3 Key Trends Driving M&A in 2022

While the world has faced major challenges from the ongoing COVID-19 pandemic, these disruptions have also created many opportunities.  Nowhere is this truer than in the technology industry, which has been by far the most active area for investment by corporates and PE firms, with companies in technology, media, and telecoms (TMT) sector propelling the M&A deal pipeline.

According to Bain & Company’s Global M&A Report, 2020 saw the greatest decline, followed by the strongest rebound in the M&A market with more than 28,000 deals reached. Fast forward to 2021 and the first half of the year had already witnessed $2.9 trillion in global M&A activity which was already equivalent to 91 percent of 2020’s annual figure.[1] The last time a figure this high was recorded was in the 4th quarter of 2016 when TMT deals reached a record $249 billion.[2]

But what exactly is the driving force behind this momentum?

1. Digital Transformation

The first and most significant factor driving growth in this sector is digital transformation. 

Initially fueled by the Covid-19 pandemic, we are witnessing new technology and changing technology needs across every industry:

• Automotive companies are acquiring capabilities for autonomous driving and electric vehicles;
• Industrial companies are buying IoT solutions for Industry 4.0, what they call the 4th industrial revolution;
• Financial services companies are buying their way into peer-to-peer payments, e-commerce payments, and blockchain.[3]

As technology needs are changing, more companies are viewing technology capabilities as a strategic differentiator. In fact, a mere 11% of companies believe their current business models will be economically viable through 2023 and more than two thirds state they need to build new digital businesses to remain viable.[4]

So, it makes sense that a majority of M&A deals are devoted to helping companies gain new capabilities. In fact, new capability deals represented only 44% of large tech deals in 2015, but grew to 81% in 2020.[5]

Notably, more companies are focusing on bringing in-house critical technology capabilities, such as online delivery, telemedicine, teleconferencing, among others. Many dealmakers also view Tech M&A as essential to transforming their existing offerings and expanding into new markets.

2. Increased competition

The increased activity overall has also increased competition.

This is particularly true in the Private Equity sphere.  Together acquirers from other industries and private equity now account for nearly three-quarters of deals in the technology sector, up from about 60% a decade ago.[6]

We are also seeing both old and new players shake up industries through innovation with the emergence of HealthTech, FinTech, CleanTech, and EdTech- if you take an acronym and put tech behind it – it’s safe to assume that they’re booming!

Competition is also being driven by increased regulation, which would seem like a contradiction as usually more regulation means less deal activity, but investors are looking to “beat the clock” before new and more restrictive regulations are put into place and deals become harder to complete.

3. Superabundance of capital

Add to this competitiveness, a superabundance of capital which is driving high valuations and thus a favorable deal financing environment, which continues to drive deal making. One PE investor put it this way: “Every deal is now an auction process”. 

Globally, 25 private equity firms hold $509.81 billion in dry powder, or capital committed by investors that has not been invested or allocated.[7]

In turn, tech values continue to rise. The Nasdaq index, mostly made up of tech stock, and S&P 500 are up 43 and 41 percent respectively. This is also encouraged by government infusions. In Germany for example, the technology sector will benefit from a recent government announcement to invest 10 billion euros into the local tech ecosystem.[8]

Given these favorable conditions, Tech M&A looks set to be a part of all dealmakers’ future strategies. 

Success is not without its Challenges

While the tech sector has really seen unfettered growth and innovation for the last few years, there are big economic and regulatory challenges on the horizon such as increased regulation, tech protectionism and heightened compliance scenarios. 

In terms of regulation, we are seeing increased Government scrutiny worldwide on security, data, privacy and platform activity.  The examples are numerous; the implementation of strict privacy laws imposed on social media in India, the recent legislation on digital advertising in Australia, China’s new Data Security law that requires a cybersecurity review process and the proposed Digital Services and Markets Act in Europe with consequences that could hold tech companies responsible for data practices, increase disclosures, and tighten competition rules.[9]

Looking into 2022, we are also seeing increased tech protectionism and tightening of Foreign Direct Investment laws in part a response to Covid-19 for national security concerns and in general a rethinking of commercial implications of localized supply chains. 

In the UK the National Security and Investment act was passed in April 21, allowing for heightened scrutiny of cross-border deals & allowing the government to intervene in tech related industries.  The EU in return has also increase government powers to screen M&A deals via FDI regulations.

Compliance measures are also being spurred on by consumer demand and government treaties.  Notably ESG considerations have taken a place of importance in M&A deals, which has required the development of new diligence capabilities of ESG criteria.

Due Diligence- Identifying OSS

For investors who want to take advantage of this favourable deal-making environment, they must be aware of the challenges that come at the point of deal due diligence, specifically having the capabilities to comprehensively assess the use of Open-Source Software (OSS).

