Podcasts

Tessa Bernhardt:

Hello, and welcome to The LathamTech Podcast, where we survey the latest trends in the world of tech and explore their impacts on your company – both the opportunities and the risks. I'm Tessa Bernhardt, a partner in Latham's M&A and private equity practice in the Bay Area. And joining me today is my fellow partner, Greg Roussel. Greg helps acquihires build long-term value through strategic transactions. Welcome, Greg.

Greg Roussel:

Thank you for having me.

Tessa Bernhardt:

In this episode, we're diving into acquihires. This transaction model has been around for many years, and is gaining increased attention given recent high-profile ones we've seen in the Bay area. So when I started my M&A practice, I started in a more East Coast M&A practice. I moved here in 2018 and I had heard of acquihires, but I'd never seen one beyond Silicon Valley, the TV show. And I remember doing my first one with you, and I was actually really surprised by the documentation and what went into it. It was very different than what I expected. And I think in the media, they're kind of described very liberally in a way that I think is a little confusing to understand exactly what goes into an acquihire. And I think that also translates into our relationships with clients who come in and say, “I really like this team. I want to do an acquihire.” And then but they don't know what it is, right? And that's a common question I had at myself when I first started. And so I think it'd be helpful to start off by just kind of describing what an actual acquihire is from a legal perspective.

Greg Roussel:

That's a great question. And I get it all the time from clients and friends and everybody else. So probably the best way to distinguish the two is go back to whenever we came up with it. This is probably 2009, at the risk of data myself here. We had just done a deal over like 3 or 4 days over the weekend, and it was a traditional acquisition. And it became very clear throughout the process that, when you only have a little bit of time, it really forces everybody to focus on what's most important. And not surprisingly, it's not the 50 pages of reps and warranties that the lawyers all negotiated and all these deals. And so really, the traditional acquisition structure was not that well suited to the transaction. I mean, sure, we want to make sure we don't have a lot of liabilities, but really, the whole weekend was very much focused on both motivating and retaining the key engineers of that company.

And then coincidentally the next weekend, same client gives us a call: “Hey, we have another deal. We want to do it just like the last one.” And it turns out that this deal with, the company was even less relevant, going forward. I don't think they even had a product yet. I think they were going to go out of, business pretty soon. It was ran out of money, and it was really about bringing over the team. And so I just kind of asked them, “why do we really even need to buy the company?” Like, we can still get money to the shareholders, we can still hire the team, and we can avoid liabilities, but we don't have to take on that corporate entity, or we don't actually have to buy the assets if you don't want them. And so that was how we came up with the release and waiver structure.

And so that's kind of how I would distinguish the two. And so if you're actually buying the entire company, even if it doesn't, you know, involve motivating the team and having different, you know, employment packages and things like that, you know, that's still more of a traditional acquisition if you structure it where we are just going to hire the team. There are some value that goes to the company or the shareholders as part of that, for the value that was created there. And as a way to maybe avoid, you know, particular like liabilities during unification or something like that. Then that's more of an actual acquihire because you're not taking on, you know, those typical assets or the corporate entity like you would in a typical structure.

Tessa Bernhardt:

I think that's a really helpful explanation. You have these two typical kinds of structures. You have the acquihire, which is really about the employees. It's a release and waiver document. It's a very short document. It's not focused on lots of reps and warranties, it doesn't have long indemnity, it’s just a very specific. And typically there's also a plan of liquidation or something attached to it with respect to the remaining company. And then you have, on the other hand, your acquisition, which doesn't mean you don't care about the employees. Many of our clients really care about the employees, and acquisition and retention is a key piece. But then they also care about the business – so they want all the reps, they want all the liabilities, they want covenants. And so I think that's the key is I think some people think oh acquihires is any deal where you care about the employees. And I think that's a little bit broader than the reality. I think a lot of our clients care about employees, regardless if it's an acquihire or a full acquisition. I think an acquihire is just you really only care about the employees, and then just protecting yourself on the back end, like you said, with respect to kind of certain liabilities.

I think over the years I've seen such a wide kind of example, what ends up happening to the companies where you do these acquihires. What is the typical, what is happening to these companies after an acquihire takes place there? Once these employees leave, what are you seeing happening to these companies?

Greg Roussel:

And that's a great question. And we've seen that, just proliferate over time because initially, the scenario we saw was, like I mentioned before, where the company was maybe going to go under and the team wanted a soft landing. And it turns out, they're really smart and had worked together really well, and so there was value created there, even if it wasn't what was owned by the company. And so by just hiring the team, you didn't really need the company to stick around much longer. And so a lot of times they would just be wound down. Maybe they would sell off a few assets if there was value there. As we're seeing over time, that model has changed a little bit because, there's all kind of different scenarios in the current environment where maybe there is a lot of value to that company, and a lot of times it's just they didn't quite need that particular team of engineers. And it was a great way for the company to realize value, either by way of future financing or some kind of other commercial agreement with the buyer. And, so there's a lot of things that can happen to a company after a group of people leave, in exchange for some kind of payment.

Tessa Bernhardt:

Yeah. I mean, that's interesting. And I think it hits on a question that I get a lot of – I'm sure you get this question a lot, too – is, I'll have a client who wants to do an acquihire, and they're like, “well, what do I pay the remaining company?” and you're like, well, it really depends. You know, I see can this number ranges so widely. I've seen thousand dollar acquihires to millions of dollars. And then in the news you're seeing billions of dollars in acquihires. And so various factors go into that. And the number of employees, what does the business look like at the end? Like what are you leaving behind? What is the license, look like that you're going to receive as part of the release and waiver? I think there's a lot of different factors that go into that. But because we're seeing values for acquihires that start to approach what an acquisition value is, why are people doing acquihires instead of an acquisition, when sometimes the value might be exactly the same? It's not necessarily cheaper. Why is that?

Greg Roussel:

There's a lot to unpack there. I think I would start with the fundamental question of what is the strategic value that the buyer is looking for. And so it could be one person, it could be ten people, it could be actually be “we want all of the employees.” Then it could also include “we actually do want some of the IP” and maybe there are some assets that are included as part of the purchase price, and that's up for the parties to negotiate. And it becomes very difficult to ascribe a particular value per engineer, like a lot of people talk about in the news. Whenever you have actually a lot of other assets coming over, you have a more complex commercial arrangement. And some of these employees are tremendously valuable, so they're not all the same. You can't just say $1 million per employee for an acquihire, whenever some of the people are worth $100 million and some are, you know, a half million, in terms of just the ability to hire somebody, in addition to whatever they're being compensated going forward. And so it is really a tough question to say what they should be valued at.

I probably would mention one rule of thumb that there's no magic to it, but coincidentally, we do see a lot of deals, like when I mentioned earlier where the company might be going under, where there's effectively a return of capital. And so if they raised $5 million, that's a good proxy or a frontier just as for what an acquirer were going to come in, return the money to their investors, they live to fight another day when a better investment. And then they will compensate the team going forward.

Tessa Bernhardt:

Which seems like, typically a very good result for those employees and the investors too. Now obviously not every deal is an acquihire, and that's probably because it's not the right structure for a lot of different transactions. And so what are some of the pitfalls that you see and reasons why you would not want to use an acquihire kind of release and waiver structure in a deal?

Greg Roussel:

I would say the biggest problem with the pure acquihire deal is that it's very, very tax inefficient. And so if you were going to do $1 billion acquihire, then that's going to be first of all, taxable to the company, just as if it were a license or other commercial deal. And then you have to then distribute those proceeds to the investors, at which time it will be taxable again. And so for a high-dollar acquihire like that, you're going to be paying tax twice on a lot of money. As the numbers get smaller, it actually makes a lot more sense from a tax perspective because the company might have enough wells to cover that payment. You could just be having a return of capital to the investors so that they don't actually incur more tax .

Tessa Bernhardt:

So break even.

Greg Roussel:

Right. And so that's why it just varies from every deal that every other deal.

Tessa Bernhardt:

I think that's really important, because people come in and they think, “oh, well we just really want this team.” And sometimes when you unpack that, you start to learn that maybe they want more than the team, right? Maybe they want more IP. Maybe they do care about some of these products. Maybe they discover in some kind of light diligence that there's certain customer contracts that are actually quite valuable and, and that they want. And so you maybe want to talk about a little bit about how this kind of evolves over the course as you learn more about what your client's objectives are, how these deals kind of can turn into acquihires or can kind of move away from acquihires, right?

