Trends and Legal Considerations for M&A Activity in Spain

Introduction

This article will present an overview of the market, trends and legal considerations as well as an outlook for the future, all in relation to M&A activity in Spain. The topics discussed within this chapter are not intended to provide a thorough analysis of each case, but rather some guidelines to enable the reader to understand and visualise the main trends and their impact in the M&A market from a practical standpoint. 

Market activity

Not only has the Spanish M&A market had one of its best years to date in 2021, but also all the relevant key indicators provide grounds for optimism and belief that the deal activity and volume of M&A transactions will continue to be robust, both in terms of number of deals and mobilised capital. 

The improvement, and expectations of continuous improvement, of the COVID-19 pandemic situation around the world will foster an even more active M&A market, not only at the level of acquisitions but also with respect to divestments. In addition, the COVID-19 framework encouraged new consumer preferences to emerge, creating demand for new products and services and entirely new business models, which will continue to have a positive impact on the M&A market. 

M&A in 2021

According to the M&A report of Transactions Track Record (TTR) for 2021, the Spanish M&A market accounted for a total of 2,936 transactions (of which 2,657, or 90%, closed by year-end) implying that the aggregate deal value increased 1% to EUR-122.74 billion. The deal of the year has been the exercise by MásMóvil Ibercom of its squeeze-out right to acquire 100% of Euskaltel.

The real estate sector led by deal volume, with 578 transactions, up 14% over 2020; whilst the technology sector followed closely, with tech 555 deals, a 30% increase from 2020. The financial services industry ranked third for volume, accounting for 226 transactions, followed by the solar energy industry, with 210 deals, up 36% and 88% respectively from 2020.

Private equity deal volume in Spain increased 41% to 305 transactions in 2021, while the aggregate value of private equity deals grew 82% to EUR36.8 billion, based on 105 deals of disclosed consideration. 

Venture capital (VC) has been one of the areas where we see a significant amount of activity, since transactions increased 27% by deal volume and 7% by aggregate value in Spain in 2021, with a total of 724 deals worth a combined USD8.92 billion, based on 599 deals of disclosed consideration.

Finally, from an IPO perspective, the number of IPOs in Spain increased from 21 in 2020 to 27 in 2021, of which 20, worth a combined EUR-2.9 billion, closed by year-end.

Current trends

Business transformation

In response to the pandemic, companies are looking for different strategies that allow them to:

• improve their working capital optimisation, cash flow forecasting and cost reduction; and 
• expand their margin by rethinking their pricing strategy, product portfolio, market segments and geographies. 

In this context, many companies have implemented, or are considering implementing in the short term, different measures that allow them to achieve these goals, many of them through business restructuring and transformation, which is expected to have a great impact on M&A activity.

Beyond the more conventional M&A business strategies (eg, divesting non-core business lines, inorganic growth through M&A, cost-cutting by combining different organisations, etc), an increasing number of companies are pursuing M&A transactions that change their business and operating models. These are called transformative deals and are changing the way in which companies approach and execute M&A transactions.

Through this new wave of transformative deals, traditional industrial and services companies are looking for digital transformation, process simplification, automation and innovation in products and services, with the aim of obtaining higher productivity, more efficient procedures and offering better services and products to their clients. All these changes in their operation models also contribute to reducing their operating costs and increasing their revenue, while helping companies to better connect and interact with a new age of digital clients.

It should be noted that not only are the more traditional industrial and services companies on board with this new transformative wave, but the already innovative, digital and new-tech companies are also looking to remain as leading companies in their respective sectors. 

As a result of this business transformation trend, there has been, and is expected to continue in the near future, a remarkable increase in the M&A activity involving the acquisition of technology companies and corporate reorganisations that help them to maximise the synergies between said acquisitions.

Supply chain crisis

Over the last few decades, globalisation has led to the offshoring of supply chains to third countries, mainly in order to reduce costs.

However, in recent months the fragility of global supply chains (especially in certain sectors such as manufacturing) has become evident, caused by factors such as:

• shortages of certain raw materials and semi-manufactured products (such as microchips and other semiconductors), which have led to delays in delivery deadlines, production stoppages and the corresponding price increases; 
• significant increases in energy prices (the price of which continues to rise as a result of the Russia-Ukraine conflict); and
• tensions across global trade channels and logistics networks, in particular, maritime transportation, leading to increased transportation costs.

