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Buyers are using “acquihires,” a discreet M&A strategy that oftentimes flies under the news radar, to bolster AI benches.

There is a gold rush in tech M&A and the gold is talent to develop and integrate artificial intelligence (AI) technology. Faced with a shortage in skilled employees, buyers are using “acquihires,” a discreet M&A strategy that oftentimes flies under the news radar, to bolster AI benches.

The surge in AI acquihires is likely to persist for the foreseeable future. Leading technology companies are dedicating a significant share of their R&D budgets to AI research. PitchBook reported that in 2020 Facebook, Apple, Microsoft, Google and Amazon spent a combined USD 133.5 billion on R&D with a significant portion budgeted for AI. Globally, there were 286 AI-related acquisitions in 2019. In 2020, the number of AI transactions increased to 449, an annual growth rate of over 50%, and 2021 appears to be keeping pace.

An acquihire is a transaction where a buyer is primarily motivated to acquire key talent rather than a business itself or its products. The transaction can be structured as an asset sale, stock purchase, merger or even simply a release of relevant employees from non-compete arrangements coupled with a defensive license to the intellectual property (IP) developed at the employees’ former firm.

As companies increasingly rely on AI, acquihires offer an attractive alternative to organic internal development of talent. For a buyer, such a transaction is a quick mechanism to acquire skilled teams with experience working together. For sellers and the target employees, an acquihire can provide value where a business has otherwise run short on cash and a soft landing for a team that might otherwise be wound down.

Because no one location represents a global center of gravity for AI development, and remote working arrangements embraced by necessity during the pandemic are likely to remain a norm for many companies, buyers should be prepared for their acquihire to involve disparate geographies and even cross-border considerations. To nimbly navigate these complications, we recommend focusing on four key legal issues during initial acquihire planning stages.

1. Factor employee transfer mechanics into transaction execution strategy.

The mechanics for employee transfers as well as any restrictions on an employee’s freedom to operate post-transfer are paramount. Employment-related laws impacting these matters differ depending on the jurisdictions in which employees provide their services.

In an asset deal, transferring employees can be complicated. In certain countries, employees must be terminated by the target and hired by the buyer, a process which may require releases from existing and entry into new employment agreements. In other countries, employees may transfer automatically under their existing terms as long as they belong to the business transferred.
A buyer should also ensure that its future employees are released from lingering non-competes.

2. Construct mechanisms to retain talent and protect from competition post-transfer.

Retaining acquihire talent and protecting from future competition can be challenging. A 2020 report from Ernst & Young found that 47% of key acquihire employees leave buyers within one year, and 75% leave within three years.

Buyers can combat attrition by using payments contingent on retention or performance (e.g., purchase price holdbacks, performance based earn outs, employee retention and incentive pools and equity claw backs). Buyers should work with counsel to determine the best combination of incentives for the deal at hand – taking into account tax, accounting and operational implications.

Tax treatment of retention incentives can vary greatly across jurisdictions. Many acquihires are structured with little upfront cash consideration. If tax liabilities on contingent future consideration are triggered at closing, a buyer may find that it does not have a viable deal structure if consideration is insufficient to pay such obligations. Contingent consideration is accordingly frequently structured to defer taxation until receipt and to accrue more favorable capital gain rates rather than compensation income.

In addition, if the contingent consideration results in the recognition of compensation income by the employee with the employing payor being entitled to a tax deduction for such compensation, it may be deemed compensation expense rather than acquisition consideration, creating undesirable operating accounting expense and a drag on buyer earnings.

Because characterizing retention payments as consideration in the transaction may raise tax, accounting seller liquidation preferences issues, buyers may be forced to rely on employment-based non-competes. The enforceability of post-employment non-competes varies widely across jurisdictions. Non-competes, particularly those justified on the basis of employment rather than receipt of deal consideration, are not enforceable in a growing number of states and non-US jurisdictions, and are in further jeopardy under a recent Biden administration executive order.

3. Protect any intellectual property developed following the acquisition.

Transferring a team alone provides no entitlements to IP assets that such team created or had access. If the team acquired will work on same or similar technology as what they worked on pre-acquisition, then the buyer should ensure that there will be no basis for claims against the IP that the team will develop. In acquihires structured as an asset sale or employee release, consider whether to transfer or license IP.

The buyer will also want to ensure that IP created by the new acquihires post-transfer belongs to the buyer through proprietary information and invention assignment agreements, as well as comprehensive policies and procedures for protection of IP rights.

4. Ensure that the sell side deal process minimizes disputes among sellers.

Because acquihires often involve limited cash consideration, instead skewing economics towards retention awards in the form of equity for employees, sellers may receive little consideration. This may be the correct result as the value of the business may be its employees. However, it can raise questions about the motives of founders and other executives negotiating employment packages in their own interests rather than seeking to maximize returns for equity holders.

No buyer wants its talent embroiled in a lawsuit or the validity of its transaction challenged. Savvy buyers (1) take account of required seller approvals and possible claims when proposing a transaction structure and (2) consider the availability of mechanisms (e.g., recusal of interested directors from board meetings) to limit exposure from post-closing claims.

Reprinted with permission from the July 2021 edition of the Corporate Counsel © 2021 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or [email protected].

Author

Lisa A. Fontenot has advised clients as to mergers and acquisitions and other complex corporate transactions, securities transactions, regulation and corporate governance matters for 25 years. Ms. Fontenot is ranked as a leading attorney in the Corporate Law and Mergers & Acquisitions Law categories of the current and prior editions of The Best Lawyers in America©. She was previously named a Woman Leader in Tech Law by The Recorder – San Francisco, a Woman of Influence by the Silicon Valley Business Journal, and shortlisted for the 'Best in Media and Entertainment' Euromoney Legal Media Group Americas Women in Business Law Award.

Author

Michelle Heisner is a member of the Firm's Global Corporate and Securities Practice Group in New York. Michelle's industry experience includes clients in the energy, telecommunications, financial services, and technology sectors. Earlier in her career, Michelle worked as an M&A attorney at a leading global law firm at its offices in New York, Australia and Washington, DC.

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