Greg Roussel:

It happens literally all the time. And, you know, we'll talk to the legal team and corp dev: “Are you sure you just want the team, need anything else?” And then like, “no, no, no, we just want the team.” And then as they negotiate further and as they talk to the team, it turns out, oh, maybe we just need that other patent or it would be great to have our code or. “oh, it would be great to.” It turns out it's really the whole company. And at that point if you're trying to renegotiate price, , then you've like effectively like doubled your purchase price because, it turns out you needed a lot more than just the team. And the investor is going to be looking to get whatever they can for, the company, if you're actually going to take the whole company. So I think you have to really be thoughtful as your structuring it and as you're talking about the economics and make sure you have a good picture of what the team is actually looking for.

Tessa Bernhardt:

I think that's great advice – it's just kind of as an iterative process. Another question that I'm sure we both are getting all the time from clients is kind of the purpose of the IP license as part of an acquihire. Most of the acquihires that we're doing, these release and waivers, they also have an IP license or an IP assignment. And I think we typically describe that as a defensive measure., and so that the employees, when they go to their new companies, if they're using know how there's no questions about there being any kind of IP infringement or anything with the remaining company. So we do get this question a lot, but I would now that we're starting to see kind of acquihires happen at larger companies where they might remain and continue to operate and be ongoing. What are you advising clients with respect to the IP license, both as the kind of acquiring company and the company where there's an acquihire taking place but the company remains?

Greg Roussel:

It's a great question, and it's really all over the map. Many times the companies may have an existing commercial relationship and then this just expands on it, and there's a different kind of license that goes along with that. Other times they don't, but they should have a license like that. And then people will license particular technology in exchange for some other value that goes to the company. I think, sometimes whenever the company is maybe going to be shut down, or there the board will be looking to sell off different assets, what you would want to avoid is a situation where you hire a bunch of really smart people, in a very niche area, and then all of a sudden, your biggest competitor buys up the rest of the company, including all the IP, and then they come after you because those employees are using the knowhow or they have some kind of trade secret claim or something like this that, would prevent them from be able to do what you wanted them to do. So to avoid that sometimes we’ll bake in a covenant not to sue we’ll bake in some other kind of short form license just to make sure that the employees are able to do what you expect them to do, separate from what happens to that remaining company.

Tessa Bernhardt:

I think that's fascinating and really important piece of how our Latham team, we work together with our IP team on these. I view them – the IP team – as sitting right next to us on these acquihires for that very reason to avoid these lingering issues that could happen down the road. The common question is what are the advantages of an acquire? Why would you do an acquire over your typical acquisition?

Greg Roussel:

That's probably three important things. One, you have the cost and speed of being able to do an acquihire. So instead of negotiating a 100-page merger agreement, you've got like a seven-page agreement that there's probably five things to talk about. And so the parties are really happy whenever the teams can actually start work before you would actually even get a turn of the draft out. I think the second thing is that you can really minimize liability this way. And we actually had a court case, it was where the client just had the team come over. They did not buy the company, they did not take any assets over, there was no their license. And the court found that you can't have successor liability whenever you just have the team come over. And so that allows you to move much faster, not worry as much about the existing liabilities of a company when you're just bringing the team over. And then I think third, it really allows the investors to capture some value here because I think at a certain level – the employees, if they want to leave, they're going to leave. And if whether the company is going under or just isn't the $100 billion opportunity everybody thought it was, the employees might get enticed to go somewhere else. And so it's kind of better for the investors to realize some of that value for what they put together, you know, through an actual hiring process, even if it doesn't mean a full acquisition of the company.

Tessa Bernhardt:

That's a really good point. So since you've developed acquihires back in the day, how have you seen them evolve?

Greg Roussel:

It's only really been limited by people's creativity and how they make deals. And we've seen it solve a lot of other problems that, that companies face. And so, by way of example, it could be that it is a way to strengthen a commercial relationship between parties. Whenever some engineers come over to the buyer and but they still work with the target. Other times we've seen it as a financing vehicle where there is some kind of debt or equity financing in connection with the team coming over, rather than just a pay out to the company, as well as we've seen what I would maybe even call a reverse acquihire where the team gets hired somewhere else, leaving a lot of employees, a lot of customers, a lot of technology behind. And somebody else will come in and say, “oh, there's a lot of value there – why don't you come work for me?” And so people have really been able to get creative with how they split up companies and divide value, among the different constituencies.

Tessa Bernhardt:

That's fascinating. And I think that's it's exciting to see this kind of space of all that and being in the Bay area, you know, I think we're really in the middle of it. So it's been it's been great learning from you and working with you on these. And I'm excited to see how acquihires continue to develop and shape the ecosystem here in the Bay area. It was great having you, Greg. Thanks for joining us.

Greg Roussel:

Thank you for having me.

Tessa Bernhardt:

And thank you for joining as well. We'll see you next time.

Shing Lo:

Hello and welcome to The LathamTech Podcast, where we survey the latest trends emerging from the world of tech and explore the impacts on your company, both the opportunities and the risks. I'm Shing Lo, a partner in Latham's Emerging Companies and Growth practice in London. And joining me today is my fellow partner, Mike Turner, who works on venture capital, growth equity, and M&A transactions for clients across tech, media and telecommunications. Hello, Mike.

Mike Turner:

Great to be with you, Shing.

Shing Lo:

Let's start with the first question. Outside of the US, where do you think London sits in the global tech ecosystem?

Mike Turner:

I think you know what I'm going to say to that, Shing, which is I think London is absolutely, the number one global tech center, outside the US. In fact, I’ll go further than that, I’d say it's probably outside Silicon Valley. The data, consistently over the last ten years or so supports that. And I think that's a very good reason for London having obtained that place in the market and attained that place in the market. London always has been, and I hope always will be, the leading financial center in the world. And that is very relevant for reasons we'll come on to talk about, I think even in the context of emerging companies and the funding cycle.

Secondly, if you go back to 2008, when the world fell apart financially, the UK government in time at the time was actually very smart and quick to alight on the tech sector and the emerging companies sectors as being something they really wanted to support and promote as they were rebuilding, in our case, the UK economy. And though those two things I think have really led to London having that position as number one. Don't want to sound arrogant about that. I think it is absolutely fair to say, and you and I both know this, that there are many other cities around Europe which do a terrific job now in the tech ecosystem. They've really developed some very strong tech economies of their own. And the one that I call out, is probably France and Paris, which have really done well. And Macron has been a huge supporter of the tech economy. Somewhat amusingly, the London tech week coincided with the VivaTech week in Paris. So you had tech icons like Jensen Huang speaking in London on Tuesday and then Paris on the Wednesday. Both were terrific events. I think they really validated each other.

Shing Lo:

That's great. When you're speaking to a founder of an emerging company here in Europe and they're looking to raise money, what would your advice be about? Where should they go to raise money? Should they go to the US? Should they look at Europe?

Mike Turner:

I think my answer to that would be quite nuanced. I think that a company needs to think about where to raise capital depending on its objectives at the time. I think for an early stage company in Europe, quite clearly, raising capital in Europe makes a lot of sense to start with. But then, I don't know, at Series A, Series B stage they may be targeting expansion into the North America market, in which case raising money from the US would make a huge amount of sense to the extent that that capital could help the company in many ways with that expansion plan. And I think that applies to many other parts of the world now as well. So I think it's a far more nuanced question. There are far more opportunities for companies to think about where they might want to raise capital, because there are a lot of sources of capital now well beyond the US and Europe as well.

Shing Lo:

Yeah, I agree. I mean, even in Europe, we see US funds setting offices here in London. So I, you know, founders, I actually have the benefit of US investors here in a market. So let's talk about trends. Where do you think has been the beneficiary of heightened investment activity at the moment?

Mike Turner:

Well, you can expect me to say AI first, second and third, I'm sure, because that is obviously where a huge amount, the most visible capital is being deployed to the moment. And it would be remiss of me not to point out that the UK really has a very strong deep tech, and AI heritage. Let's not forget that DeepMind was a London company. Still is a London company in many respects. And that, you know, Google's own AI plans very much revolve around DeepMind. And then you have players like Mistral in Paris, which is one of the leading AI, Gen AI companies in the world now. So I think AI, of course, fintech for sure. I mean, London is just the standout place in the world for fintech. I was listening to, the founder of Flex, which is a US fintech, speaking at London Tech Week, and he said he is just, always amazed when he comes to London at how proficient and leading we are as a fintech economy. Beyond that, I think, you know, enterprise software is a gift that keeps giving, and quite clearly there's a lot of really good enterprise software companies in the UK. The one place that I'm pleased to see quite a lot of capital being deployed now is in the world of video games and esports, which have become the, most single, most important, part of the digital economy. So that's pleasing to see. What else are you seeing?