The reality is that software is ubiquitous, and you’d be hard pressed to find a company today that does not rely on it in some respect for their operations.  But in the field of tech M&A, it is essentially the crown jewels of a company. 

In fact, over 90% of code in modern software is Open Source, which makes sense due to the vast cost-savings and efficiency gains attributed to it.

So what is Open-Source?  In simple terms, it is third-party software that is covered by an open-source license.  Open-source software, like all software, is governed by copyright so that the software editor has exclusive rights to it. If a company cannot identify all their open-source code or dependencies they are likely unable to ensure that they are in compliance with OS licenses, putting them at risk of IP infringement, business disruptions, and reputational consequences.

The majority of IP law in the OS realm relates to license compliance, so while lawsuits and injunctions are certainly a real risk, they are less frequent.  More often, it is disruption of the business which occurs, and it can be severe.

A company that has a culture of noncompliance faces two important risks:

1) Many young programmers today see making contributions to OS as almost a right, so in the competition for talent, having a good OS reputation should not be underestimated

2) If compliance is being demanded, a company must decide whether to release the source code under the GPL license (and reveal their IP) or re-engineer the product.[10] 

It is extremely difficult to operate any company at scale without OSS – so it’s there and it needs to be identified early on given the risks involved.  And ultimately without using the right due diligence tools, the risk is that deals may be slowed down, devalued or occasionally unsuccessful.  Acquirers do not want to acquire a lawsuit or reputational risk and insurer’s counsel will not want to provide insurance without a clear picture of OSS issues. 

Due Diligence- Cybersecurity Threats

In addition to OSS, the biggest issue we investors are faced with is the pervasive and exponential growth in cybercrime. 

Every day, at least one of the top stories in any given newspaper, anywhere in the world, is a story about a major data breach or ransomware attack.  And these stories are just the tip of the iceberg as the majority go unreported or undetected.

The global cost of cybercrime and spending on cybersecurity - combined – is an estimated $1 trillion dollar drag on the economy.[11]  But the costs of a cyber-attack go beyond paying off a ransom: The financial impact of downtime to any given department in an organization is on average $600,000 alongside the hours of efficiency also lost.[12] Time and money may not be the worst thing to lose, as cyber risks can also lead to IP theft.

Reputational damage is also a serious consequence that can come from a data breach, leading to loss of trust for a company or brand. Due to these reasons, it comes as no surprise that cyber threats have surpassed over-regulation as the top concern for CEOs in the insurance, private equity, banking, and technology sectors.[13]

The importance of running a cyber assessment during the due diligence phase cannot be underestimated.  While a company may have state-of-the-art cyber security, if it acquires a company with weak security or existing vulnerabilities it could be liable for any damage from incidents that occurred prior to the merger.

Let Vaultinum worry about the risks

With 2022 presenting favorable investment opportunities in the technology industry, it's more important than ever that investors check the tech with a thorough due diligence.

Vaultinum has developed a solution – the Know Your Software Tech Due Diligence tool that provides investors and businesses with critical information on a company’s technology and operational environment.  The solution operates by assessing compliance, identifying vulnerabilities, mitigating risk and facilitating growth.

Know Your Software is a tool made up of two essential parts:

1) KYS Code Audit is a software source code scan that analyzes the components of a source code and provides a thorough risk analysis covering IP, Security, Scalability and Vulnerability.

2) KYS Online Assessment is a self-auditing series of questionnaires that offers Cybersecurity, Intellectual Property, Operations, and Third-Party Software assessments.

The results of the online assessment and code audit are then reviewed by IT experts, who adapt the recommendations to the context of the business. The report includes clear findings, illustrations, an estimated time of fix.

Speak to us today and find out more about how Vautinum’s Know Your Software Tech Due Diligence delivers the information needed to help make informed decisions without losing time or your competitive edge.

[1] Morrison Foerster / Mergermarket. “Fast Forward How Technology M&A is Reshaping Industry”, 2021.

[2] Idem.

[3] Bain & Company. “Global M&A Report”, 2021.

[4] McKinsey & Company, “Global Survey on Digital Strategy.” May 2021

[5] Bain & Company. “Global M&A Report,” 2021.

[6] Idem.

[7] S&P Global Market Insights, “Half a trillion dollars of dry powder held by 25 PE firms”, April 2021.

[8] Morrison Foerster /Mergermarket, FAST FORWARD How M&A Technology is Reshaping Industry, 2021.

[9] Idem.

[10] Above the Law / Fossa, A New Wave of IP Risks: How Open Source is Changing IP in the Software Supply Chain, 2021.

[11] Smith, Z.M., Lostra, E., Lewis, J.A. (2020). The Hidden Costs of Cybercrime. McAfee.

[12] Idem.

[13] PriceWaterhouseCoopers