With the advancement of digitalization in nearly every world of life and business, the importance of technology M&A transactions has also increased significantly – a trend that is expected to intensify in the years to come. Established business models of traditional industrial companies are challenged by easily scalable digital offerings; and institutional and financial investors, struggling with low or negative interest rates, seek appropriate and lucrative investment opportunities while minimizing risk amid the “money glut”. As a result, companies and financial investors are welcoming emerging start-ups, especially in the IT / software and healthcare sectors: in 2020 alone, according to PitchBook (European Venture Report 2020), European start-ups have raised nearly € 43 billion in investor funds, including nearly € 20 billion from strategic investors – two records that will (most likely) be set again in 2021.
Interest and instruments
In their (co-) investments in start-ups, financial investors mainly seek the highest possible financial return, which they realize in the event of an exit, i.e. a sale or an IPO of the company concerned. Depending on the respective orientation of the industry and the phase of the business, corresponding venture capital funds are set up and invest in selected start-ups over a certain period of time. The motivations of industrial companies, on the other hand, are more complex, but mainly strategic and aim, among other things, at access to new innovative technologies, a strengthening of the innovation pipeline or, in general, “learning effects”. and / or presence in the new emerging sector ecosystem of market players. Companies can cooperate with or participate in start-ups in different ways. Depending on the strategic objective and the sector, the following may be considered: (technological) development and cooperation agreements, licensing agreements, joint ventures, incubation / acceleration programs or investments in start-ups for which companies receive a minority stake in return. Firms generally invest through specially designed investment vehicles (called “enterprise venture capital”), but sometimes also directly “from the balance sheet”. In Germany and in Europe, enterprise risk capital is now an integral part of the (external) innovation strategy of companies.
Structuring of (co-) investments
Financial investors and strategic investors who invest in technology companies typically aim for a 10-25% minority stake. Depending on the stage of development or the liquidity needs of the start-up concerned, convertible bonds are issued as an alternative, allowing the investor to become a shareholder of the company during a financing round subsequent to a valuation of capped company (plus any discount). Financial investors are primarily exit oriented in their investments and tend to interfere less in operational issues of management. On the other hand, strategic investors attach particular importance to contractual regulations that allow them to acquire the start-up completely at a later date, or at least grant them a right of veto on the sale to competing companies, as well as a right of veto on the sale to competing companies. active influence and involvement in relevant decision-making processes, which is reflected accordingly in the governance of the start-up. However, the contractual fixing of acquisition rights in favor of strategic investors is a double-edged sword: it limits the start-up to a concrete exit option and can therefore have a negative impact on its valuation (achievable in the event of exit) in the long run.
Particularities of technological investments
The essential value of technology companies lies in the technology they have developed, their know-how and their key employees. Therefore, the “protection” of these critical assets plays a major role in technology investments. This is done, on the one hand, by contractual guarantees with which the respective company (and the founders behind it) ensure that the rights to the software concerned and the source code underlying it belong to the company and that the possible use of “open source” does not oblige the company to disclose its source code (“copy-left” effect). However, such standard guarantees are often not worth much in the case of start-ups (and the corresponding W&I insurance policies are not yet in place). Depending on the size of the specific investment, it may therefore be wise to subject the start-up to in-depth IP / IT due diligence and, for example, to identify the risks associated with the use of open source software by means of back duck due diligence as well as analyzing the existing IT infrastructure (s) and data protection management systems. In order to “lengthen” the risks to a certain extent, financial and strategic investors also invest in technology companies whose technology is still in the early stages of its development and commercialization depending on the achievement of certain technological milestones and / or commercial – and it is only when these milestones are reached that contractually agreed installments of the total investment are due. Finally, creating incentives for founders and other key employees as well as their retention in the company is of particular importance in technology investments. Particular attention must therefore be paid to the appropriate provisions to bind key employees to the start-up as well as to the usual non-competition clauses (and their support by appropriate contractual sanctions) in the event of departure from the company.
Success factors for technology investments
The key structural success factors for investment strategies for technology investments, in particular by industrial companies as part of their corporate venture capital activities, are: well networked within the parent company itself; a clear investment objective aligned with the industrial company’s strategy as well as clear indicators of success by which technological investments in the company are assessed (and, if necessary, terminated); rapid decision-making processes on (follow-up) investments that are not influenced by hierarchical levels; and finally, the establishment of organizational and human “bridges” between the start-up and the company, which on the one hand allow the start-up to access critical resources and company experts, and on the other hand allow the knowledge gained from the technological investment for the company to be used in the best possible way and in the right place in the company.
(Co-) investments in technology companies open up great opportunities for financial investors and strategic investors to participate financially and / or strategically in current growth trends. At the same time, the structuring of such investments entails a complexity that should not be underestimated. Due to lowered thresholds (according to the 17th Amendment currently in force to the German Foreign Trade and Payments Ordinance, already from an acquisition of 10% or 20% of the shares) and further expansion in related areas security – in particular technological fields such as artificial intelligence, autonomous driving, robotics or cybersecurity – depending on the origin of the investor, the obstacles of foreign trade law must increasingly be taken into account and treaties in technology investments – a development that is expected to intensify in the coming years in view of the struggle between the United States, China and Europe for global supremacy in key technology industries.