Shing Lo:

I'm seeing quite a lot of activity in the defense tech sector. We've been working on a number of transactions, not just in the UK, but also in other parts of Europe, whereby investors are investing in all kinds of defense technology, where it touches on deep tech, where it also touches on hardware. So it's quite varied.

Mike Turner:

Yes. That I think, that's a that's a really good one to call out. And then beyond defense tech, we're probably also seeing some — I know you and I are seeing a lot — in the consumer space in the world of beauty tech for example. So there are always going to be some interesting new areas developing as each year goes by.

Shing Lo:

Well, I think it's always fun working in this sector — we come across all types of different businesses. But why don't we move into fund raising trends? So what are you seeing when it comes to primary and secondary? Are you seeing more secondary these days because of the M&A exit market being pushed out?

Mike Turner:

Definitely. So I think, one of the new dynamics, relatively new dynamics in the market is that a lot of the earlier stage, particularly institutional investment funds, have found themselves tied into their investments for a much longer period of time than they would like. So finding a secondary exit for at least part of their investment has become increasingly important to them. We're also seeing buyers. We're seeing, you know, a good appetite for secondary acquisitions often because those can be bought at a discount to the primary value that is being raised at which the company is raising capital. Often those earlier stage investors are very happy to sell out at a discount because I can still share them a very good return on their investment. So I think it's a dynamic which tends to work very well, but the secondary market is very buzzy at the moment.

Shing Lo:

Yeah, I think you and I have been involved in quite a number of growth stage companies financings. And when it comes to growth stage, it's always about cleaning up the cap table, isn't it? So a large portion of the financing funds will go into secondary to take out, early invest investors, early employees for example, especially when a company has issued plenty of equity and has, like, a hundred employees, on your cap table.

Mike Turner:

It is that and I think the other thing you just touched on when you mentioned employees is that actually finding ways to give some liquidity to the employees and to keep them happy and to allow the companies to take a little bit longer to find its, its own liquidity is a really important point as well. And we see some very, you know, very sizable employer liquidity programs being introduced in Europe.

Shing Lo:

Why don't we talk about the kind of players we're seeing in the market? I think one of the things that I'm finding with London emerging as the hub whereby plenty of sovereign wealth funds are in the market, we've worked with quite a number of them. what's been your experience?

Mike Turner:

Well good for you for calling that out, because I think that's been one of the biggest disruptive influences — positive, positive, disruptive influences in our market for the last couple of years. The Middle Eastern sovereign wealth funds in particular, as they're looking to regenerate their own economies with tech investments, we have seen them being particularly prolific in the UK, but around Europe generally as well. Why I’d say particularly prolific in the UK is that a lot of those funds have established their offices in the UK, in fact their global offices are headquartered in London. And that goes back to the comment I made earlier about London and the importance of London still being the leading global financial center. So I think, I would call out those the Middle Eastern SWFs in particular, and as being the greatest influence on, on my life professionally over the last couple of years in particular. What else are you seeing?

Shing Lo:

We're seeing quite a number of strategic players in the market, you know CVCs, and a lot of these strategics come from the US, in fact. And they’re very interested in the AI, deep tech companies here in Europe.

Mike Turner:

The CVCs, the corporate venture capitalists are very, very important. You're absolutely right. And I think seeing strategic capital in companies now is quite commonplace actually from series B on. Probably I shouldn't say too many of them is series A, but series B as companies are really beginning to find traction we’re tending to see them. Yeah, I agree.

Shing Lo:

And I think the PE growth funds are still opportunistic. I think every once in a while we do see them coming out, on the fundraising rounds of companies. Presumably you do the same.

Mike Turner:

Yeah. I think that that high end growth capital has obviously gone through a little bit of an up and down over the course of the last two or three years. But we're now seeing the, the larger PE minority equity investment funds coming back into play. But seeing, interestingly, for the first time for a good two years, I would say the particularly the US crossover fund is really coming back into the market. And they could have some of you crossover to cross over into to. So hopefully that is an encouraging sign that the IPO markets are coming back.

Shing Lo:

So this leads me into the next question: with the diversity of investors in the market, how would you advise a founder who's looking to raise money from a sovereign wealth fund versus a venture capital or a conventional VC funds? I think they're culturally quite different.

Mike Turner:

Yeah, and culturally quite different from a large corporate, for example. I think it's a really good question, and it's a really important piece of advice to the founders, to think very hard about the differences that are required to their approach in negotiating with these investors. You're going to see a lot of cultural differences depending on the parts of the world, like a Southeast Asian sovereign wealth fund is very different in its behavior to a Middle Eastern sovereign wealth fund, which is just very reflective of the cultures which, from which they come. I think the critical thing is for founders to understand that there's no book, there's no playbook which applies to everybody. You can't look at a whole group of investors and say, okay, you guys have got 28 days to do this deal because a sovereign wealth fund, maybe well want 6 or 8 weeks because they just take a little bit longer with their diligence. They're a little bit more hierarchical in their approach. It doesn't make them a bad investor. It doesn't make them a great investor. It just makes them an investor. And I think it's really important that founders can understand the difference, not only that investors can bring to the table, but in how they will behave during the course of the transaction. One thing I would point out is that also, founders should be thinking about how patient the capital is that they raise because of course, strategic or even sovereign wealth fund capital is a lot more patient and institutional venture capital.

Shing Lo:

Thanks, Mike. So on to the next question that I have is about exits, because I think having different types of investors on your cap table may lead you to a different outcome on an exit, potentially. Am I right or wrong?

Mike Turner:

Yeah, look, I think the first myth that needs to be debunked, if you like, is: what an exit actually is, because institutional investors in private equity will talk about an IPO as being an exit. For a founder it's not an exit. For a founder an IPO is the next stage in the company's growth, and the founders are likely to be committed to running the business for many years to come and at an indefinite period of time. An M&A is an exit because the founders are selling their shares that realizing their investment, they may well be tied into the business for a year or 2 or 3 post-acquisition as part of the into integration with the purchase. But it's a very different thing. So I think, first of all, I would say talking to founders and those founders talking to their investors and really just trying to manage expectations around what type of process is best for the company, liquidity process is best for the company, and I use that expression far more obviously that I would an exit. Does that make sense?

Shing Lo:

Yeah it does. I think most founders would ideally love to an IPO exit, but not all businesses are suited for an IPO exit. Most of them actually get bought out on an M&A transaction.

Mike Turner:

I heard a very interesting podcast just this morning, actually with one of the very leading private equity sponsors that growth fund, and the guy who runs that growth fund in Europe saying, you know, it's actually a very small percentage of their exits are IPOs. He said “Everyone thinks we drive all our portfolio companies to IPO.” I can't remember the precise number was 75% or 85%, by way of strategic exits only 15% or 25%, by way of IPO, which I think makes the point.

Shing Lo:

Yeah, I think you're right. That's very interesting statistics actually. Well, so that takes us to the end of the session. Thank you so much for your time, Mike. It's been great having you here.

Mike Turner:

Thank you, Shing. Always great to chat.

Tessa Bernhardt:

Hello, and welcome to The LathamTech Podcast, where we survey the latest trends emerging from the world of tech and explore their impacts on your company-both the opportunities and the risks. I'm Tessa Bernhardt, a partner in Latham's M&A and Private Equity practice in the Bay area. And joining me today is my fellow partner, Kelly Fayne, who helps companies navigate the evolving global antitrust landscape. Welcome, Kelly.

Kelly Fayne:

It's a real pleasure.

Tessa Bernhardt:

In this episode, we're discussing the shifting global antitrust landscape and what that means for tech companies moving forward. So Kelly, in the past several years there's been a notable increase in regulatory activity around tech companies doing M&A deals. A lot of our clients and companies are asking, is the environment becoming more amenable to these deals, or do we expect activity to stay the same? So what are you seeing from a regulatory perspective?

