Deep Dive: New Merger Guidelines and Private Equity
The FTC and DOJ (the “Agencies”) released their new Merger Guidelines on December 21, 2023, and they are packed full of information with a little something for everyone. In this Deep Dive, we examine the specific guidelines that are most relevant to private equity firms and their portfolio companies.
Although these guidelines are not legally binding law, they provide a better understanding of the Agencies’ decision-making process and the factors they will consider when examining whether a merger violates antitrust laws. Being aware of the guidelines that will most likely impact the private equity landscape will better prepare private equity firms, sponsors, other sources of private capital and their portfolio companies when analyzing the benefits and risks of a potential transaction.
Private equity acquisitions represent three-quarters of the mergers that are reportable to antitrust regulators, and the new Merger Guidelines certainly provide a basis for increased scrutiny on private equity transactions.
The guidelines – little “g”
As a reminder from our first advisory, there are eleven guidelines (with a little “g”) within the new Merger Guidelines: guidelines 1-6 describe the frameworks that the Agencies will use to analyze the mergers and any antitrust violations while guidelines 7-11 explain how those frameworks are applied in specific merger situations. Guidelines 6, 8 and 11 will likely be used primarily to analyze a transaction with private equity components.
Guideline 6: Mergers Can Violate the Law When They Entrench or Extend a Dominant Position
Guideline 6 provides that the Agencies will take into account whether one of the firms in a transaction already has a dominant position in a particular industry that the merger may reinforce. In other words, if you already have a large share of a relevant market, your acquisitions are subject to more scrutiny. This is nothing new. What is new is what effects the Agencies will analyze. The guideline states “the Agencies . . . may also consider the (often longer term) impact of the merger on market power and industry dynamics. Important dynamic competitive effects can arise through the entry, investment, innovation, and terms offered by the merged firm and other industry participants, even when the Agencies cannot predict specific reactions and responses with precision.” (emphasis added). It goes on to identify three key effects they are concerned about 1) raising barriers to entry or competition; 2) eliminating a nascent competitive threat; or 3) extending a dominant position into another market.
Raising barriers to entry or competition can happen in many ways but in its most basic form is when the actions of the dominant firm prevent a rival from successfully entering the market as a viable competitor or realistically continuing to compete in the market. One example of particular interest in the guideline is when a dominant firm acquires a service that supports the use of multiple providers, the dominant firm may have an incentive to modify that service to make it less useful to others or to steer customers to itself.
Eliminating a nascent competitive threat becomes relevant when a dominant company is attempting to acquire a company that does not compete yet, but might in the future, either itself or by helping other companies grow into more effective rivals. These acquisitions often are below the pre-merger notification threshold and are difficult for the Agencies to catch before they are consummated, but can become relevant as roll-up acquisition strategies grow and mature.
Private investment firms and their portfolio companies will need to consider all of these scenarios when making acquisitions in industries or geographies in which they or their portfolio companies already have a strong position. Further, if a private equity firm is having a great deal of success in a particular industry, it needs to be mindful that acquisitions in related industries that help extend their dominance in a market could also face scrutiny under this guideline.
Guideline 8: When a Merger is Part of a Series of Multiple Acquisitions, the Agencies May Examine the Whole Series
Guideline 8 makes explicit what the Agencies have been concerned about for years – making a series of smaller but accretive acquisitions in order to ultimately achieve a dominant position in a market. If acquisitions are small enough, they often fly under the pre-merger notification threshold so the parties do not have to notify the Agencies prior to consummating a transaction. Unwinding a consummated transaction is very difficult and often, in the Agencies’ view, does not fully undo the anticompetitive effects of a merger. In this version of the Merger Guidelines, the “Agencies feel compelled to address this expanding issue and will now consider individual acquisitions with a cumulative effect of the whole series.”
This “cumulative effect” will be analyzed by looking at the acquiring firm’s history and strategic incentives, both current and future. Evidence of the firm’s history is of course primarily based on the firm’s strategic approach towards acquisitions, both completed and contemplated, in any market. Evidence of the firm’s strategic incentives includes information found by reviewing documents and testimony reflecting the firm’s plans and strategies for the acquisition under examination and the firm’s position in the industry – making contemporaneous documents all the more critical. Agencies have broad power to request company documents from acquisitions in markets related to the one at issue and markets that are completely unrelated to the acquisition under scrutiny in an attempt to find and analyze patterns. Prior actions by the Agencies have emphasized quotes and messaging from investment firms and their portfolio companies with respect to creating a dominant enterprise within a specific market or industry, and these companies should be mindful of that fact when crafting marketing and pitch materials and in their internal messaging.
