1. No private equity M&A boom in 2025, but….
Thousands of private equity portfolio companies are past their “sell by” dates and private capital institutions have trillions of dollars in dry powder to finance everything from senior debt to equity for purchases of these companies by M&A buyers. This seems like a perfect formula for an M&A explosion, right?
- Price will not be a friend of portfolio company sales. Many of these private equity portfolio companies were bought at relatively high prices and when interest rates were lower. It’s doubtful that interest rates are going to return to such low levels and even more doubtful that buyers are willing to pay those kinds of high prices right now given macro uncertainties and the performance of these companies over the last few years. The private capital professionals whose funds own these portfolio companies will be disincentivized to sell at mediocre returns that don’t result in their receiving personal windfalls.
- New era of fund-level innovation will continue to transform private equity liquidity. Let’s assume that the assumptions underlying the preceding paragraph are wrong – i.e., markets and portfolio company performance shift so that M&A and IPO exits of portfolio companies the old-fashioned way start to make financial sense. Even if that were to occur, we need to recognize that the stagnation of private equity exits over the last few years has opened a door that is not going to shut in 2025: We have entered the golden era of private capital fund innovation in fund-level liquidity as an alternative to M&A and IPOs. The GP-led secondary markets, pervasive use of continuation funds, preferred equity and NAV loan markets, and LP secondary markets are just the beginning. 2025 will be the year when we realize that fund level transactions are here to stay as the primary vehicles for private equity liquidity.
- Private equity take-privates of public company targets will be sporadic. Public companies will continue to employ the private equity playbook – cost-cutting, operational reforms to enhance efficiency, non-core assets divestitures and wind-downs, returning cash to equity holders, and incurring debt and investing heavily in capex, marketing, R&D and other areas that reliably promise substantial near-term upside. Thanks for this direction among public companies goes to not only the activists, but also the actively managed funds that, although not running flashy activist campaigns, will continue to aggressively push companies in their portfolios to adhere to this model while remaining public. Boards and executive teams at publicly listed companies will continue to live in fear of stepping outside this private equity model. Moreover, the alarmist horde of activism advisors, eager to tell clients that an activist campaign is a heartbeat away, will further reinforce this discipline. The results are that (a) there’s not much left for the private equity guys to do to “add value” if they were to take these companies private and (b) the market is already fully pricing these companies for including all these private equity value-additive strategies. The board room refrain of “we can do X only if we were private,” is largely over. There will be sporadic take privates by financial sponsor groups at a similar pace to 2024 and likely a few splashy ones due to the eagerness of sovereign wealth money to be active, but the financial sponsor take-privates that we will see will primarily be: (i) weak performers that have not received the message that they should be operating in the private equity model while public or that are simply poorly run and do not have the wherewithal to overhaul their operations and strategy; and (ii) controlled companies where the founders or other controllers do not want to deal with the burdens of being a public company much longer. There will be a lot more activity doing private equity investments in infrastructure, data centers, and related energy projects than in the sponsor take-private realm. This means 2025 will be another tough year for public company boardrooms dreaming of an easy private equity exit.
- M&A exits of VC-backed, founder-led companies will be similarly limited. Just as private equity portfolio companies will not be rushing to M&A and IPO exits in 2025, we will see a similar trend among venture-backed, founder-led tech companies. The eco-system for many of these companies to continue to raise money, find liquidity in secondary markets, and permit employees to monetize their equity awards through tender offers will continue to flourish without interference from the SEC in the coming year. Eventually, the privately-held world will have its own Enrons and Worldcoms, and then we’ll have a S-OX for the private world and the SEC scrutiny will step up, but we are not there yet.
2. Regulatory will remain a challenge for M&A. Let’s assume a best-case scenario for M&A arises from the replacement of Khan/Kanter with Ferguson/Slater – i.e., the US agencies return to more traditional economic-based, consumer-welfare focused analysis and a willingness to engage proactively in constructive dialogues about remedies and consent decrees to enable approvals of M&A transactions. Moreover, let’s set aside that there’s lots of room for uncertainty on this assumption given the mercurial nature of the incoming administration. Even under these circumstances, regulatory approval risks are going to remain a serious issue for M&A in 2025.
