Will the Government Ask About You Buying a Business?

Government scrutiny of business purchases is a reality some companies face.

Will the government ask about your business purchase? The answer is likely yes, especially if the deal exceeds $101 million.

Federal agencies review mergers to maintain fair competition and prevent monopolies. This process can significantly impact your acquisition timeline and strategy.

Understanding the review process is crucial for businesses of all sizes. Let’s explore what you need to know to navigate this complex landscape.

Understanding Government Oversight of Mergers

TL;DR:

• Government reviews mergers to maintain fair competition
• Key factors include market impact and deal value
• Process involves multiple stages with specific timelines

Key Factors in Federal Review

When the government scrutinizes business acquisitions, they focus on several crucial elements. These factors determine whether a merger might harm competition or create a monopoly.

Market Concentration

The primary concern is how a merger will affect market concentration. Regulators use the Herfindahl-Hirschman Index (HHI) to measure this. The HHI calculates market shares of all firms in an industry, squaring each percentage. A post-merger HHI increase of more than 200 points in a highly concentrated market (HHI above 2,500) often triggers scrutiny.

Deal Value Threshold

Mergers valued at more than $101 million automatically trigger a government review. This threshold adjusts annually based on changes in gross national product. Smaller deals may still face scrutiny if they significantly impact competition.

Potential for Innovation Reduction

Regulators also consider how a merger might affect innovation in the industry. They examine whether the combined entity would have less incentive to innovate or if it would stifle emerging competitors’ innovative efforts.

Antitrust Laws and Their Impact

Antitrust laws form the backbone of merger regulation in the United States. These laws aim to prevent excessive market power concentration and maintain healthy competition.

Sherman Act and Clayton Act

The Sherman Act of 1890 and the Clayton Act of 1914 are the primary antitrust laws affecting business purchases. The Sherman Act prohibits monopolization and attempts to monopolize, while the Clayton Act specifically addresses mergers and acquisitions that may substantially lessen competition.

Hart-Scott-Rodino Act

The Hart-Scott-Rodino Antitrust Improvements Act of 1976 requires companies to notify the Federal Trade Commission (FTC) and Department of Justice (DOJ) before completing large mergers or acquisitions. This act established the modern framework for merger review.

Recent High-Profile Cases

The FTC’s review of the Microsoft/Activision Blizzard deal showcases how antitrust laws apply to modern markets. The $68.7 billion acquisition faced intense scrutiny due to concerns about market concentration in the gaming industry.

Timeline of the Review Process

The government review process for business acquisitions follows a structured timeline with specific stages and deadlines.

Initial Filing

The process begins when the merging parties file a premerger notification with the FTC and DOJ. This filing must include detailed information about the companies and the proposed transaction.

Preliminary Review (30 Days)

Upon receiving the filing, regulators have 30 days to conduct an initial review. For cash tender offers or bankruptcy sales, this period is shortened to 15 days. During this time, they assess whether the merger raises any competitive concerns.

Second Request (If Necessary)

If the initial review raises concerns, regulators may issue a “Second Request” for additional information. This extends the review period by 30 days after the companies comply with the request. For cash tender offers or bankruptcy sales, this extension is 10 days.

In-Depth Investigation

During the extended review period, regulators conduct a thorough investigation. This may involve interviewing company executives, customers, and competitors, as well as analyzing market data and internal company documents.

Final Decision

At the end of the review process, regulators will either:

1. Allow the merger to proceed
2. Challenge the merger in court
3. Negotiate conditions or divestitures to address competitive concerns

Timing Considerations

The entire process can take several months to over a year for complex cases. Companies should factor this timeline into their merger planning and be prepared for potential delays.

Government Acquisition Strategy

While the focus here is on private sector mergers, it’s worth noting that the government itself has an acquisition strategy for its own purchases. This strategy aims to ensure efficient use of taxpayer money and fair competition among suppliers.

Key Elements of Government Acquisition

The government’s acquisition process typically involves:

1. Identifying needs
2. Market research
3. Solicitation of bids or proposals
4. Evaluation of offers
5. Contract award
6. Contract management

Understanding this process can provide insights into how the government approaches acquisitions and what it values in business transactions.