These factors are having an impact, to a greater or lesser extent, on the business activity of the companies and, consequently, on their income statements and cash flows. 

The supply crisis is also having a series of impacts on the M&A market, including the following.

• Regionalisation of supply chains – vertical integration operations are being carried out to strengthen or shorten supply chains, through mergers and acquisitions of companies that, for example, ensure the supply of raw materials, guarantee flexibility and improved response times, or a reliable logistics system because they are geographically closer. These actions, aim to acquire the highest degree of self-sufficiency possible and avoid, as far as possible, dependence on third parties.
• Digitisation of the supply chain – the COVID-19 pandemic has highlighted the fissures in traditional supply chains, leading to an acceleration of digital transformation processes. The digitisation of supply chains and, in particular, of the logistics area (for example, in connection with real-time data analysis), results in improved operational efficiency for companies. This business area, which is one of the pending issues for European companies (including Spanish companies), is generating great interest from investors, both private equity and corporates.
• Dilation of M&A processes – it is difficult to foresee the behaviour of the supply crisis and its specific impact on the business plan of each company, which makes it very complicated to determine the effects of this circumstance on the valuation of the target in a transaction. As a result of the above, M&A processes are being delayed, either because the conservative buyer prefers to wait a few months to observe the company's financial performance, or because due diligence processes are lengthened so that the buyer can carry out a thorough review that will reassure them when deciding to acquire a target. Additionally, and in relation to the valuation of companies, within the framework of certain M&A transactions (especially in certain sectors), price adjustment clauses are being included in the purchase and sale agreements based on the impact that the supply crisis may have on the target in question.
• Complementary sectors – the supply chain crisis is leading to the flourishing of sectors that are complementary to the hardest hit sectors. Consider, for example, the semiconductor crisis affecting multiple industries, such as the automotive industry, a key sector in Spain accounting for almost 10% of GDP. In this context, and in the face of a lack of semiconductors that is causing the stoppage or cutback of production plans for new vehicles, companies dedicated to the production of spare parts are arousing great interest (mainly in private equity).

As the supply crisis persists, interest in M&A processes aimed at redefining and securing the supply chain is expected to increase during 2022. 

Environmental, social and corporate governance (ESG)

Though ESG cannot be deemed as a trending topic in itself, its impact on the M&A market during the last 12 months, and  its anticipated constant growth as a matter to be taken into account in future deals, places it amongst the most relevant trends for market development in 2022. 

ESG has certainly become a more prominent factor in the way customers and society evaluate companies, which has fostered the fact that the organisations, in their capacity as potential acquirers, incorporate ESG metrics into target valuations and have re-evaluated their portfolios through the lens of ESG, driving them to urgently transform their core strategies. The reputational impact ESG matters have in the current market has significantly led the acquirers to seek to improve their ESG credentials, making ESG one of the most relevant drivers within the M&A decision-making process. All of the foregoing leads us to believe that every deal will be scrutinised on ESG parameters, in order to reduce risk and generate long-term value. 

Within this context, beyond their capacity to condition, impair or – on the contrary – boost a potential M&A deal, how do ESG issues actually impact an M&A process from a legal standpoint? 

• Due diligence scope – apart from the traditional areas covered within a legal-labour, financial and tax due diligence over a target entity, the ESG impact on the M&A sector has clearly enhanced ESG topics within the scope of due diligence, including new specific areas (many of them linked to the value chain verification) that are, however, part of the more generic traditional areas, simply expanding their scope, such as:
1. human rights and modern slavery issues, as well as equal employment opportunities, which can be framed within the labour due diligence;
2. pure environmental checks, ensuring the lack of environmental show stoppers, (public law and/or technical due diligence);
3. internal anti-corruption and bribery measures, as well as assessment of compliance with national regulations and international treaties that may be relevant within an ESG context (governance due diligence); and
4. full compliance with data protection matters, namely in those target entities which might handle a high volume of personal data due to their core business (legal-regulatory area) – the scope of any ESG due diligence work will be tailored to reflect the material ESG issues inherent to the specific target company. 
• Financial standpoint – one the best ways to foster an M&A market where ESG issues will become a driver is through interesting financing conditions for acquisitions that meet such ESG requirements. In recent years, in response to such demand, the financing markets have designed several types of financing with cheaper pricing and more attractive and favourable terms available. This point is closely linked to the prior ESG due diligence work, since one of conditions to be met for financing an acquisition under any of these financings would be the obtainment of a clean external due diligence report. The best example would green finance, which is any structured financial activity that has been created to ensure a better environmental outcome. However, there are some other financing alternatives linked to ESG purposes, such as sustainability-linked bonds, social bonds and hybrid arrangements. 
• Transactions documents – the positive outcome of a due diligence process carried out prior to the implementation of an acquisition, shall be reinforced by the inclusion of specific representations and indemnities to be granted by the seller within the overall set of R&Ws in the transaction documents. Before the ESG matters became a trend in the M&A market, traditional deal documentation already foresaw a general representation (compliance with laws), the aim of which was to cover these matters. Nowadays, the context outlined above demands specific representations covering such aspects and ensuring particular commitments from the seller within its liability regime. 