Kelly Fayne:

We're definitely at an inflection point for antitrust enforcement globally and in the United States. We've seen changes in the regulators in the U.K. and the European Commission, and probably the most notably in the U.S. I think a number of commenters initially kind of speculated about whether the changes, especially in the U.S., kind of create more opportunities for companies to do deals. We are seeing that, but we are also seeing a very enforcement forward, regulatory regime out of the DOJ and the FTC. And we continue to see a lot of attention on antitrust enforcement just around the world. And that remains like a really critical part of the consideration set for companies when they're thinking about their strategic growth opportunities, figuring out how you are going to structure deals to get them done, or pursue a pipeline of investments with the global antitrust landscape, in mind, creates, a lot of challenges for companies, but also a lot of opportunities if you do it well.

Tessa Bernhardt:

And it's funny that you talk about this pipeline or this kind of looking at the future and trying to plan things. Now that we have this kind of increase in regulatory activity and all these different jurisdictions our clients have to be thinking about. And I think that has been playing itself out in and how we work together. I mean, the first time we worked together, I think it was almost ten years ago. And the first person I called on that deal was tax. That's who we used to always call and hopefully taxes isn’t watching. But now the person I talk to is you first. And sometimes we both are staffed on the deal at the same time. Like our client will reach out to you and me simultaneously and say, hey, we have this new deal and, you know, your antitrust counterparts talking to you, the Corp Dev and M&A teams talking to me. And you see now that companies are thinking much more proactively. And I think that can be really helpful. Has that integration from kind of day one on a deal, has that been helpful from an antitrust perspective for you and your team?

Kelly Fayne:

Yeah, I think it's a really valuable part of the way, as you and I and our partners at Latham provide client service on these deals, is, is we really work together hand in hand in terms of trying to figure out how we are going to take our clients kind of strategic vision, whatever that may be. It may be M&A, it may be a series of transactions, it may be certain strategic investments. How do we kind of take those goals and get them all the way from inception to closing in, kind of as efficient and as frictionless way as possible? And in, in the antitrust environment, it's very hard to do large, transformational…

Tessa Bernhardt:

…transformational – I literally was going to say, because, every pitch that I do, they say it’s a transformational deal.

Kelly Fayne:

Yeah. So with the current global antitrust landscape, it can be very hard to do a major transformational deal or series of deals when, when you go into it kind of on the back foot from an antitrust or even, global foreign direct investment, another regulatory clearance standpoint. If you play the tape forward from the very beginning and think about, well, who, where am I filing, who's going to be looking at this deal? What are the enforcement priorities of regulators around the world that are going to be looking at this transaction? What are the trends in the types of transactions that are more likely to look at and plan out an entire path from inception to end? That really takes that global consideration set into account. It is much easier both to kind of structure a path towards achieving the end goal, which may be closing, or maybe a whole bunch of deals. But to do that in a way where you kind of anticipate the important hurdles and the important investment points, from the very beginning, and there's a lot more transparency in terms of what to expect, even though the process is going to be hard.

Tessa Bernhardt:

Yeah. I mean, it can be so helpful to have that integration and understand, where the client is looking for it. What are their goals? And, we've had these conversations before where we're like, the agreement for this transaction is going to be filed publicly. And like other targets are going to be able to read this because of the rules in this jurisdiction. Or regulators share notes back and forth. And so, you need to really be thinking as holistically when you enter into these negotiations and when you are thinking about what who are the key targets that you're looking at and how do you want those deals to be cadence and what makes the most sense? So, I think that integration from day one, I mean helps also with various other M&A things – small plug for, you know, just are you issuing equity, what is your debt look like, governance considerations. But then of course from antitrust perspective it seems to be really helpful as well.

Kelly Fayne:

Yeah. I'm glad you brought up kind of the importance of thinking about kind of the overall deal. And for me, like, we have this one little microcosm of an M&A transaction, which is thinking about antitrust. But I really appreciate the opportunities we have to partner together to talk about things like efforts covenants. I mean, as you know, parties try to figure out, if this transaction is going to take me eight months to close, am I going to have to think about a breakup fee? Am I going to think about having to litigate with the agency? And it's helpful to have these conversations with you about, well, what do we do about allocating the risk? How are you seeing your clients approach these risk shifting questions, especially with antitrust, is such a big factor in when we're considering deals and executing on them.

Tessa Bernhardt:

I mean, it's so interesting. Obviously this is coming up in every deal, and it always has at some point. But I think ten years ago you would you would punt on antitrust. You'd say, okay, closing timeline, outside date, we'll figure that out after we sign this LOI right? And hell or high water standard when you do some diligence first. And now you're starting to see more and more of that creep in to kind of the LOI stage, an offer letter stage, because it is so important. And when you're dealing with buyers, for example, who are looking at a seller who's going under, having an auction process. Antitrust and doing your diligence from the get go can actually help you really stand out as a buyer. So from M&A perspective, I really like that we kind of frontload the antitrust assessment now earlier in the deal because we can, some deals there aren't issues. It's not like every deal there's an issue, even though, this podcast might make it sound that way, there's a lot of deals that are completely fine. And if you know that about your buyer and you know that there's really not a lot of overlap or no overlap at all, then you can say, we're okay with a hell or high water standard. And we're going to put that in our bid, and that's going to make us more competitive because we're increasing closing certainty for that deal. So I think it's really helpful. And I think sellers are requiring that that conversation earlier on to they want to understand the risks. They want to understand the likelihood of a deal going through. Of course, they don't want to, to have a failed deal.

Kelly Fayne:

I'm so glad you brought up the this idea of kind of predictability and really this concept of kind of easy deals, which, I mean, oftentimes especially kind of at a firm like Latham with some of the deals we do, we do a lot of really complex deals. But you're exactly right that a lot of what our clients want to do is unlikely to either be a very large transaction or they may be doing something that doesn't raise any antitrust issues. And then the kind of really interesting area for antitrust practices is what you do with those middle case deals. And how do you help clients kind of begin to sort? Well, what is the likelihood that this transaction is going to raise serious antitrust questions that I'm going to need to be prepared to answer? What is the likelihood that, I'm going to need to spend a lot of time? Am I going to be able to get away with the kind of short financing term on this transaction, or do I need enough time and money to litigate? And being help, being able to help, for instance, with, with a seller and an auction sort, potential buyers money kind of who creates the most risk, so that they can begin to think about where they want to make those tradeoffs is a big part of, I think, where you and I work really well together.

Tessa Bernhardt:

Yeah. And something that you brought up and I want to address too is these closing timelines. There's an expression: time kills all deals. I think that actually antitrust proves that's not the case. In fact, sometimes you do need those longer timelines to closing. That actually helps deals. But of course, there are risks that our clients have to deal with when the closing timeline is, two years out, sometimes longer than two years out, I mean, which is crazy to think about. When I got started, it was like six months outside date was the furthest you would go. And now you're seeing 24 months, sometimes 36 months, I mean, depending on the deal. There's a lot for buyers and sellers to think about there. Obviously, if you're a buyer, a lot can change in a business in two years, three years. So that's something that you have to be thinking about. And there's things that are going to protect you. The merger agreement, like the interim operating covenants, of course.

But, ultimately there are macro risks. I think tariffs are a good example of that now. If you signed a deal a year and a half ago and you're in the process of litigating it in a jurisdiction, that business might look different now than it did a year and a half ago. And if you're a seller, there's risk as well. It's not common, but you have to bring down the reps. And if things change a lot in your business, like you could see yourself not meeting some of the conditions to closing, if things change drastically for you over that time period. So there are risks, of course, to having that extended closing and one. But I do think antitrust, you can help mitigate some of these risks. And I think one risk that we're seeing is that you and I saw very recently is that, just because outside is two years from now doesn't mean that's when the deal closes.

Kelly Fayne:

Yes, it may not. And that's always our goal as antitrust lawyers. We try to plan for the worst case scenario. And we try to help our clients understand, is it beneficial to me to have a long time, to kind of go through a second request or to actually litigate a transaction. And a lot of the times we include time to litigate is because it's actually an important disciplining function for the regulators to know that if they are going to sue to block your transaction, that you're going to fight with them in court and, and many times win. And be able to continue your transaction and spend, in addition to your time and money, their time and money as well. But our ultimate goal is always to try to get the deal from side to close in a shorter period as possible. And there's a lot, we, we can do to try to you, for any given transaction, try to position the deal for its best possible path to clearance.

