ITALY: An Introduction to Corporate/M&A: Mid-Market

The Italian M&A (Mid)Market 

In 2023 macro-economic conditions (uncertainty, high interest rates, etc) reduced the number of large deals in Italy, making the mid-market even more relevant. Overall, the M&A market saw a reduction in deals of only 4% (1,219 deals) compared to 2022, but an almost 70% reduction in terms of absolute value. The trend is confirmed for PE (same number of deals, around 500, as in 2022, but almost 70% less in overall value) and for VC (from 350 rounds to 300 rounds approximately, and minus 50% in value). All in all, 2023 provides a more realistic picture of the Italian M&A market and of its opportunities. Suffice it to say that only 1.3% of Italian SME's are invested by private capital and it should be noted that the drying up of IPO's due to the situation has not at all translated into a greater number of large PE transactions, confirming the reluctance of Italian entrepreneurs (also the bigger ones) towards private capital.

This state of affairs entails a notable and growing prominence of non (or, rather, “less”) institutional operators, whose weight with respect to more established buyers/investors (large corporations, large funds) is probably more relevant than elsewhere:

-club deals (structured or occasional), business angels, search funds, pledge funds, financial holding companies, etc. -family offices are certainly destined to play an increasingly relevant role. The market situation has led to several P2p transaction and subsequent delisting -and it is a fair guess that the trend may continue. Since these (formerly) listed groups were mostly in the hands of families, it is likely that the proceeds will be used to fuel private investments. Higher flexibility in the timing of exit and the understanding of the mindset of sellers (in turn, also mostly family owned) can make family offices an attractive alternative to proper PE funds; - corporate venture capital, though still marginal, is beginning to gain traction.

The Macro-Trend 

The overall effect is a blurring of the lines among the different investment and acquisition approaches, with many deals not qualifying as either exclusively financial or exclusively industrial. This leads to a kind of convergence or hybridisation of strategies and of the legal techniques implementing them.

Examples of the trend towards the 'industrialisation' of financial investments are, for instance, precisely the investments of family offices, which are characterised as super-patient investments, as opposed to traditional PEs, and with a different balance of contractual instruments (eg a different emphasis in the negotiation of how to enforce an exit). Or the add-ons in the PE's portfolio companies, which predominantly feed the mid-market (about 49% of PE transactions are actually add-ons). Or the accelerated buy and build schemes (that is, buying and merging more than one target at the very beginning of the investment period), most notably happening in the IT/digital space and which influence and complicate the deals (eg certain typical JV clauses or components can be found in these investment contracts that would otherwise be, strictly speaking, financial, for example in respect of governance). Examples in the opposite direction, i.e. of 'financialisation' of industrial investments are instead the still limited but growing role of corporate venture capital (which pursues strategic purposes but also uses financial metrics) and the portfolio approach (which presents similarities with the investment strategies of funds) adopted by some large industrial buyers.

All this translates into a kind of mutual influence or convergence among industrial M&A, PE and VC, which are also becoming fierce competitors in certain sectors within the mid-market. For example, higher rates and the reduction of valuations make industrial buyers to compete with PE’s more than before.

Legal Ramifications 

What does this mean from a legal/contractual perspective?

First of all, a variety of flexible approaches to troubleshooting and for narrowing differences. For example, a greater recourse to vendor loans, that help investors in calming down the higher cost of money and present interesting returns to sellers. Or a wider use of convertible loans or SFPs' (strumenti finanziari partecipativi, a sort of cross-over between equity and debt), since both instruments can be used to manage effectively the effect of uncertainty on valuations.

Investments/acquisitions in Italy have two main structural weaknesses. A normally lengthy process in the beginning and a lengthy and uncertain process at the time of exit. The former weakness depends on local practices: for example, negotiation around VC deals still remains very much influenced by PE approaches, for example to R&W’s, etc, which is a nonsense. The adoption of SAFE, or SAFE-like approaches, is starting to help moving things quicker. As regards exit, which may take a long time to be enforced, a variety of self-enforcing techniques (usually incorporated in the by-laws) are being more widely adopted. For example, by tying to the lack of compliance with option or drag obligations the exclusion of the breaching shareholder, or by using self-extinguishing participations.

This increased “creativity” in addressing problems is being made possible by a more open approach by Notaries (that in Italy play a crucial role when it comes to the do’s and don’t’s in the by-laws of companies) and also by Courts (though unevenly).

The W&I's/contingency insurance market is coming of age, and it is not anymore limited to PE. As these insurances are still under-represented, one should expect an exponential growth.

The reduction in valuations will probably lead to a wider use of continuation funds, that per se can lead to conflicts of interest issues. Once could therefore predict an increased litigation in that area (likely to bring more settlements on values rather than decisions of Courts).

Regulatory 

Due to size of transactions, the M&A mid-market has always been mostly under the radar of authorities and regulators, and thus regulatory issues have also received little attention by operators. But this state of affairs has changed and is continuing to change.

Firstly, due to the progressive extension (not without uncertainties) of the scope of the so-called “Golden Power(s)” (which, despite being an English term, is only adopted in Italy to define “CFIUS- like” scrutiny). The notification obligation depends not on size but on the holding of certain assets or the relevance of target in certain supply chains that are potentially strategic.

Secondly, due the recent change in merger control law that allows the IAA to require notification of acquisitions “below the threshold”, ie below the turnover threshold making the notification due by law, specifically if there might be anti-competitive effects; for example, but not only, in respect of “killer acquisitions”.

And it is worth noting that whilst Golden Power(s) regulation is neutral when it comes to fostering innovation (actually, it is seen by various constituencies as in principle “innovation-adverse”), the “below the threshold” merger control is aimed exactly at protecting the innovation capability of smaller firms. However, one will need to see in practice if it will be implemented to that purpose, or if it will just be an additional element of uncertainty.