Cybersecurity due diligence 

The digitisation of processes encompasses multiple facets of a company's activity and cybersecurity challenges have begun to take on greater significance over the past few years. 

Cybersecurity is particularly relevant in certain industry sectors and types of companies, for example, those that handle personal data, financial institutions, etc. 

Therefore, cybersecurity matters have started to play an important role in several M&A processes: when acquiring a company (specially, certain types of companies), it is important to confirm in advance the creation and maintenance of strong cybersecurity protection systems by the target. 

There are several examples of companies that, as victims of cyber-attacks and security breaches (often caused by the inadequacy of their cybersecurity systems), have suffered not only material damages (such as payment of important fines or incurring unforeseen expenses in order to adapt cybersecurity systems to protect the company) but also reputational damages. These unexpected situations can be avoided if a cybersecurity due diligence is carried out in the framework of the M&A process.  

Cybersecurity due diligence is focused on key aspects, such as:

• the target's cybersecurity history (past data breaches, fines deriving from non-compliance with applicable regulations, etc);
• analysis of the target's current cybersecurity systems;
• cyber-risk review, as well as mitigation plans with prioritised tactical steps for remediation; 
• the calculation of cyber-risk costs and the impact on the overall deal price; and
• if applicable, the integration of the target's cybersecurity systems with the buyer’s infrastructure (identifying, developing and implementing controls and processes to support “day 1” activities).

In view of the above, organisations are expected to give increasing importance to cyber-risk management and include cybersecurity as part of the scope of due diligence in the framework of M&A processes.

Foreign direct investments 

Within the framework of protectionist trends at the regulatory level as a consequence of COVID-19, Law 19/2003 of 4 July on the Legal System of  Transfers of Capital and of Economic Transactions with Foreign Countries ("Law 19/2003") was amended in order to impose restrictions on foreign direct investments in Spain, suspending the previous deregulation regime. 

"Foreign direct investments" are understood as those made (i) by investors resident in countries outside the European Union (EU) and the European Free Trade Association (EFTA), or (ii) by residents of EU or EFTA countries whose beneficial ownership corresponds to residents of countries outside the EU and EFTA; and, as a result of which, the investor acquires a stake equal or higher than 10% of the share capital of the Spanish company, or acquires control ("control" is defined in Article 7.2 of the Spanish Antitrust Law) of the Spanish company.

According to the applicable law, it shall be mandatory to obtain prior administrative authorisation from the Spanish government if:

• the foreign direct investment is made in certain strategic sectors affecting public order, public security and public health (eg, critical infrastructures of energy, transport, health, communications, defence, etc); or
• the foreign investor, regardless of whether the investment is to be carried out in a "non-strategic sector”, has certain characteristics (eg, if a third country government, including public agencies or the armed forces, controls, directly or indirectly, the foreign investor, this could affect, for example, sovereign funds).

Likewise, the Spanish government may require prior administrative authorisation in relation to foreign direct investments in Spain in those other sectors not considered as strategic, when they may affect public order, public security and public health. 

If an investment subject to authorisation (taking into the account the above) is carried out without obtaining such prior authorisation, the transaction will be null and void and important fines may be imposed.

Additionally, the requirement of a prior administrative authorisation granted by the Spanish government shall also apply, until 31 December 2022, to “direct foreign investments” carried out by residents of countries inside the EU and EFTA in listed companies in Spain, or in Spanish unlisted companies if the value of the investment exceeds EUR500 million.