A lot of that begins really early. It begins even before the deal is starting to become a concept where you're talking about what's the strategic vision for the company and starting to work with the principles to articulate, what we think of as a pro-competitive story for the deal, a way to explain to the world and to regulators. Why your transaction is good for competition, good for consumers, good for partners, that narrative and that deal shaping narrative is very counterintuitive to people who spend most of their time talking about why their strategic vision is good for their shareholders and their investors, and so helping companies think, well, not only do I need to explain that this deal is great for my shareholders, but I'm going to save a bunch of money on logistics and that's going to mean lower prices for my customers, or by joining with this new partner, this long term partner of mine and bringing them into part of my company, I am going to more efficiently kind of improve my services in a way that's really beneficial for our users. And building that story around a transaction and then having it carry through your documents in the way you talk to the with the market and the way you talk to your customers about the deal is one of the best things you can do to try to speed your time from sign to close so that you're not, we may be prepared to litigate, but we certainly don't want to have to litigate because we want to explain why we've got a pro-competitive story from the outset.

Tessa Bernhardt:

So I think that's a really good point about how you help clients explain the rationale, the deal. And I think actually that, one thing that clients may not realize and people might realize is that you help explain the deal's rationale, not just in the United States, but around the world. And I really think that's one place where Latham really stands out. And I feel very lucky to be an M&A lawyer at Latham because of our global resources and how we can tackle so many things in our different offices around the world. We have regulators focus on different things. In the UK, in China to, jurisdictions that we're working a lot with. They take a different approach,. And you help kind of find that strike that balance across the UK, across China, across the US, across Europe to help kind of put the client's story in a way that is going to make sense and is going to speak to all of these different kind of counterparties. Can you speak a little bit more about what you're doing and all of the quarterbacking that you do for us, on our transactions?

Kelly Fayne:

I mean, you and I both sit in the Bay area. And we work with a number of local and global tech companies. And I think it might be very surprising to them sometimes, a new transaction comes in the door and they talk to some California-based antitrust lawyer. And the first thing out of my mouth is like, we got to think about our China strategy or, you don't actually have an HSR filing in the US, but, you have a really challenging kind of path ahead in the UK that we need to think through. Or, we've got 12 jurisdictions that we're going to need to get cleared and we're going to need to make sure that we are saying similar things to regulators in all 12 of those jurisdictions. And I think the way that we approach transactions is to really think about them from a global basis. Sometimes we really are, solving for a very specific U.S. antitrust risk. And, we're in there and in the door with the DOJ and the FTC, kind of advocating for a complex transaction, but where I think there's something often really special happening in addition is when we do that at the exact same time that, my partners in London are making very similar and coordinated arguments to the UK CMA, and we've lined up the kind of timing of the filings in those jurisdictions, in the CMA and in the US and in the EC, in the exact way we wanted to line up the timings so that the regulators are all thinking about the questions we think are most important in the order and in the time we want them to be thinking about it.

For instance, we often. and this could be unusual, we often like when we set up a deal so that we're sure that the SEC is kind of running out ahead of the pack. Sometimes we purposefully structure a transaction so that we get a little headway with the U.S. regulators, because we think we're going to get to clearance quickly, and that will be informative and persuasive to, I mean, who knows, a regulator in Singapore. And part of what we do from the very beginning is to just plan out the map and plan out the kind of strategic and pro-competitive narrative for the deal so that we know how we're getting from beginning to end. Both from a kind of logistical filing standpoint, but also from a substantive standpoint.

Tessa Bernhardt:

I mean, I'm lucky enough to be a fly on the wall in some of those conversations with our colleagues around the world, and it's fascinating and I've really felt like we have the best of the best. And I'm very lucky that, as you know, I always drag you to pitches and talk about your pitches and, it really pays off when the full team comes together. And I think it always impresses everyone, how we are so interconnected and how well we know our colleagues globally and how we can call them up, sometimes unfortunately at any hour of the day, and get a really helpful response. So, I mean, I really do think that sets us apart. And it's super important in, in the landscape that we're in right now.

Kelly Fayne:

Yeah. I mean, it's especially surprising. I mean, you say you say we have a great team. I am constantly surprised – we have more than 200 antitrust professionals working around the world, in our practice. And it very much feels like a, well, a kind of a very healthy family, but also hybrid. But we work really well together, partly because, we are we are one big global practice that works well with our M&A teams and some of our other teams, kind of on the timelines that best suit our clients.

Tessa Bernhardt:

So, Kelly, I think what you're saying is the days of jamming the antitrust team with the HSR filing on the day of signing are long, long past us. And in fact, to be a good M&A lawyer now, you need to be coordinated with your antitrust team as early as possible on a deal. And, luckily for me, it's very easy to do that. I talk to you every day, and so it's not lost on me how critical working with an antitrust team like the one we have at Latham. And with yourself and all our colleagues around the world, how helpful that is to our clients. And so, what are the key takeaways that you have now for tech companies, our clients watching this now, thinking about doing transactions, whether it's small transactions or transformational ones?

Kelly Fayne:

So first, you've reminded me that I need to remind everybody else, you certainly can't jam anybody with HSR anymore. For those who haven't heard the HSR forum, which is the filing that's required, for a number of transactions in the U.S., anything over 125 million, usually. That form has gotten a lot longer, a lot more complicated, and a lot more substantive in the last six months. I think the key takeaways for anyone thinking about, doing deals in today's current regulatory environment, first is that they are getting done and they can be done. The vast majority of deals that are that are filed and reported in the U.S. are cleared. And the same is true for a number of jurisdictions around the world.

That said, it is never too soon to start talking about antitrust. The worst thing that could happen is that you think about antitrust and other global regulatory clearances too late, or that you find yourself surprised by a jurisdiction. Many times we will have an early conversation with our clients, and we will talk about antitrust, and the conversation will be quick and done, and everybody will move on to clearing their deals and require no further work from us. But sometimes we will be able to take steps in the early days that really make the path to clearance much smoother, much more predictable. Deals can get done – you should start early and you should think globally.

Tessa Bernhardt:

Well, I personally have not had any deals been blocked and I you're my good luck charm, I guess. So, thank you for all the advice, not just on this podcast, but on a daily basis when I call you. I'm sure I'll be calling you again later today. This has been really helpful. I think that's a good place to wrap up our conversation. Thank you so much for joining us.

Kelly Fayne:

It's been a pleasure.

Tessa Bernhardt:

And thank you for tuning in to this episode of The LathamTech Podcast. You can subscribe and watch or listen to new and archived episodes of Latham's podcast at lw.com, YouTube, Apple Podcasts, Spotify, or wherever you get your podcasts. If you'd like more information about the topics in this podcast, please email us from links located in the show description. We hope you'll join us again next time.

Stephen Wink:

Hello and welcome to LathamTECH Podcast, where we survey the latest trends emerging from the world of tech and explore their impacts on your company – both the opportunities and the risks. I'm Stephen Wink, Co-Chair of Latham's Fintech and Digital Assets Group, and I'm joined today by my colleague Stuart Davis, who advises tech companies on regulatory aspects of cutting edge fintech initiatives. Welcome, Stuart.

Stuart Davis:

Thanks for having me on the podcast, Steve.

Stephen Wink:

In this episode, we're going to discuss the shifting fintech regulatory landscape in the US, the EU, and the UK, and what that means for tech companies moving forward. So, Stu, let's start with, you know, what are companies on your side of the Atlantic thinking about now? What are their biggest concerns?

Stuart Davis:

I think there's probably two things, Steve. The first is what's going to happen in the US. So what we've seen is a quite restrictive approach from the US historically. We now have a new administration. I know you'll probably want to talk a little about this in more detail, but from our side of the pond, we're thinking, is this going to change the perception of digital assets, this less restrictive approach with the new administration? That's the first thing.

The second thing is new regulation. So we have seen the first fully comprehensive crypto assets regulatory regime be released in the EU with the MiCA regime. And that covers everything from issuance of crypto assets, stablecoins. It covers crypto asset service providers and how they're going to be regulated, prudential regulation, everything, market abuse. What that does is very significant for digital assets because it takes what was an unregulated asset and therefore a risky asset for institutional investors, and it legitimizes it. It means that players can come in where they couldn't before. They can now get a license. They have compliance standards, and they can effectively issue these assets in a compliant manner. So institutional investor’s not going to look at this sector and it starts to look more like regulated securities. So new regulation is going to change the game.

The UK isn't quite there yet. We have currently a restrictive regime which says you need to be regulated in a TradFi sense in order to market these assets into the UK, but it's currently looking at and consulting on a similarly wholesale regulatory regime for the UK market as well. And if you think the UK and the EU, taken together, consists of population about 450 million people, you know, the EU is the largest trading bloc in the world. It's a really significant thing and I think it could potentially inform the regulatory approach in the US as well.