Framework for Assessing Federal Agency Acquisition Function

The Government Accountability Office (GAO) has developed a framework for assessing the acquisition function at federal agencies. This framework provides valuable insights into what the government considers important in acquisitions.

Four Cornerstones

The GAO framework focuses on four cornerstones:

1. Organizational Alignment and Leadership
2. Policies and Processes
3. Human Capital
4. Knowledge and Information Management

These cornerstones reflect the government’s emphasis on structured, well-managed acquisition processes. Companies involved in mergers or acquisitions should consider how their own processes align with these principles, as it may influence how regulators view their proposed transactions.

Navigating Federal Review of Corporate Purchases

TL;DR:

• Learn how to conduct a thorough pre-merger analysis
• Understand essential documentation for government review
• Discover strategies for effective engagement with regulatory bodies

1. Conduct a Pre-Merger Analysis

Internal Assessment of Antitrust Issues

Businesses must start with a comprehensive internal assessment of potential antitrust issues. This process involves several key steps:

1. Market Definition: Clearly define the relevant market for your products or services. Consider both geographic and product markets. For example, if you’re a regional grocery chain, your market might be “food retail in the Midwest”.
2. Market Share Calculation: Determine your current market share and estimate the combined market share post-merger. Use reliable industry data and sales figures.
3. Competitive Landscape Analysis: Identify key competitors and assess their market positions. Consider how the merger might affect competition in the industry.
4. Vertical Integration Evaluation: If the merger involves companies at different stages of the supply chain, assess potential vertical integration issues.
5. Efficiency Gains Assessment: Identify and quantify potential efficiency gains from the merger, such as cost savings or improved innovation capabilities.
6. Consumer Impact Analysis: Evaluate how the merger might affect consumers in terms of prices, product quality, and choices.

Involving Legal Experts

Engaging legal experts early in the pre-merger evaluation process is crucial. Here’s how to involve them effectively:

1. Choose Experienced Counsel: Select attorneys with specific experience in antitrust law and merger reviews.
2. Early Consultation: Bring in legal experts at the beginning of the merger consideration process, not just when issues arise.
3. Full Disclosure: Provide complete information about your business and the proposed merger to your legal team.
4. Regular Updates: Keep your legal team informed of any changes in the deal structure or market conditions.
5. Mock Reviews: Consider conducting mock antitrust reviews with your legal team to prepare for potential government scrutiny.

2. Prepare Required Documentation

Essential Documents for Government Review

Preparing comprehensive documentation is key to a smooth review process. Here’s a list of essential documents:

1. Financial Records: Provide audited financial statements for the past 3-5 years for both companies involved in the merger.
2. Market Data: Compile market share data, industry reports, and competitive analysis documents.
3. Business Plans: Include strategic plans, growth projections, and synergy analyses.
4. Corporate Structure Documents: Provide organizational charts, ownership details, and subsidiary information.
5. Product/Service Information: Prepare detailed descriptions of products or services, including pricing strategies and distribution channels.
6. Customer and Supplier Lists: Compile lists of major customers and suppliers, including contract terms.
7. Internal Communications: Gather relevant internal communications about the merger, including board meeting minutes and executive memos.
8. Previous Merger Information: If applicable, include documentation from any previous mergers or acquisitions.

Tips for Effective Information Organization and Presentation

Organizing and presenting this information effectively can significantly impact the review process:

1. Create a Master Index: Develop a comprehensive index of all documents, categorized by type and relevance.
2. Use Clear Labeling: Label each document clearly with a unique identifier and brief description.
3. Prepare Executive Summaries: Create concise summaries for complex documents or data sets.
4. Utilize Data Visualization: Where appropriate, use charts, graphs, and infographics to present data more clearly.
5. Ensure Consistency: Cross-check all documents for consistency in data and messaging.
6. Implement Version Control: Use a robust version control system to track document updates and revisions.
7. Secure Digital Storage: Store all documents in a secure, easily accessible digital format.
8. Prepare a Narrative Document: Create a document that tells the story of the merger, tying together the various pieces of information.

