Legal Review 2023: Ticking over in testing times

Donnie Munro, partner and head of corporate, commercial and regulatory at Harper Macleod, says: “While it doesn’t do anyone any favours to talk the market down, we need to be realistic about the operating environment for business owners considering a sale, and active acquirers.”

He adds that there are at least three key factors in play, and the first two are contributing to the third: “The hike in interest rates is impacting on deals which would have been underpinned by debt, by making them unworkable from a buyer’s perspective. At the same time, the inflationary pressures will be working their way through the systems for both sides of the equation.

“Those two forces combined are creating an uncertainty in the market which could be seen as unsettling for both buyer and seller.”

Meanwhile, Stephen Trombala, partner in corporate finance at Shepherd and Wedderburn, says: “As with last year, US and European buyers were most active, with financial sponsor-backed vehicles being the next most active in the market.

“Undoubtedly economic uncertainty has dampened M&A activity, and also other investment activity more generally, with transaction terms now tending to favour buyers and capital providers, and with valuations under greater pressure.”

Danny Lee, an Edinburgh-based corporate partner at Burges Salmon, agrees that trading conditions have been challenging for sellers, buyers and investors.

He says: “As for the dealmaking activity that is under way, investors are operating with caution when shaping up risk profiles, and this is resulting in longer due diligence processes, increased lead time in agreeing heads of terms, potential delays obtaining indemnity and warranty insurance, all of which have a considerable knock-on effect on deal timetables.”

Craig Stirling, head of corporate at Davidson Chalmers Stewart, says there is no question that Scottish businesses are still having to contend with a number of volatile macro-economic factors, including rising inflation, spiralling wages, increasing costs for borrowing and market uncertainty. But he adds that Scotland has still outperformed other parts of the UK.

Brian Moore, partner at Dentons Scotland, says: “We’ve definitely seen evidence that an uncertain economy has influenced M&A activity. Some exit processes have taken much longer than expected, or in some cases cancelled whilst in flight.”

Barry McCaig, partner and head of corporate in Scotland at Pinsent Masons, agrees that deals are generally taking longer to complete, thanks to an increased focus on due diligence during uncertain times.

He adds: “We are now in a high-interest environment compared to recent years, and this is impacting on the banks’ ability to lend money and reducing the appetite of acquirers looking to borrow funds. The increased price of debt is squeezing potential returns for investors, and supply chain issues, and inflation – which is coming down – are creating a perfect storm which stunts M&A transactional growth.”

Despite this slowdown, lawyers point out that certain firms and industries have stood out as particularly strong – many of which emerged relatively unscathed from the pandemic, or built on their strengths during that period.

Munro says: “From a sector perspective, we’re continuing to see a lot of activity in those which have performed well over consistent periods, such as healthcare, technology, energy, food and drink, and professional services. We would fully expect to see that continue, with the caveat being that transactions underpinned by bank debt may be affected by the higher interest rates.”

In the last year, he says Harper Macleod’s corporate and M&A team has been involved in a wide range of deals, such as advising Clyde Munro Dental Group on its Scotland-wide acquisition programme. It also worked with Kingdom Technologies, one of Scotland’s fastest-growing technology start-ups, on an investment of around £2 million from Scottish Enterprise and European venture capitalists.

McCaig refers to deals in such areas as high-value energy, infrastructure and tech, which he says are keeping his firm’s Scottish teams busy. Recent deal activity at Pinsent Masons includes advising Prax Group on its £249m acquisition of AIM-listed exploration and production company Hurricane Energy, and Zenobe Energy on a £500m investment by New York-based global investors KKR.

Lee says: “It’s not all doom and gloom and some sectors are showing great resilience. Energy is chief among them, offering the long-term opportunities to garner investor confidence. The sector has had a particularly strong year and we advised on many acquisitions and investments which support offshore wind, battery storage, hydrogen and EVs, for example.”

He adds that pharmaceuticals, healthcare and life sciences continue to have investor backing, driven by a number of factors including the need to innovate, an ageing population and strong public support – especially in the aftermath of the pandemic.

One of Burges Salmon’s clients in this space is Cytomos, an Edinburgh-based life sciences company, which it advised on a £4m funding package to support the development of its cell analysis solutions for the biopharma industry, and to fast-track its novel therapies to market.

Moore comments: “Tech is still hot, especially AI, fintech and clean energy technologies. Food and beverage businesses with strong brands, customer engagement, and market penetration are always in demand. And there are more whisky distillery deals in the pipeline – but demand for those assets continues to outstrip supply.”

He adds that Dentons has been involved in some great M&A deals in Scotland this year, such as the sale of Superglass to Belgium-headquartered Etex, the sale of Tryzens by Scottish Equity Partners, and Stagecoach’s acquisition of Peoplesbus.

Frank Fowlie, head of corporate (Scotland) at CMS, says: “Despite some of the existing challenges within the market, demand for power and renewable energy deals remains strong.”

CMS advised on the completion of the £320m sale of South Kyle Wind Farm by Vattenfall to Greencoat, owning one of the largest onshore windfarms in Scotland.

Munro says: “Looking ahead, the next general election will be held no later than January 2025. Even the potential for a change in administration – let alone likelihood – causes further uncertainty that the market will have to contend with. Depending on the sentiment of the electorate, this could have a further impact on the economy and M&A markets.”

Stirling says: “I think the position is definitely improving. Increased certainty within the market, along with valuation recalibration, combined with signs that inflation may have peaked, and interest rates are stabilising, should help ensure continuing uplift in M&A activity into 2024.”

Moore points to a number of macro risks for the next 12 to 18 months, including elections in the UK and US, the war in Ukraine and the Middle East, inflation and interest rates, but he expects to see an uptick in M&A activity during the first half of 2024 as investor confidence continues to rebound.

Trombala says: “The outlook for the balance of 2023 remains unclear – processes already under way are taking longer than would have been the case last year and many businesses are exploring inside-led bridge financings to extend their capital, pending greater market stability returning – hopefully, during 2024.”