Tech M&A: Recent "Acquihires" in the Tech Sector

The tech sector has seen a number of recent high-profile exits by AI and other technology companies in the form commonly known in the industry as "acquihires", certain of which have attracted the attention of regulators in the UK, US and elsewhere.

What do we mean by an "acquihire"?

While a traditional M&A transaction is structured so that a buyer acquires the shares of a target company, there have been a number of recent high-profile acquihire transactions structured so that the buyer hired a team of founders and engineering talent ("Founders") and licenced (or acquired) the target's core IP. In this structure, the economics are primarily directed to the Founders (via signing bonuses, retention payments and vesting stock options in the buyer) and the target, where there is an IP licence (or acquisition). This 'pick and choose' structure can be seen as a variant of an asset sale that is almost unique to the technology sector, placing little to no value on the target outside its Founder team and IP. 

Why would stakeholders pursue an acquihire instead of traditional M&A or IPO exit?  

Given that a share sale (M&A) is the more common and well-tested structure, it is worth considering why stakeholders would choose this more unusual transaction structure.

• Frequently, these transactions occur where a start-up has had difficulty raising additional funding on acceptable terms, it has not been able to find an acquiror for its shares (M&A), and an exit via IPO is not available. It may be that the target has outstanding liabilities or holds non-core assets that make a share sale challenging.
• For the Founders, it may be that an acquihire is a face-saving option where they can communicate to the market that they were "bought out" rather than announcing that they left their own start-up to join another company.
• For investors in the start-up, an acquihire isn't ordinarily the optimal outcome as they would not receive sale proceeds directly (given that the target's shares aren't being acquired). However, in practice investors often use their leverage to negotiate to receive, directly or indirectly, a portion of the acquihire proceeds. This outcome may be acceptable to investors as long as it yields a better return than the alternative, i.e. liquidation. 
• The acquihire structure may also be a means of enhancing what would otherwise have been straightforward 'poaching' or defection of a startup's talent by ensuring a return of some value to the investors, which in turn helps Founders and investors maintain good relationships in what is often a small tech ecosystem. 

Key considerations when considering an aquihire transaction

Before embarking on an acquire transaction, there are a number of key questions that need to be anticipated and considered:

Allocation of proceeds

The buyer, Founders, target and its shareholders will need to consider how the total proceeds for the transaction will be allocated between stakeholders:

• Typically, proceeds will be directed to the Founders in the form of compensation (i.e. signing bonuses, retention payments and vesting stock options in the buyer) and, if applicable, the purchase price or licence fee for IP.  The allocation between compensation and IP fees will need to be negotiated and the Founder and target may have divergent interests, with each requiring their own legal counsel. Frequently, the licence is put in place to protect the buyer from potential IP infringement claims by the target or its shareholders in relation to the hire of the Founders.

• Unless the acquihire were to be structured as a share sale, there would not be a purchase price payable to the target's shareholders. However, in practice the investors would nonetheless hold leverage in the form of approvals, waivers and consents and indemnities necessary to implement the acquihire (see below). In these circumstances, the investors may condition their cooperation upon the transaction being structured so that they receive a portion of the 'deal consideration' (often a 1x return to the investors).

Merger/regulatory approvals

A key question from antitrust regulators in the US, UK and elsewhere is whether these acquihires are in fact de facto mergers that are subject to notification to or investigation by  the competition authorities. Certain transactions have caught the attention of US and UK anti-trust regulators e.g. the Microsoft/Inflection AI transaction is under investigation by the US Federal Trade Commission and the UK Competition and Markets Authority (CMA). The CMA have also launched a Phase 1 investigation of the transaction, having concluded that the arrangements amount to a merger under the  UK merger rules; the CMA will now consider whether the transaction has a realistic prospect of resulting in a substantial lessening of competition in the UK such that a detailed Phase 2 review is required.  The UK is a jurisdiction with a wide reach in relation to acquihire transactions given the flexibility of the concept of a merger under UK law. A merger will arise where two "enterprises" cease to be distinct, and an enterprise is defined as "the activities or part of the activities of a business", with the consequence that hiring key staff and acquiring IP rights will often satisfy the test.

Structuring considerations

An acquihire transaction structure raises numerous issues and careful consideration should be given to the following:

• the extent to which the target company will be wound down or liquidated, its timing and how the target will address its outstanding liabilities (e.g. tax, employees, creditors).
• the consequences for any remaining employees (e.g. retention or termination, restrictive covenants, winding down stock option plans). If the target company continues to exist, then a key question is whether all or some of the remaining employees will be retained (on existing or possibly new contracts of employment) or made redundant subject to the  necessary notification and consultation obligations.  If the target company is wound down, the parties may need to consider the implications of the Transfer of Undertakings (Protection of Employment) Regulations 2006 ("TUPE") and whether the remaining  employees and any liabilities associated with their employment will automatically transfer to the buyer.
• the terms of any IP licensing arrangement (e.g. exclusivity, revocability, term, fees, geographical or other limitations).
• the structure of an acquihire from a tax perspective – the corporation tax and VAT treatment of payments may vary significantly from a traditional asset or share purchase and the implications of this for potential returns to founders and investors will need to be understood.

Give the relative complexity of the above, it is often worth confirming whether structuring the acquihire as a traditional share sale remains an option.

Employment restrictions

• Founders would usually be subject to obligations towards the target, including confidentiality, non-compete provisions and fiduciary duties of loyalty. The buyer and the individuals concerned would need to consider carefully whether moving to the buyer would expose them to claims by the company or its investors for breach of these obligations. For this reason, a buyer would want to seek indemnity protection from the target's investors as part of an acquihire transaction. In practice if the investors benefit from the transaction (see above) this should be forthcoming.

Investor/shareholder approvals

• In a typical M&A transaction, investors are selling the target and receiving proceeds. In an acquihire, the buyer is often negotiating with the Founders directly and the target would be involved to the extent there is an acquisition or licensing of IP. The exception is where the investors benefit from investor consents or veto rights triggered by e.g. a transfer of key IP. To avoid the risk of being sued for the 'poaching' of the Founder team, the buyer may also seek a covenant not to sue from the target and its shareholders. As noted above, shareholders may require payments in return for granting these approvals, consents, or releases.

Reporting obligations

• This applies to both the buyer and the target. Where the buyer is a listed company, it will be important to consider how the transaction is described to investors and the public in investor materials. Examples have been cited where the compensation paid to hired founders and employees were reported as "acquisition value". Caution is advised regarding these announcements particularly if the buyer is a listed company where shareholders or regulators could take action for deficient disclosures.

Companies, founders and investors considering an acquihire structure would be well advised to seek specialist legal counsel regarding the corporate M&A, structuring, antitrust, employment, IP and tax issues and the Ashurst team would be more than happy to discuss various options and the pit-falls to be avoided.

Authors: Chris Grey, Partner; Jonathan Cohen, Partner; Stuart Dullard, Partner; Duncan Liddell, Partner; Nigel Parr, Partner; Steven Vaz, Partner; Sunny Kumar, Partner; Crowley Woodford, Partner; Nicholas Gardner, Partner; Aaron Cole, Senior Associate