Rachel Willcox 7 Mar 2018 12:32pm

Are M&A rules a blow to tech?

There is an international trend for controls on inward investment as technology is positioned as a threat to national security. Could tech sectors suffer if M&A rules tighten? Rachel Willcox reports

Caption: Photography: Getty Images

You were ever in any doubt about the UK government’s concerns about potential meddling by the Russians in Western democracies, “that speech” at the Lord Mayor’s banquet pulled no punches, overtly condemning President Putin’s alleged campaign of cyber espionage, fake news and electoral interference.

“I have a very simple message for Russia,” Theresa May told the banquet audience in November. “We know what you are doing and you will not succeed.”

The extraordinary speech by the prime minister marked something of a seminal moment in diplomatic relations with the Kremlin, although a public dressing down is unlikely to have much of a dissuasive impact on any dubious goings on.
As the political battleground shifts from firepower to the “weaponisation of information”, it is clear the government has set its sights on the use of technology as one of the biggest threats to national security in recent times.

It is no coincidence, the government has outlined plans to beef up its powers for scrutinising the national security implicationsof particular types of investments, under the auspices of its National Security and Infrastructure Investment Review. The Green Paper, published in October 2017, is the result of the government’s review of the Enterprise Act 2002 and brings under the spotlight the scope of transactions subject to public interest review.

The risks

The vast majority of investment into the UK’s economy raises no national security concerns, the paper states. “However, we need to be alert to the risk that having ownership or control of critical businesses or infrastructure could provide opportunities to undertake espionage, sabotage or exert inappropriate leverage.”

The government’s proposals are divided into short- and long-term plans. In the short term, it proposes amending the existing jurisdictional thresholds for mergers in the military and dual-use sectors – items used for civilian purposes that may have military applications – and parts of the advanced technology sector. For these areas, together with media and financial sector deals, the government proposes to lower the UK turnover threshold from £70m to £1m and to remove the requirement for an increase in the share of supply, meaning that the target alone could trigger the 25% share of supply threshold. New legislation could be in force in early 2018.

In the longer term, the government intends to undertake “a comprehensive reform” focusing on whether foreign investment in businesses essential to the UK raises any national security concerns. Two potential reforms have been identified: an expanded version of the “call-in” power, which will allow the government to use the current voluntary notification regime to scrutinise a broader range of transactions of national security concern than it can review at present; and a mandatory notification regime for foreign investment into identified key parts of the economy, or into specific businesses or assets. The consultation on these longer-term reforms ended on 9 January.

The challenge

Bearing in mind the considerable benefits brought by foreign direct investment (FDI) to the UK economy – the injection of foreign capital, new jobs, ideas, talent and leadership – the challenge facing the government is to strike the right balance between protecting UK jobs, know-how, and technology without putting the brakes on inward investment and an already shaky M&A market, reeling at the uncertainty brought on by the UK’s decision to leave the European Union and the General Election in June 2017.

The government says it expects the need to act would be relatively rare and it is also at pains to stress that scrutiny does not mean making any part of the UK’s economy off-limits to foreign investment. But despite promising that reforms will only be necessary and proportionate steps to protect national security, there is genuine concern that swathes of technology companies could be inadvertently caught in the crossfire of new rules.

Despite pledges from the prime minister that the UK will remain “open for business: open to investment in our companies, infrastructure, universities and entrepreneurs”, any protectionist measures are at best unhelpful and at worst detrimental to an already unsettled market, warns David Petrie, head of ICAEW’s Corporate Finance Faculty.

“We have one of the most favourable regimes to encourage foreign investment. The problem here is one of dual use [technology that can be used for civilian and military applications]. Unless the regulations include clearly-set out tests, a large number of tech-related deals or new investment arrangements could be delayed as a result of referral to the Competition and Markets Authority (CMA),” says Petrie. “Private equity firms may be reluctant to invest if the acquisition options are severely limited by legislation.