Stephen Wink:

And in the US we're seeing this sea change as you reference, where we went from a very restrictive regime, you know, where, you know, regulation by enforcement, lots of enforcement actions being prosecuted, you know, against all kinds of players in the industry. And now, just a few months later, we've already had many of those cases getting close to all of them being dropped by the SEC. So clearly the enforcement environment has changed dramatically.

What hasn't really changed is the law. You know, we still have the same laws on the books. We have court cases based on those SEC enforcement cases that still are standing on the books, and are precedent – the precedent that plaintiffs lawyers have used as well. So that's still there. And we also have, you know, the SEC commission saying here are some areas that we'd like some feedback on. And lots of folks in the industry are responding to those questions and providing that feedback. And they've already started to provide further guidance to the industry as well. Like, we recently had a statement on meme coins clarifying that meme coins are not securities, which actually made a ton of sense, was a very sort of common sensical approach. But it was extremely refreshing to see this kind of actual statement from the SEC, and very helpful to the environment overall.

Stuart Davis:

And let's talk about that. So we're in a position now where we can see that there is a change in the approach from the government and from regulators as well in terms of pulling back enforcement action. But we haven't yet seen legislation. What companies do in this interim state when they want to try and launch in the US or expand their businesses in the US? What are some of the pitfalls and how would you advise clients?

Stephen Wink:

Well, it is a little hard because as you said, that nothing has really been changed substantively. Certainly the risk level overall has decreased. And so clients are obviously much more willing to take on some of that risk, but we still think it's prudent to, you know, to use, utilize many of the same procedures that we've used in the past to ensure that you have a valid securities law exemption, for example, for transactions in the US, at least until there's a, you know, a better, you know, sense of what the actual approach should be.

So, Stu, what does MiCA mean for fintech companies?

Stuart Davis:

It means a few things, and it really depends on what type of business you are. So MiCA is focused on the crypto assets market. It excludes securities: so tokenized securities, tokenized bonds, etc., they're outside of scope. They're regulated by a traditional securities regulation called MiFID. What MiCA means for issuers is that unless you're issuing a stablecoin, you need to produce a white paper, which is a mini version of prospectus. It follows a very fine format and content requirements, and it's intended to be a disclosure document that purchasers of crypto assets can look at and understand what they are buying, what they're investing in, understand the risks, understand the issuer itself.

That disclosure document needs to be sent to one regulator. Once that a regulator has the disclosure document, the asset is able to be marketed throughout the EU. If you're a stablecoin issuer, on the other hand, and a stablecoin issuer means an issuer of a stablecoin that's backed by fiat or what's called an asset reference token, which is a stablecoin backed by a commodity or another asset. If you're one of those, you need to get a license. So you need either be an e-money issuer or you need to be an asset reference token issuer. And that involves a whole host of compliance requirements, prudential requirements, safeguarding requirements.

The other aspect of MiCA is the crypto asset service provider regime. So this covers exchanges, broker dealers and other forms of intermediaries in the market. If you're one of those and you're offering services to EU users or your customers, then you need to again get a license and comply with a bunch of compliance requirements that are similar to the kinds of requirements that apply to traditional securities businesses.

The final thing that MiCA does is it implements a market abuse regime that's very similar to the TradFi market abusive scheme for securities. So it involves concepts like inside information, market manipulation and market disclosures. It's really important to note that it's extraterritorial. So even if you're a US business, if you are trading in a token which is admitted to trading on an EU cryptoasset venue and you have inside information, then it's prohibited to deal off the back of that inside information. And as I said, extraterritorial nature of that means that it could impact, you know, people or businesses anywhere in the world.

Stephen Wink:

You mentioned the white paper as a disclosure document. Now what, you know, when people hear prospectus, when you're comparing it to a prospectus, that sounds like a big, expensive document to produce. What is the sort of the level of that disclosure? Is it, you know, is it something in this startup, you know, can handle or is it, you know, or is there a simplified version of it or is it a very, you know, comprehensive document?

Stuart Davis:

It's a great question. So the good news is it's not as substantive as a traditional prospectus. You know, traditional prospectuses can be three, four hundred pages long, involving hundreds of pages of financials and forward looking statements, etc.. The MiCA White Paper isn’t that. It reflects the idiosyncrasies of the crypto asset market and the smaller nature of issuers. The areas it focuses on, it's a very factual document. It focuses on description of the issuer, a description of the purpose of the token and the nature of the blockchain that the token is on. It focuses on risk factors. So explaining to users the risks of purchasing the token. And there's a part at the end of the of the document that focuses on sustainability disclosures.

Now, that was an area that was kind of hotly contested when MiCA is being debated in the European Parliament. At one point, there was a proposal to ban proof of work consensus mechanisms or tokens that use those from being permitted to be traded in the EU. But they realized that that would effectively ban Bitcoin, which is the largest, most widely traded asset in the crypto asset market. So they pulled back from that and said, well, actually, instead of that, we'll take a disclosure based regime. So there's quite a significant amount of sustainability disclosures. The good news is that there's a bunch of consultants that offer this service. What's the, I guess, what's the upshot? We're seeing these documents, you know, topping out at 50 to 60 pages in terms of length. They're quite factual. And therefore, in my experience, they're a lot easier and more cost effective to produce than prospectuses.

Stephen Wink:

Got it. So it's a little bit more like what the industry has traditionally seen as a white paper, it sounds like, with a few extra bells and whistles.

Stuart Davis:

It's more like what they've seen traditionally as a white paper, but probably removing most of what you would think of as the marketing content. It's a much more factual description of the token and its risks. There is a regime, a separate regime, so I'm glad you mentioned it, which covers marketing. And at a high level summary, what that regime size, under the MiCA, is you can market these tokens outside of the white paper, but the rule is that in marketing them, you can't say anything inconsistent to the white paper. It has to all be consistent. So nothing kind of factually inconsistent. And the other rule is that you need to have a flag to the white paper, the URL to the white paper in that marketing document.

Stephen Wink:

That's a good point.

Stuart Davis:

So I guess, Steve, from my perspective, looking ahead, it seems like the big question in the digital asset space is what's the future of legislation going to look like in the US? Do we have any indications of that yet?

Stephen Wink:

Well, we're starting to see, you know, the stablecoin bills are getting some traction in Congress. And that seems to be, priority one. You know, the President has said he wants something on his desk before the August recess. And I think there's every intention to make that happen by that time. There are three bills currently that have been considered, are being considered. I think really two of those have the most traction currently. And, you know, probably they'll just be one that will go to a vote. So we'll see about, you know, the details of each of those are different. But, you know, I think there's some real promise that we get a stablecoin bill this summer.

So there's also some support for an infrastructure bill, you know, that would that would revise or utilize is a is kind of an initial draft. Some of the prior iteration of these digital asset infrastructure bills like Fin 21 in the House. So there's some momentum building around that. But it's also unclear just how much support that will receive and on a bipartisan basis. So it remains to be seen, it appears to be a bit of a longer road than the stablecoin bills. I mean, that's as far as we can kind of see into the future on the legislative front at this point.

Stuart Davis:

Yeah. And what about the reserve fund? What's happening there with the new administration?

Stephen Wink:

Yeah, this strategic reserve, you know, which was announced to some fanfare. There's still quite a bit of uncertainty about what exactly is happening there. But, you know, there's a number of assets that were mentioned. That's, you know, I think still remains to be seen what exactly happens there. We've also seen a number of states propose similar strategic reserves. So that will be, you know, an interesting development. But overall, not sure how entirely significant that is in the long term. But what I think it's important for is kind of establishing, you know, the value of these assets in the broader, you know, marketplace and in broader American life.

Stuart Davis:

So this is the federal government and the states potentially investing on a proprietary basis in digital assets.

Stephen Wink:

Right. This is, you know, this is kind of the, you know, similar to, you know, the gold in Fort Knox, you know, having this strategic reserve of assets. Well, you know, as I mentioned, we'll see how this develops and unfolds over the course of this year. But it's a fascinating, you know, new idea that, you know, supports, I think, the growth of the industry generally.

Stuart Davis:

And presumably makes the asset more, seen as more legitimate from an institutional investor perspective.

Stephen Wink:

Yeah. What do you think, Stu, companies can do to adapt to, you know, this continually evolving global regulatory landscape? You know, we've got, you know, the uncertainty in the US. We've got the new MiCA regime. We've got the UK regime that's beginning to evolve. Maybe talk a little bit about where do you think the UK fits between MiCA and wherever we end up in the US?