3. Engage with Regulatory Bodies

Importance of Open Communication

Maintaining open lines of communication with government agencies is crucial for several reasons:

1. Transparency: It demonstrates your company’s commitment to transparency and cooperation.
2. Early Issue Identification: It allows for early identification and addressing of potential concerns.
3. Process Efficiency: Open communication can help streamline the review process.
4. Relationship Building: It helps build a positive relationship with regulators, which can be beneficial in the long term.
5. Information Accuracy: It ensures that regulators have accurate and up-to-date information about your business and the proposed merger.

Strategies for Proactive Concern Addressing

To address concerns proactively, consider these strategies:

1. Pre-Filing Meetings: Request pre-filing meetings with relevant agencies to discuss the merger and potential issues.
2. Regular Updates: Provide regular updates to the reviewing agencies, even if not explicitly requested.
3. Prompt Responses: Respond promptly and thoroughly to any agency requests for information or clarification.
4. Anticipate Questions: Try to anticipate potential agency questions or concerns and prepare responses in advance.
5. Expert Testimonies: Be prepared to provide expert testimonies or studies to support your position if needed.
6. Flexibility: Show willingness to consider and discuss potential remedies if issues are identified.
7. Consistency: Ensure that all communications with regulatory bodies are consistent with your internal documents and public statements.
8. Designated Point of Contact: Assign a dedicated team or individual to manage all communications with regulatory agencies.

By following these steps, businesses can better prepare for government scrutiny during acquisitions. This process not only helps in navigating the federal review but also ensures that the company is well-prepared for potential challenges and questions that may arise during the merger process.

Antitrust Scrutiny in Business Deals: What to Expect

• Antitrust reviews assess market competition and consumer impact
• Companies may face requests for data, market analysis, and remedies
• Preparation and expert guidance are key to navigating the process

Market Concentration Analysis

The government’s antitrust review process starts with a thorough market concentration analysis. This step is crucial for understanding how a proposed merger or acquisition might affect competition within a specific industry.

Defining Relevant Markets

Regulators begin by defining the relevant product and geographic markets. This involves identifying all products or services that consumers view as close substitutes and the geographic areas where competition occurs. For example, in a merger between two smartphone manufacturers, the relevant market might be “high-end smartphones” in “North America.”

Assessing Market Shares

Once the relevant market is defined, regulators calculate the market shares of the merging companies and their competitors. They use various data sources, including company sales figures, industry reports, and consumer surveys. The combined market share of the merging entities is a key factor in determining whether the deal raises antitrust concerns.

Herfindahl-Hirschman Index (HHI)

One of the primary tools used to measure market concentration is the Herfindahl-Hirschman Index (HHI). The HHI is calculated by squaring the market share of each firm competing in a market and then summing the resulting numbers. For example:

• Pre-merger market: Company A (30%), B (30%), C (20%), D (20%)
• HHI = 30² + 30² + 20² + 20² = 2,600

Post-merger (if A and B merge):

• HHI = 60² + 20² + 20² = 4,400

The change in HHI (1,800 in this case) is a critical factor. Generally, an increase of more than 200 points in highly concentrated markets (HHI > 2,500) is likely to raise antitrust concerns.

Consumer Impact Evaluation

Beyond market concentration, regulators closely examine how a proposed deal might affect consumers. This evaluation considers various factors that could impact consumer welfare.

Price Effects

A primary concern is whether the merger will lead to higher prices for consumers. Regulators analyze historical pricing data, company financial projections, and economic models to predict potential price changes post-merger.

Quality and Innovation

Antitrust reviews also consider non-price factors. Will the merger reduce product quality or slow innovation? For example, in the 2018 review of the T-Mobile/Sprint merger, the FCC examined how the deal would affect the rollout of 5G networks and rural broadband access.

Choice and Variety

Regulators assess whether the merger will reduce consumer choice by eliminating competing products or services. In the 2008 Sirius/XM satellite radio merger, the FCC considered how the deal would affect programming variety for listeners.