The warnings

A formal response submitted by the Institute warns that the success of any reform will hinge on a combination of targeting clearly-defined sectors and transactions; and a highly-effective screening process. “The targeting point will prevent uncertainty and ambiguity over interpretation, either of which will hold up investment. The point about process recognises that efficient implementation of the regime will be key – adequate resources and sector experience will be necessary to deliver the service so that the operations of the businesses involved are not unduly disrupted,” it says.

ICAEW also urges the government to pursue joined-up policies so that reforms in this area do not undermine the impact of measures announced following the Patient Capital Review consultation, which focused on measures to increase the supply of capital to growing innovative firms.

The importance of the tech sector to the UK economy was drummed home by the latest Tech Nation report, which found that the UK leads in Europe, attracting £28bn in technology investment since 2011, compared with £11bn in France and £9.3bn in Germany. The digital economy, which is growing at twice the rate of the wider economy, now contributes around £97bn per year, up 30% in five years, according to the report.

“The tech sector is a source of real competitive advantage to the UK economy and if the ability to get a return or change ownership is limited, that could be really damaging. Our function is to make sure that investment and M&A activity can take place without being slowed down by the unintended consequences of well-intentioned government policy,” adds Petrie.

“The UK is a very attractive market for overseas acquirers and in 2017 over 40% of all UK technology acquisitions had an overseas acquirer,” says Brian Parker, co-founder and head of M&A at Icon Corporate Finance. Parker isn’t unduly concerned that reform of the rules will have a negative impact on the market and believes the UK will continue to be an attractive location for overseas investors.

But not everyone shares his optimism. Jon Gill, a partner at law firm TLT, believes the proposals are counterproductive to the UK’s goal of becoming a world leader in the “industries of tomorrow” and could have a chilling effect on investment. “The proposed definitions of these areas of advanced technology, being multi-purpose computing hardware and quantum-based technology, are not sufficiently well-defined to give companies and investors enough clarity on whether a particular transaction would fall within the scope of this regime,” Gill says.

Against a backdrop of growing protectionism globally, uncertainty is a deal killer warns Salmaan Khawaja, a director in the corporate finance advisory team at Grant Thornton. “The UK has long seen foreign investment in infrastructure projects and there has been a mechanism for dealing with it. But there is a risk that if the balance isn’t right it could create volatility and uncertainty for UK plc and for investors. If the UK is seen as a difficult investment environment, they will look elsewhere and the world is a big place.”

“The tech sector is a source of real competitive advantage to the UK economy. Our function is to make sure investment and M&A activity can take place without being slowed down by the unintended consequences of well-intentioned government policy”

The world view

What’s true is that foreign investment controls around the world vary widely. Following a review by the UK government of the approaches taken by the US, Canada, Australia and France, it considers that the UK’s current approach to scrutinising national security implications of foreign investment, particularly those into national infrastructure sectors, appears less well developed and more limited than in other countries.

Andre Pienaar, managing partner at specialist technology investor C5 Capital, believes the proposed changes would bring the UK in line with other G7 nations: “Developing a national security framework for technology investment has become the norm. It gives more certainty and clarity in terms of processes and approvals rather than the case by case approach we had in the past, and as an investor, we welcome it.”

Pienaar speculates that the risk of losing privileged access to the US market was more of a driver than a desire to follow best practice. “They may have developed a view that the UK could not be such a trusted investment partner because we did not have our own house in order.”

While the National Security and Infrastructure Investment Review isn’t perhaps enough in itself to cause concern, taken in the context of other attempts to tighten up foreign ownership, it may do little to boost confidence among foreign investors. The independent Takeover Panel’s proposals for reform of the Takeover Code came into effect on 8 January 2018, although its motivation is driven less by national security and more to ensure public funds are protected in merger situations.

Adam Hadley warns that greater recognition of the existential threat that technology represents is needed. He runs Tech against Terrorism, a UN project to help combat exploitation of technology by terrorists. “National security and technology are intertwined like never before and the government is right to be concerned. The challenge is, will they come up with the right solutions and is enough investment being made in this area?”

Pienaar too believes it is time for change. “We recognise the scale and pace of innovation happening now so making sure our own companies are protected is an important recognition of the threat environment.”