Stuart Davis:

Yeah, that's a really interesting question, Steve. We're seeing this very European regime emerge with MiCA based on core principles of European securities law. The UK, in terms of its current discussion papers and proposals, seems to be leaning towards the EU framework. And that makes sense, right? Because the UK's financial services framework, until Brexit, was entirely aligned with the EU's framework, it was the EU’s framework that was implemented in the UK. But I think a really interesting question for the UK is, is that the right approach? The US is the largest capital market in the world. It's going to be the largest market in terms of digital asset investment. And what we don't know yet is what the US regime is going to look like.

If you're the UK at the moment and you haven't committed to a draft of your regime, would it be better to wait and see? Wait to see what the US regime looks like and maybe, you know, maybe have a regime where you are you're a bridge between the US and Europe. I think what will happen because of the integration of the UK's financial services framework, is that it will continue to lean on the EU path. I'm not sure that is right.

In terms of what fintech’s can do to try and navigate this space. Obviously, having a good legal firm representing you is very important, but what we're seeing is these businesses, they operate on a global basis often. How do you manage to navigate, you know, two hundred, hundreds of different legislative regimes that are emerging? What we always say to clients is focus your marketing efforts, focus your business efforts on the key low hanging fruit jurisdictions and navigate the regulatory regimes there first. Where are the core places where your users are based? Where are you incorporated? Make sure that you're complying with those regimes. And then as you expand, you can deal with chunks of different jurisdictions, we split it up like that. It's very difficult for even the largest companies to have a big bang approach and say, we're just going to comply with the legislation of the world in one go. So make it bite size. And that way, I think, is a reasonable way to achieve it.

Stephen Wink:

That's a great point. And, you know, I think it's true in the US, I think it's true in many jurisdictions around the world. It's, you know, the main concern is where are your customers? Where are your clients, where are those folks located? That probably determines your primary jurisdiction of regulation. And then also where you're operating from, of course. You know, but we also get folks saying, well, hey, if I just offshore, you know, my, you know, my operations, am I out of the out of the woods on this, on the regulation stuff in the US, for example. The answer is no. If you're still, you know, dealing with US persons in some way, then you're likely captured by these.

Stuart Davis:

Yeah. If only it was that simple.

Stephen Wink:

Absolutely. So I think that's a good place to stop. And, Stu, thanks for joining me.

Stuart Davis:

Thanks for having me, Steve.

Stephen Wink:

My pleasure. And thank you for listening to this episode of the LathamTECH Podcast. You can subscribe and watch or listen to the new and archived episodes of Latham's podcast on lw.com, YouTube, Apple Podcasts, Spotify, or wherever you get your podcasts. If you'd like more information on the topics in this podcast, please email us from the notes in the show description. We hope you'll join us again next time.

Seth Gottlieb: 

Hello and welcome to The LathamTECH Podcast, where we survey the latest trends emerging from the world of tech and explore their impacts on your company, both the opportunities and the risks. I'm Seth Gottlieb, Co-Chair of Latham’s Tech Industry Group, and with me today is my colleague and partner, Ashley Wagner. Hi, Ashley.

Ashley Wagner: 

Hey, Seth. Happy to be here.

Seth Gottlieb: 

It's great to have you. In this episode, we're discussing RSUs in secondary offerings, a trend that's reshaping employee equity management across the tech industry. Ashley advises on executive compensation and employee benefits. She provides companies with insight into balancing talent retention with legal and financial considerations. So let's kick things off. So, Ashley, can you just explain the concept of what an RSU is and what a double trigger RSU is?

Ashley Wagner: 

Sure, Seth. So they are the right to receive shares in the future on vesting. They don't have an exercise price. They don't have a purchase price like regular options, but they do become taxable as soon as they vest. To avoid a taxable event for most private companies, we issue what's called double trigger RSUs. So these have two vesting requirements. The first is that traditional time base service schedule. The second one is a liquidity event trigger. This doesn’t require continued service, but typically needs to be achieved within a specified period of time.

Seth Gottlieb: 

So why do you think RSUs have emerged, and we're seeing this with just increasing popularity, particularly I think, in the last five years, and what are the implications for private companies?

Ashley Wagner: 

So I think we're having a lot of high value companies staying private longer, especially given recent market conditions. And so RSUs are a helpful tool for those employees when the exercise price gets really high and there's no longer, kind of, a retention incentive to those employees. And so RSUs are a full value award, again we talked about there's no purchase price. And so companies can issue these RSUs without worrying about fluctuations in stock price or any kind of expiring period similar to options. 

Seth Gottlieb: 

I've also had it come up where the RSUs attract a certain kind of talent. If a company's growing, the talent that they're trying to hire might expect RSUs because they're used to working at a public company, and now coming to a private company, that might be another consideration. Would you, do you see that too?

Ashley Wagner: 

Totally, I agree. And like a bunch of, you know, the late stage hot companies, you know, from long ago with the kind of Metas and Uber, they all started this. And so a lot of companies are expecting if they're late stage and they're high profile, their employees that they're attracting are going to be, you know, expecting these double trigger RSUs.

Seth Gottlieb: 

And then, you know, getting into our topic, they're probably going to expect some secondary as well. So let's talk about that a little bit. I mean it seems like I'm having this conversation almost every day. There's stockholder liquidity transactions, whether in connection with a financing or elsewhere. And many of those companies are later stage with RSUs outstanding. And sometimes those have been outstanding for several years. What are the implications if a tech company wants those RSU holders to participate in a liquidity event or secondary transaction?

Ashley Wagner: 

Yeah, so a lot of employees are looking for liquidity before the final liquidity event of a change of control IPO, because like you said, they've been holding on to this equity for a while, even a couple of years. A final liquidity event, maybe a couple more years or even longer down the road. And so they're saying, you know, is this equity worth anything? And so I think, you know, having these secondary opportunities for employees really shows tangible value of their equity and can keep them in their seats far longer. And this includes allowing RSUs to actually participate in the secondaries. But, you know, there's various considerations you have to have around the structure. If you're going to have those RSUs participate in a secondary.

Seth Gottlieb: 

So how would that work? What would those considerations be and how would you structure that?

Ashley Wagner: 

It's a very gray area in the tax code. So the IRS has never actually opined on RSU participation in secondaries. But you've got kind of two main concerns when you're thinking about RSUs participating. The first one is does your liquidity event trigger for all your RSUs still constitute a substantial risk of forfeiture? Your second one is how are you going to deal with the taxes for someone who's been allowed to participate in a secondary, whether or not they sell the shares? And so those are kind of your two main considerations you're trying to plan around if you're going to allow your RSUs to participate in the secondary.

Seth Gottlieb: 

So what's the substantial risk of forfeiture and how does that apply?

Ashley Wagner: 

Yeah. So, like we were talking about with that liquidity event trigger, it's got to constitute a substantial risk of forfeiture in order to delay your tax event. And so when we're issuing RSUs, we really want that second trigger to still constitute a substantial risk of forfeiture. The more we waive that, the more there's some concern that that could potentially result in that substantial risk of forfeiture no longer constituting that, because you're waving it periodically. And so the question is, you know, is a waiver of that liquidity event considered a waiver of the substantial risk of forfeiture?

Seth Gottlieb: 

Okay. And then what are the kind of pros and cons of waiving that substantial risk of forfeiture?

Ashley Wagner: 

So when you allow RSUs to participate in a secondary, typically you waive the liquidity event prong for a set percentage of your double trigger RSUs. You then net settle them. Net settlement basically means that you're reducing the number of shares they receive in order to cover any tax withholdings. And then the company uses its own cash to remit to the IRS those tax holdings. So first, the company needs to have the cash. If the company doesn’t have the cash, you know, there's other problems we need to go into, because otherwise you're asking employees to come up with the cash on hand. Now, once you've net settled, you then let people sell those shares into the secondary. 

You know, the market's been changing constantly on this. So I would say five years ago the general rule of thumb was RSUs could not participate at all in secondaries. That's now evolved to where everyone is very comfortable. They can participate at least once in a secondary using this kind of net settlement concept, where we then sell the shares. Now, any more than that, you start getting more into a gray area. And so that's where again, the cons start coming, because we have these companies who are doing pretty consistent secondaries and we're trying to figure out, you know, how do we let them continue to get value from their RSUs and let them continue to participate. And it kind of comes down to various considerations where the company may want to think about structuring their RSUs.

