakings of more than €500 million – one of the undertakings generates a turnover of more than €25 million in Germany, and a second one a turnover of more than €5 million.
The Government’s motivation and first reactions on the market
According to the Federal Government, the business ideas of start-ups can be “of major economic importance to a well-established buyer and lead to a dominant position in the market which is undesirable in the overall economy.” In particular “multilateral platforms“ such as search engines and social network service providers seem to have been identified as source of potential competition concerns. In this regard, the Federal Government intends to examine how their specific features – network effects, interdependencies between platforms, the collection of a large amounts of user data – can be taken into account in a competitive assessment even outside of merger control.
There have been marked reactions in the German start-up scene to the Federal Government’s announcement within a very short period of time. Some are afraid that the plans would not only mean an additional obstacle for financially strong investors seeking to acquire or invest in start-ups, but that they would basically prevent such venture capital transactions.
The cause of concern is not the transaction value as such…
This concern seems to be a little exaggerated. In fact, the transaction value to be introduced by the planned Act is not known yet. Such a criterion for merger control procedures is indeed rare. However, it is precisely in the United States – virtually the heartland of Internet start-ups – that a “size of transaction” test has been applied as a threshold for merger control for decades. Transactions from a value of currently US$312.6 million require filing in the United States even if the parties to the transaction (and in particular the target company) generate only a minor turnover in the United States. If the transaction value is higher than US$78.2 million but below US$312.6 million, a filing is generally required only if one party has turnover or assets in excess of US$15.6 million, and the other turnover or assets in excess of US$156.3 million, in the United States.
It is not yet known what amount is intended to be determined for the transaction value if the plans actually result in a draft bill. The German Monopolies Commission, an independent advisory committee to the Federal Government, in its special report “Competition policy: The challenge of digital markets”, proposed a value of €500 million. A significantly lower amount should be neither in the interest of the Federal Government nor in the interest of the FCO. That is because the authority’s limited resources would then be tied up to a flood of merger filings with most of the transactions being of no significant competitive relevance. This would thwart the purpose of such new threshold.
It appears that the use of the transaction value as a threshold has had no impact on venture capital transactions, in particular founders’ exits, in the United States. At most, the transaction landscape may be affected if a very low transaction value is set above which merger control would be triggered.
…but the interpretation of the term itself…
The additional work resulting from the introduction of a threshold based on the transaction value, however, will not predominantly depend on the nominal amount of the transaction value. In practice, it will be more important how the transaction value is to be calculated.
Transactions with a fixed purchase price, including if applicable the assumption of liabilities of a certain amount, should be unproblematic. However, difficult questions of interpretation can arise for example if sellers are offered the option to receive purchaser’s shares in consideration and holding periods are agreed in that context. Would the transaction value in such a case have to be determined based on the value of the options at the date of signing of the contract, or based on their value (or presumed value) at the date of granting, i.e. at the closing of the transaction? Or does the transaction value depend on the value of the options on expiry of the holding period? How should arrangements be dealt with under which at least part of the purchase price is to be determined only at a later point in time? Will it be necessary to perform an enterprise valuation for every transaction and, if so, is such valuation to be governed by the Principles for the Performance of Business Valuations (IDW S 1), the standard of the German Institute of Public Auditors? What valuation standard is to apply if the purchase contract is not governed by German law?
If the lawmakers intend to leave these questions of interpretation up to the FCO, it would be desirable for corresponding guidelines to be developed in close consultation with those affected the most – start-ups, venture capital and private equity investors and M&A experts – to provide market participants with practical and, most importantly, easy-to-handle guidelines.
It will also be important to design the new threshold in such a manner that the transaction value is related to Germany. According to the Monopolies Commission, it would suffice if at least one of the undertakings participating in the transaction generates a turnover of more than €25 million in Germany. This threshold, however, could also be met by the investor alone. As a result, even the acquisition of start-ups which are not (yet) active in Germany could be subject to German merger control. Arguably, a filing requirement could be denied in this case based on a lack of domestic effects (Sec. 130(2) ARC). However, this leaves room for interpretation which is not conducive to the predictability of transactions. For a sufficient connection to competition in Germany, it therefore seems preferable to determine as sole (or at least one) criterion that the target company has at least some, not completely insignificant assets or turnover in Germany.
…and most of all the competitive assessment by the FCO
The requirement of a merger control procedure in the acquisition of start-ups will be an obstacle above all if the transaction raises competition concerns. It is therefore decisive whether, as part of the 9th amendment to the ARC, the FCO’s material assessment criteria are to be tightened as well.
Up to now, a transaction can only be prohibited if the FCO shows that the transaction would result in a significant impediment to effective competition, in particular by establishing or strengthening a dominant market position. The lawmakers should not change this standard in future.
Start-ups often provide services which were previously not available or not available in that form. It is therefore often unclear whether such services are to be qualified as belonging to an already well-defined product or services market or to a new one, and in the latter case, how such new market should be delineated precisely. The business ideas of start-ups are also often comparatively easy to reproduce, so that many competing providers are quickly formed which offer the same or very similar service or product. It is not least in the platform sector that the half-life of market dominance can be short. Who still remembers former “Internet giants” such as AOL, MySpace or StudiVZ?
As before, the FCO will have to take into account these dynamics of the “new markets” when deciding on the competitive effects which a transaction may have. Being overly careful in taking such decisions would also in future do more harm than a “false positive” decision, i.e. clearance of a transaction that later turns out to be critical in terms of its effects on competition. The examples of hotel booking portals Booking.com, Expedia, and HRS show that competition authorities do not need merger control to be able to investigate (presumably) anticompetitive conduct of Internet platforms. On the other hand, an assessment of transactions in the start-up sector which is too critical could lead to major economic disadvantages in the medium or long-term.
The planned introduction of an additional merger control threshold based on the transaction value should per se not prevent venture capital transactions. The amount and definition of the relevant transaction value should, however, be determined reasonably. In order to ensure a sufficient connection to competition in Germany, a minimum should be fixed for the target’s turnover or assets in Germany as a criterion to be applied in addition to the transaction value.
The degree of additional burden resulting from the planned new regulations will therefore not so much depend on whether, but much more on how, a merger control assessment is carried out. Both the lawmakers and the FCO are called upon to exercise caution. The currently applicable law already provides for a sufficient set of tools to tackle actual or presumed restraints of competition and abuses of market power. If the Federal Government intends not only to introduce an additional threshold, but also to tighten material assessment criteria in merger control, that would not only be needless but also less than conducive to a lively venture capital scene and, therefore, economically counterproductive.
Any questions? Please contact: Dr. Kathrin Westermann or Peter Stauber
Practice Group: Antitrust & Competition