Other guidelines – for example, guideline 6 – may be used in combination with guideline 8 in a review of the cumulative impact of the pattern of acquisitions to determine if the strategies behind those patterns substantially lessen competition or tend to create a monopoly. A firm engaging in a pattern of anticompetitive behavior by conducting multiple acquisitions to create or entrench a dominant position may find itself in the crosshairs of an Agency investigation.
Serial acquisitions are at the core of private equity firms and their business strategies, and buy-to-sell and buy-and-build strategies bring these firms and their transactions directly into the spotlight of the Merger Guidelines. It will be imperative to monitor activity by the Agencies in this area to determine whether they are limiting enforcement to truly dominant or potentially dominant positions, or if their enforcement regime may challenge the private equity model as we know it.
Guideline 11: When an Acquisition Involves Partial Ownership or Minority Interests, the Agencies Examine Its Impact on Competition
Guideline 11 opens the door to examine acquisitions that result even in partial ownership or the grant of a minority interest. The Agencies have indicated that partial acquisitions that do not result in full control still present competitive concerns. But, in the past, these minority or co-investment situations were typically dealt with through non-merger antitrust laws. With these Merger Guidelines, the Agencies have made clear that they will analyze even minority investments, co-investments or partial acquisitions as a potential merger violation. This is a significant development for independent sponsors and their capital partners in today’s private equity landscape.
Acquisitions of partial ownership or minority interests are often coupled with certain minority protections and “veto” rights, which may still give the investor many rights in the target firm, including but not limited to, the “rights to appoint board members, observe board meetings, influence the firm’s ability to raise capital, impact operational decisions, or access competitively sensitive information.” These various rights provide even minority investors with the kind of “operational control” that the Agencies look for in their analysis of full mergers.
Owning less than full control of a target firm is not the shield from a merger investigation that was once believed, and firms cannot assume that a minority ownership position will allow them to escape an investigation.
This was discussed in our prior advisory addressing the FTC’s suit against Welsh Carson and U.S. Anesthesia Partners, Inc. (USAP) alleging anticompetitive conduct over a decade.This conduct included roll-up acquisitions of many large anesthesia providers, as well as price-setting agreements and agreements to divide the geographic area with another anesthesia provider, which allegedly created a dominant provider in Texas in violation of antitrust law. Welsh Carson owned less than 50% of USAP for the majority of the time at issue, but the FTC nonetheless alleged, consistent with the principles of guideline 11, that Welsh Carson directed its strategy and decision making in these illegal acquisitions and agreements. It is becoming clear that the Agencies are far more concerned with how much influence and control the investment firms have over their portfolio companies than they are about the percentage of the ownership interest.
Impact on Private Equity
The new Merger Guidelines put the touchstone of private equity – buy-optimize-sell – under scrutiny which will undoubtedly impact private equity firms’ tactics and potentially create a roadblock to their traditional portfolio investment strategies.
First, a core practice of private equity firms – serial acquisitions – is directly targeted by guideline 8. No longer will small acquisitions be evaluated (or avoid evaluation) on a standalone basis.
Second, the buy-to-sell strategy makes it difficult for portfolio companies to argue merger-specific efficiencies that may balance against anticompetitive effects. Because private equity firms generally buy with the focused goal of increasing value prior to selling the company, they often have limited interest in sharing costs, skills, strategies or customers among anyone else in their industry.
Third, minority positions are not a safe harbor if the investment firm is nonetheless the one calling the shots. The Agencies look to function over form and will analyze contemporaneous documents of both the investment firm and its portfolio companies to understand operational and management dynamics and motivations/modeling with respect to potential transactions.
While much remains to be seen with respect to Agency enforcement in these areas, private equity firms and other sources of private capital need to be prepared for increased scrutiny from the Agencies pursuant to the new Merger Guidelines. Firms with an established presence in an industry, through one or multiple funds or portfolio investments, should evaluate any subsequent acquisitions – even minority positions and co-investments – through the lens of the Agencies as outlined in these new Merger Guidelines. Antitrust counsel should be consulted as early as possible in the transaction process to analyze the firm’s action plan and assess any risk of an antitrust violation.
Buchanan’s antitrust, M&A, and private equity teams can help private equity firms, sponsors and other providers of private capital to navigate these issues with respect to their portfolio companies and investment decisions.