Remedies and Negotiations

If antitrust concerns arise, companies may need to negotiate with regulators to address these issues. This process can lead to various outcomes:

Structural Remedies

Structural remedies involve changing the structure of the merged entity, typically through divestitures. For example:

• In the 2018 Bayer/Monsanto merger, the companies agreed to divest $9 billion in assets to BASF to maintain competition in various seed and pesticide markets.
• When CVS Health acquired Aetna in 2018, CVS agreed to sell Aetna’s Medicare Part D prescription drug plan business to WellCare Health Plans.

Behavioral Remedies

Behavioral remedies impose ongoing obligations on the merged company. These might include:

• Agreements to license technology to competitors
• Commitments to maintain certain service levels or pricing
• Firewalls to prevent information sharing between certain business units

For instance, when Comcast acquired NBCUniversal in 2011, the company agreed to various behavioral conditions, including non-discrimination in content distribution and adherence to open internet principles.

Negotiation Strategies

When facing antitrust concerns, companies can employ several strategies:

1. Proactive problem-solving: Anticipate potential issues and propose solutions before regulators raise them.
2. Data-driven arguments: Use economic analysis and market data to challenge regulators’ concerns.
3. Timing considerations: Be prepared for the review process to extend beyond initial timelines, especially in complex cases.
4. Expert involvement: Engage antitrust economists and legal experts to strengthen your position.

Agency Jurisdiction and Process

In the United States, two primary agencies conduct antitrust reviews: the Federal Trade Commission (FTC) and the Department of Justice (DOJ) Antitrust Division.

Agency Allocation

The FTC and DOJ divide responsibility for merger reviews based on their expertise in specific industries. For example:

• FTC typically handles mergers in retail, pharmaceuticals, and healthcare
• DOJ often reviews mergers in telecommunications, banking, and airlines

Hart-Scott-Rodino Act Process

Most large mergers are subject to the Hart-Scott-Rodino (HSR) Act, which requires companies to notify the agencies before completing transactions above certain thresholds. The process typically involves:

1. Initial filing: Companies submit HSR forms with basic information about the deal.
2. 30-day waiting period: Agencies conduct an initial review.
3. Second Request (if necessary): Agencies may request additional information, extending the review.
4. Final decision: Agencies either clear the deal, challenge it, or negotiate remedies.

International Considerations

For global businesses, antitrust scrutiny often extends beyond U.S. borders. Companies may need to navigate reviews by multiple international regulators, such as the European Commission’s Directorate-General for Competition or China’s State Administration for Market Regulation.

Coordination and Timing

Managing multi-jurisdictional reviews requires careful coordination:

• Align filing timelines across jurisdictions when possible
• Prepare for potentially conflicting remedies in different regions
• Consider the impact of one jurisdiction’s decision on others

Divergent Approaches

Be aware that different countries may have varying antitrust priorities:

• EU regulators often focus more on potential harm to competitors
• U.S. agencies primarily consider consumer welfare
• Emerging markets may prioritize domestic industry protection

Understanding these nuances is crucial for developing a global antitrust strategy.

For a deeper dive into international antitrust issues, consider reading “Global Competition Law and Economics” by Einer Elhauge and Damien Geradin.

Small Business Concerns in Government Reviews

• Small businesses face unique challenges in acquisition reviews
• SBA size standards and industry-specific criteria play a crucial role
• Understanding benefits and exemptions can streamline the process

SBA Size Standards

The Small Business Administration (SBA) defines small businesses based on specific criteria that vary by industry. These standards are critical in determining eligibility for government programs and in the context of acquisitions.

Industry-Specific Size Standards

The SBA uses North American Industry Classification System (NAICS) codes to set size standards. These standards are typically based on either annual receipts or number of employees. For example, a manufacturing company might be considered small if it has 500 or fewer employees, while a retail business might qualify if its annual receipts are under $7.5 million.

In the context of acquisitions, these size standards become particularly relevant. When a larger company acquires a small business, it may affect the target company’s eligibility for small business programs or contracts. This can have significant implications for both the acquiring company and the target.

Affiliation Rules

The SBA also considers affiliation when determining size status. This means that the size of other businesses with which a company is affiliated may be counted in the size determination. In acquisitions, this can be complex, as the acquiring company’s size might affect the target’s small business status.

For instance, if a large corporation acquires a controlling interest in a small business, the small business may no longer qualify for certain government contracts or programs due to the new affiliation.