Seth Gottlieb: 

Okay. What are some ideas that you've seen or some creative solutions to structuring the RSUs?

Ashley Wagner: 

So there's various I think, considerations you can have. So the first one is, you know, when we're doing that we're waiving that liquidity event prong, where we talked about, we're waiving that, we're net settling those RSUs. Consider what percentage you want to waive it for. Is it a broader percentage where, you know, those RSUs are just going to start net settling in the future, and then you let those participate for any future offering? You know, we've a lot of late stage companies who do that, where they just don't have that second prong for a large portion of theirs. You can also require continued service on your liquidity event prong. And where, you know, you have to stay employed through a liquidity event for some portion of your RSUs, because then you can accelerate those as many times as you want for your liquidity event. 

So there's various kinds of structuring alternatives. I'd also say, you know, if you've got a large outside of the US population, these concerns are basically non-existent. So Section 409A is a US-specific concept. Like outside the US, they just don't have the same considerations. So, you know, we have a lot more flexibility, especially for these large companies who have a lot of non-US presence. And so we can use that as kind of the ability to let them participate. And then for the US holders, we can structure the awards in certain ways depending on how the company wants to handle it. So that those RSUs, we don't have to waive a liquidity event trigger multiple times. But a lot of it is also probably about risk tolerance, like I'm sure you've seen.

Seth Gottlieb: 

Yeah, I love 409A. I mean it's a gift that keeps giving.

Ashley Wagner: 

Who doesn't?

Seth Gottlieb: 

So can companies pick and choose the RSUs that they want to have the liquidity event accelerated for?

Ashley Wagner: 

To a certain extent, yes. So you do need an objectively determinable criteria. You know, kind of like the tender offer rules, which I usually end up deferring to you guys on. But as long as it's not discriminatory. And again, if you've got a non-US presence, you need to be especially careful about that discriminatory basis. But as long as it's not discriminatory, you can pick and choose how many, whether it's 10%, whether it's 5%, whether it's 100%, or somewhere in between and what makes sense. I would say, you know, if you're going to waive it, and let's say you have 20% participating in the secondary, consider if you want to waive it for more. If you're going to do this next year, you might want to waive it for a larger portion now, so you don't have to take any risk on waiving it in the future.

Seth Gottlieb: 

Okay. Got it. And you mentioned this earlier. So what happens when you waive it, you net settle, I assume you do that at withholding rates, right?

Ashley Wagner: 

Yep.

Seth Gottlieb: 

So do employees then have a taxable that they have to worry about in the future?

Ashley Wagner: 

So they may. And so you want to be really careful about your taxes. So the general rule of thumb is you withhold at statutory minimum. That's what accounting guidance says. Many people are in higher tax brackets. And so they will end up owing additional tax. And if the company is not careful in its withholding rates, those people may have what we call a dry tax, where they're taking the tax hit without actually receiving any compensation to pay that tax. And so especially if they're not selling in the secondary and they're not receiving that cash, you want to be very careful, you know, at the rate you're withholding. And that's where you really consult with your legal counsel and kind of go through your employee base to see what makes the most sense on your withholding rates and how that's going to work.

Seth Gottlieb: 

Yeah. So it's not something that you just wake up one morning and decide to do. There's a little bit of planning that goes into this. So, you know, given this limitation, I mean, I'm not, I assume you're not seeing RSUs participate in one-off secondary transactions. It's usually kind of a larger sort of organized tender offer.

Ashley Wagner: 

Agreed. Yeah. It's definitely not the same as stock options and especially shares where we're seeing these one-off secondary sales. This is usually a large scale tender offer that's involving a lot of shares with the company. And part of it is it helps our justification of waiving the liquidity event trigger. So one of the requirements to have that substantial risk of forfeiture we keep talking about is that it constitutes the reason of the compensation. So it's liquidity. It’s the whole reason of the compensation of these RSUs. And if we're waiving it as part of a liquidity program for the company, that gives us a better argument under 409A as to why we're waiving it. Because just like the end result of an IPO, or a change of control, this is more liquidity for the company. So it's back to the reason of the compensation.

Seth Gottlieb: 

Got it. But then, you know, doing it more than once, there's, like you said before, there's really no substantial risk of forfeiture, or potentially less.

Ashley Wagner: 

Potentially. You still get into a very gray area. Like the IRS has never ruled one way or the other on this. So we just don't know where it's going to be. And it's kind of a constantly evolving landscape, which is, again, why you really need to consult with your legal counsel.

Seth Gottlieb: 

So stepping back, you know, what would you say are the best practices for structuring, you know, RSUs if a company intends to have, you know, liquidity events in the future? So if I'm starting fresh, maybe I'm 3 to 5 years from an IPO or an exit, and I want to do an RSU program, how would you think about it holistically if I want to have some flexibility for liquidity?

Ashley Wagner: 

So I think it's really taking a step back and seeing how long you guys are anticipating staying private. You know, some companies, we’re looking at upwards of ten years. That's helpful to know. Some companies are more like, nah it's probably three years. So how long do you guys, are you guys looking at before your final liquidity event? And then from there you want to see how often do we want to do our secondaries. Is this going to be like one bite of the apple, two bites of the apple? Or is this going to be more of a yearly thing? If it's going to be a yearly thing, you definitely want to start thinking about how we structure our RSUs from the beginning, as a true double trigger RSU may not be the best approach, given if, especially if you're employee base is mostly in the US. So, you know, it may make sense to do a hybrid of things, whether that's, you know, like some RSUs that don't have that second liquidity event trigger. 

And so you just keep net settling them. And that's especially helpful if the company's got some cash on hand to deal with the taxes. And that way you can just sell those shares in the secondaries you want to. You know, that may mean having a continued service requirement through the liquidity event. So there's various ways, but really be thoughtful instead of just going forward with a traditional double trigger like I see most companies do, where they're just like, of course it's double trigger. Like that's what we do.

Seth Gottlieb: 

Right.

Ashley Wagner: 

Like that doesn't always make sense. And so I think finding a balance between those two, it may be, you know, like half traditional double trigger and then half something else, depending on the needs of the company.

Seth Gottlieb: 

Got it. Got it, that's great. So what do you feel is the future viability of RSU participation in these interim liquidity events, you know? I mean it's mostly the tech industry but, so how do you feel these will play out in the future?

Ashley Wagner: 

So I think the landscape is going to keep evolving. Like we've talked about before, four or five years ago, we were telling people you cannot do a single tender offer with RSUs. We were like, it is not viable. And then we started doing them. And like some of the big late stage companies started doing them and everyone kind of followed suit. And I think given, especially market conditions changing, we're going to see that change again. And we're going to see more pressure on how we structure these RSUs, so that they can have more participation liquidity events and really what, how much risk we want to take on with that substantial risk of forfeiture prong.

Seth Gottlieb: 

Yeah, I mean, the IPO market has been six months away from opening for the last four years.

Ashley Wagner: 

Yeah.

Seth Gottlieb: 

So we’ll see what happens.

Ashley Wagner: 

Yeah, we've been saying that forever. So I think, you know, companies are trying to come up with creative solutions for that.

Seth Gottlieb: 

Yeah, that's great. And so in closing, you know, what key points should companies keep top of mind when it comes to RSUs?

Ashley Wagner: 

So I think they need to think about the right timing for it. So RSUs are not always right for every company. Think about, you know, where your exercise price is, where your fair market value is, how far off you are from liquidity. And then if RSUs are the right mode, how often are you guys looking to provide interim liquidity to your employees? If it's often, think about alternative structures of your RSUs. And then think about your employee base. If you've got a huge non-US presence and a small US presence, it may make sense to, you know, structure in a way that makes sense for non-US folks. But if you've got a huge US presence, you know, be creative in the structuring from the beginning, because it makes it much more flexible going forward.

Seth Gottlieb: 

Ashley, this was great. Thank you so much. I found it really helpful and hopefully our listeners found it helpful as well.

Ashley Wagner: 

Yeah, no, of course. Always happy to join.

Seth Gottlieb: 

And thank you for listening to this episode of The LathamTECH Podcast. You can subscribe and watch or listen to new and archived episodes of Latham's podcasts on lw.com, YouTube, Apple Podcasts, Spotify, or wherever you get your podcasts. If you'd like more information about the topics in this podcast, please email us from links located in the show description. We hope you'll join us again next time.