- First, boards of directors have been traumatized by the Khan/Kanter years. Directors are now fluent in concepts of “hell or high water,” “efforts covenants,” “outside dates,” “regulatory reverse termination fees,” and, most importantly, the risk that a deal may actually be blocked. No target company board is going to be prepared to welcome an attractively priced bid if they are not first hearing a compelling narrative about the regulatory approval timeline, likelihood of approval, strategy for obtaining approval, and allocation of the risk of non-approval.
- Second, the complaint in Albertsons vs. Kroger (filed Dec. 14, 2024, Del Chancery) spells out, more clearly than ever before, a major risk that haunts M&A: The target company’s complaint highlights (ironically given that the author is the target company) just how hard it is for a target company to enforce even a strong set of “efforts” covenants in a merger agreement. The lesson from the Albertsons case, even if the target company-plaintiff prevails, is that, even with a target-favorable set of antitrust “efforts” covenants and a lengthy outside date, a target can easily end up losing over a year tied up by interim operating covenants and be left simply with a tough haul on a litigation. Bidders can expect much tougher negotiations of these provisions in the coming year.
- Third, despite the fact that Khan/Kanter may not have had that impressive a batting average in blocking mergers, they did cause the federal judiciary to block a sufficient number of high-profile mergers that they succeeded in normalizing the idea for judges, boards and others in the dealmaking world that the blocking of an M&A transaction is not a blue moon event but a real risk for every single business combination. Going forward, even under Ferguson/Slater, signing up a merger in reliance on the instinct that antitrust approval “should not be a problem” is not going to fly in the boardroom. This risk for every merger will need to be seriously diligenced with the results memorialized and understood in advance. The return to casual, “we don’t think it will be an issue” days in the boardroom are over for the time being.
- Fourth, to the extent the new HSR rules go into effect in January 2025, they will increase the scope of documents turned over to the US agencies in initial HSR filings. The result will be an increased focus, in advance of signing a merger agreement, on language used in the merger parties’ respective internal documents that allude to potentially anti-competitive effects of mergers. This expanded scrutiny will further enhance anxiety among advisors and, in turn, clients about antitrust risks.
- Fifth, CFIUS and non-US foreign investment regimes are going to continue to ramp up their intensity. The trajectory of CFIUS – increasing breadth of focus (far beyond Chinese buyers), depth of internal resources, and lack of hesitancy to require more time and information – has been steady from Obama through Trump-1 through Biden, and therefore is not likely to deviate going forward (subject, again, to the usual carve-out for the unpredictability of the new administration). Meanwhile, outside the US, these regimes have proliferated and have similar trajectories. One additional risk to watch out for in 2025 is the potential for the enhancement of restrictions by the US and other nations on their domestic companies investing abroad.
All that being said, we will see boards of some sizeable, publicly listed companies take the plunge and sign up exciting merger of equals transactions, especially those involving the synergies that arise from combining operations in multiple jurisdictions.
3. M&A litigation and what’s in the cards for Delaware in 2025.
- Corwin, Trulia and MFW will remain the three great walls to protect M&A from litigation challenges. Of the three, MFW is currently the easiest safe harbor for plaintiffs to sabotage and therefore conflict M&A (i.e., M&A involving controlling stockholder buyers, or target CEOs who engage in duty of loyalty missteps by taking care of their own personal arrangements while getting out ahead of, and lacking candor with, their boards during sale processes) will continue to be the focus of M&A litigation. We will see Delaware decisions in 2025 strive to add more certainty to the ability to secure the MFW safe harbor and to decrease anxiety about the appropriate level of disclosure to boards and shareholders about the relationships and interests of advisors.
- We’ll hear noise from the Republicans in Washington about the benefits of federalizing corporate law, just the way we did from some Democrats during the early years of the Biden administration, but these will ultimately fizzle.
- The myth that it is easier for a controller in Texas to engage in self-dealing transactions will be debunked as the Texas Business Courts start to apply their doctrines for conflict scenarios, and we learn that they are not that dissimilar from the entire fairness doctrine.
- The most important tell in 2025 for the future strength of Delaware will be where the class of 2025’s US IPO issuers incorporate. IPO advisors love to do everything the way it was done the last time there was a successful IPO. That approach bodes well for Delaware. Nonetheless, expect directors and, even more so, founders during IPO planning sessions to start to ask about incorporating in states other than Delaware and whether that is advisable and what the costs and benefits will be.