Spanish regulations related to the regime of foreign direct investments in Spain have raised many interpretative doubts, mainly as regards the determination, in practice, of the strategic sectors and investors affected by such regulations. In this regard, in the context of the execution of M&A transactions with foreign investors, there are many occasions in which doubts arise as to whether or not it is necessary to obtain prior authorisation. That is why, when in doubt, the parties to a transaction often adopt a conservative position and request authorisation in order to avoid uncertainties as to the validity of the relevant transaction. Taking into account that the obtainment of such authorisation can take up to six months, this circumstance is delaying many M&A processes.

As a consequence of the above, there is currently a draft regulation (pending approval from the Spanish government) that aims to shed light on the issue, developing the prior authorisation regime provided for in Law 19/2003. The main changes are as follows. 

• The procedure for requesting, processing and granting the relevant authorisation is regulated.
• The strategic sectors subject to prior authorisation for being potentially vulnerable are developed and specified. 
• Certain exemptions to the prior authorisation regime are established:
1. several exemptions in the energy sector, provided that certain conditions are met (eg, that the company does not carry out regulated activities or acquire the status of dominant operator in certain subsectors, etc); 
2. investments in companies with a turnover of less than EUR5 million, as they are considered to be of minor importance, provided that certain requirements are met (eg, that the target technologies have not been developed under programmes and projects of particular interest for Spain); and 
3. investments in real estate not assigned to critical infrastructures or to the provision of essential services.
• Interested parties may submit a prior voluntary consultation, which will be binding for the Spanish authorities, on whether it is necessary to submit a specific M&A transaction for authorisation. The Spanish authorities will have up to 30 working days to respond. The purpose of this measure is to clarify the procedure and, consequently, to reduce the number of transactions that in practice request prior authorisation.

COVID-19 as part of material adverse change (MAC)

A material adverse change (MAC) is a pro-buyer clause (particularly common in M&A transactions where the signing is deferred from the execution of the transaction ("closing")), the main goal of which is that buyer seeks to allocate to the seller pre-closing adverse change risk on the business, providing a way out for not closing the transaction. 

Among such pre-closing adverse change risks, we find:

• increases in raw material, commodities, labour or other costs;
• changes in financial markets, interest rates, currency exchange rates, unemployment levels or other macroeconomic conditions;
• changes in law that may have an impact on the target’s business;
• unwise business judgements; or
• force majeure events such as natural disasters, war or acts of terrorism.

While the COVID-19 pandemic situation and its impact on the worldwide market since 2020 has certainly decreased and there is a clear improvement in the markets’ confidence that there will not be further social lock downs like those imposed during 2020, the potential impact of COVID-19 is still being (and will be very likely during all 2022) included by buyer’s advisors as one such risk that may be deemed to have a potential material adverse effect, and is therefore included within the MAC clause. 

Representation and warranties insurance (R&W insurance)

Although, the use of R&W insurance (ie, insurance that covers potential damages derived from a seller’s breach of the representations and warranties granted to the buyer within the context of an M&A transaction) is less popular in the Spanish market than in other countries, the use of this type of insurance is gradually increasing year by year. In this regard, competition among insurers has reduced the average prices while increasing the coverage of the policies, and their more frequent use has resulted in a better understanding of their advantages and has accelerated the involvement of the insurer in the M&A process.

As a result, both sellers and buyers are increasingly motivated to engage a R&W insurance policy as they know that R&W insurance can:

• allow the seller to obtain a “clean exit” (ie, without post-closing liability risk or, at least, with a considerable reduction of such risk), while providing additional comfort to the buyer in cases of loss of solvency, dissolution of the seller or several liability scenarios among the sellers – this circumstance could be of high importance when the seller is a natural person, a private equity or a large group of sellers;
• reduce or even eliminate the need of collaterals to secure seller’s liability under the relevant transaction documents (eg, price retention, bank guarantees, escrows, etc); and/or

• make the negotiation of the relevant transaction documents easier, especially regarding seller’s liability (usually one of the most important and hardest topics to negotiate in any M&A transaction).

Moreover, and following the global trend, the “staple R&W insurance” (a target “tailor-made” R&W insurance proposed and negotiated beforehand by either the buyer or the seller) is also continuing to grow in the Spanish M&A practice, especially in organised auctions, beauty contests or organised selling procedures.