Benefits for Small Business Concerns

Small businesses often enjoy certain advantages in government reviews of acquisitions, designed to protect and promote small business participation in the economy.

Simplified Acquisition Procedures

The federal government uses Simplified Acquisition Procedures (SAP) for purchases below certain thresholds. These procedures are less complex and time-consuming than traditional procurement methods. Small businesses often benefit from SAP, as many of these contracts are set aside exclusively for small businesses.

In the context of acquisitions, a small business being acquired might have existing contracts under SAP. The acquiring company needs to understand how the acquisition might affect these contracts and whether they can be maintained post-acquisition.

Set-Asides and Sole-Source Awards

Certain federal contracts are set aside exclusively for small businesses. These set-asides can be general small business set-asides or specific to certain socioeconomic categories like women-owned small businesses or service-disabled veteran-owned small businesses.

In some cases, agencies can even make sole-source awards to small businesses without going through a competitive bidding process. This can be a significant advantage for small businesses in the federal contracting space.

When a larger company acquires a small business with these types of contracts, it’s crucial to understand how the acquisition might affect eligibility for these set-asides and sole-source awards.

Potential Exemptions for Smaller Entities

Small businesses may be exempt from certain regulatory requirements that apply to larger corporations in acquisition reviews.

Hart-Scott-Rodino Act Thresholds

The Hart-Scott-Rodino (HSR) Act requires companies to notify the Federal Trade Commission and Department of Justice about large acquisitions before they occur. However, transactions below certain thresholds are exempt from this requirement.

As of 2024, transactions valued at $119.5 million or less are generally exempt from HSR filing requirements. This exemption can significantly reduce the regulatory burden on small business acquisitions.

“Size of Transaction” Test

Even for transactions above the basic threshold, the HSR Act includes a “size of transaction” test. This test exempts certain transactions from filing requirements based on the size of the entities involved and the value of the voting securities or assets being acquired.

Understanding these exemptions can be crucial for small businesses involved in acquisitions, as it can significantly impact the regulatory process and associated costs.

Impact on Government Contracts

Small business status can have a significant impact on a company’s ability to win and maintain government contracts. When a small business is acquired, it’s crucial to understand how this might affect existing contracts and future opportunities.

Novation Agreements

When a small business with government contracts is acquired, a novation agreement is often required. This agreement transfers the obligations and benefits of the contract from the original party to the new owner.

The process of obtaining a novation agreement can be complex, and the government has the discretion to approve or deny the transfer. Factors considered include the new owner’s technical and financial capabilities, as well as their ability to perform the contract.

Recertification Requirements

Small businesses are generally required to recertify their size status for long-term contracts at specific points, including when they are acquired or merged. If a small business is acquired by a large business, it may no longer qualify as small for the purposes of the contract.

This recertification can have significant implications. While it typically doesn’t affect the current contract, it can impact the business’s ability to win future contracts or receive contract options or extensions.

Due Diligence Considerations

When acquiring a small business, due diligence takes on additional dimensions related to small business status and government contracting.

Verification of Size Status

It’s crucial to verify the target company’s size status claims. This includes reviewing their NAICS codes, annual receipts or employee counts, and any affiliations that might affect their size determination.

Review of Set-Aside Contracts

If the target company holds set-aside contracts, these need to be carefully reviewed. The acquiring company should understand the requirements for maintaining these contracts and assess whether they will remain eligible post-acquisition.

Compliance History

Reviewing the target company’s compliance history with small business regulations is essential. This includes checking for any past size protests or investigations related to size status or eligibility for small business programs.

In conclusion, small business concerns in government reviews of acquisitions involve a complex interplay of size standards, regulatory exemptions, and contract considerations. Understanding these factors is crucial for both small businesses considering being acquired and larger companies looking to acquire small businesses, especially in industries heavily involved in government contracting.

Preparing for Business Acquisition Regulations

• Learn key compliance areas for small businesses in acquisitions
• Understand SBA requirements and industry-specific criteria
• Gain insights into ownership, profit motive, and operational considerations

1. Size Qualification

Small businesses must meet specific size standards set by the Small Business Administration (SBA) to qualify for certain programs and contracts. These standards vary by industry and are based on either annual receipts or number of employees.

To determine if a business meets SBA size standards:

1. Identify the correct North American Industry Classification System (NAICS) code for your primary business activity.
2. Look up the size standard for that NAICS code in the SBA’s Size Standards Table.
3. Compare your business’s annual receipts or employee count to the standard.

Accurate reporting of revenue and employee count is crucial. Misreporting can lead to severe penalties, including fines and disqualification from small business programs.

Common Size Standard Metrics

• Annual Receipts: Typically averaged over the last three completed fiscal years.
• Employee Count: Usually based on the average number of employees for each pay period over the preceding 12 calendar months.

2. Ownership and Control

The SBA has strict requirements for ownership structure and control of small businesses. These ensure that the benefits of small business programs go to genuinely small, independently operated companies.

Key ownership and control requirements:

1. At least 51% unconditional ownership by qualifying individuals (e.g., U.S. citizens, permanent residents).
2. Direct ownership (no trusts or holding companies)
3. Day-to-day management and long-term decision-making by qualifying owners

Common issues during government review:

• Complex ownership structures that obscure true control
• Excessive involvement of large businesses in management
• Disproportionate profit distribution not aligned with ownership

3. Profit Motive

The SBA requires that small businesses operate primarily for profit. This distinguishes them from non-profit organizations and ensures they contribute to economic growth.

Key aspects of the profit motive requirement:

1. Business must be organized for profit
2. Primary aim should be generating revenue and profits
3. Reinvestment of profits into the business is acceptable and often encouraged

Exceptions and special cases:

• Certain non-profit organizations may qualify for specific SBA programs (e.g., disaster loans).
• Social enterprises that balance profit with social impact may need additional scrutiny

4. US-Based Operations

To qualify as a small business for SBA programs, a company must have its principal place of business in the United States.

Requirements for US-based operations:

1. Majority of employees based in the US
2. Significant management and business operations conducted domestically
3. Contribution to the US economy through payment of taxes and use of American products, materials, or labor.

Considerations for companies with international ties:

• Extent of foreign ownership and control
• Location of key decision-makers and executives
• Proportion of domestic vs. international revenue

5. Industry-Specific Criteria

Some industries have additional SBA requirements due to their unique characteristics or regulatory environments.

Examples of industry-specific criteria relevant to acquisitions:

1. Construction: Bonding capacity and experience requirements
2. Manufacturing: Compliance with the Non-Manufacturer Rule for resellers
3. Technology: Intellectual property ownership and development location
4. Professional Services: Licensing and certification requirements

Additional SBA Requirements

Beyond the five core requirements, small businesses should be aware of other factors that can affect their status:

1. Affiliation: The SBA may consider affiliated businesses when determining size status. This can include relationships through ownership, management, or contractual ties.
2. Economic Dependence: A business that relies too heavily on a single customer (often the government) may be deemed “other than small” due to economic dependence.
3. Ostensible Subcontractor Rule: In joint ventures or prime/sub relationships, the small business must perform the primary and vital requirements of the contract.
4. Recertification: Small businesses must recertify their size status for long-term contracts at specific intervals or upon certain events, including mergers and acquisitions.
5. Limitation on Subcontracting: Small businesses must perform a certain percentage of work on set-aside contracts themselves, limiting how much can be subcontracted.

Understanding these requirements is crucial for small businesses considering acquisitions or being acquired. Compliance ensures continued eligibility for small business programs and avoids potential legal issues.

Summary Table

Small businesses must navigate these complex requirements to ensure compliance and continued eligibility for SBA programs. Understanding these regulations is crucial for successful acquisitions and business operations.

Navigating the Regulatory Landscape of Business Acquisitions

Government scrutiny in business purchases is complex but manageable. Understand the review process, prepare thoroughly, and engage proactively with regulators. Small businesses have unique considerations and potential advantages. Accurate self-assessment and documentation are key.

Are you ready to tackle your next business acquisition with confidence? Start by reviewing your company’s size classification and market position. Then, consult with legal experts to develop a solid strategy for navigating potential regulatory hurdles.