Having the correct people leading an organisation at the right time can make the difference between a firm failing or succeeding. This then raises the question, if a firm poaches executives from another firm, does it amount to a merger that may require notification to the competition authorities?
At a glance
- An “acquihire” can be understood as instances where companies acquire another firm’s specialised skills and know-how by hiring its key executives, researchers and engineers, while also acquiring relevant software and intellectual property.
- The European Competition Commission and the US Federal Trade Commission have drawn their attention to the increasing use of acquihires and the competition concerns they raise.
- In South Africa, depending on the facts, acquihires can amount to a merger for the purposes of the Competition Act 89 of 1998 and large-scale key employee acquisitions (especially from competitors) should be closely scrutinised going forward as acquihires may be on the Competition Commission’s radar in future.
Acquihiring global merger control trends
Firms in the digital and technology sector differ from traditional businesses in that they often depend on the specialised skills and knowledge of a small number of key employees, together with their software and intellectual property. These people are often the founders of the firm and are the key driving force behind the company’s product offering, mission and strategy. This employee dependence is more pronounced in the emerging market of artificial intelligence, which is marked by accelerated development, innovation and constant change. This dynamism makes every strategic decision count and increases the value of the people who make these decisions. Traditional acquisitions are therefore becoming less common in these markets. Instead, companies now seek to acquire another firm’s specialised skills and know-how by hiring its key executives, researchers and engineers, while also acquiring relevant software and intellectual property, an arrangement commonly referred to as an “acquihire”.
In this way, one firm can obtain another firm’s key employees and technology without formally acquiring the target firm in the traditional sense, which would ordinarily engage merger control.
The European Competition Commission (European Commission) and the US Federal Trade Commission (FTC) have drawn their attention to the increasing use of acquihires and the competition concerns they raise. In particular, the European Commission and the FTC are concerned that such acquihires may be designed to eliminate emerging competitors before they can become meaningful market participants, while avoiding the scrutiny ordinarily associated with the merger review process. The European Commission has encouraged national agencies to refer acquihire transactions that meet the threshold to it for review, while the FTC has indicated that it is also examining acquihire transactions and whether some transactions may have been structured to avoid conventional merger review.
Acquihiring in South Africa
While the South African Competition Commission (Commission) has not taken a formal stance on acquihires as yet, it has expressed concerns about certain transactions in the digital and technology sector generally. In its Guidelines on Small Merger Notification, the Commission has highlighted the potential anti-competitive risk of so-called “killer acquisitions” and has called to be notified of such transactions going forward. In short, killer acquisitions are transactions where a firm acquires a new, very innovative firm, at an early stage in the target firm’s development, before it has generated sufficient turnover or accumulated the assets required to trigger mandatory merger notification. The theory is that these transactions will harm competition as potential competitors are removed from the market without having the necessary competition law oversight. Very often, these transactions entail the valuation of the target being high, owing to the anticipated future value of its concept, technology, intellectual property or specialised skills.
It is for similar reasons that the European Commission argues that acquihires can be considered as mergers, arguing that as employees are the holders of knowledge, information and skills that facilitate economic activity, they are in fact ‘human capital’ and form part of the target firm’s assets. This argument then begs the question: could the large-scale hiring of key executives from another firm amount to a merger in terms of the South African Competition Act 89 of 1998 (Competition Act)?
When can acquihires be a merger in South Africa?
Section 12 of the Competition Act states that a merger occurs where a firm acquires or establishes direct or indirect control over the whole or part of the business of another firm. A firm acquires control over another if it, among other things, has the ability to materially influence the policy, or strategy, of a firm in a manner comparable to a majoritarian controller. This acquisition or establishment of control may occur through the purchase of shares, interests or assets of another firm.
For an acquihire to be a merger in terms of the Competition Act, it would seem that one of two arguments would need to be made in respect of acquiring the key employees in question:
- one, the acquisition of the key employees effectively amounts to the acquiring firm obtaining control over the firm that employed these employees; or
- two, that the key employees that will be acquired will collectively amount to a “business” for the purposes of the Competition Act and they should be viewed as the target firm.
In respect of the first argument, if the firm that initially hired the key employees will continue to operate post-hire, presumably selling the same products or services and using a similar strategy developed by the key employees, it is difficult to argue, without more, that the acquiring firm has acquired control over this firm as the acquiring firm will not be able to dictate the other firm’s strategy and operations going forward. However, the outcome may be different if the firm that hired the key employees will be wound down post-hire as this seems to suggest that the business of the firm is transferred together with the key employees.
In respect of the second argument, the key employees themselves can only be a target firm for purposes of South African merger control if they can collectively be regarded as a part of a “business”. The Competition Appeal Court has defined this as the “transfer of an identified set of activities and structures which can now be identified as a separate business undertaking and which could be pursued by the transferee”. This is measured by determining whether there is an immediate and relatively permanent transfer of market share from one to another.
Although the key employees are clearly important to the strategic direction of the firm that employed them, it is again difficult to see that the transfer of such employees, without more, could amount to the transfer of market share to the acquiring firm. If it is only the key employees that transfer, leaving the relevant productive assets, intellectual property and equipment behind, it will be difficult to argue that this results in an automatic and long-term transfer of market share as the other firm can continue to service the market. The situation may be different, however, if the key employees are transferred together with productive assets or protected know-how (such as intellectual property rights over an innovative product). It is conceivable that there will be market share attributable to the transferred assets and, together with the know-how of the key employees, that this can amount to a part of a business for purposes of the Competition Act.
If this transfer does amount to a merger, under either argument one or two, it raises another question as to how one would evaluate whether the financial thresholds for mandatory merger notification would be met. These thresholds are measured according to turnover and asset values as per International Financial Reporting Standards compliant financials. Employees themselves and their know-how are not measured as assets in financials, so attributing turnover and asset value of these key employees to a business will be difficult under the existing regulations. If analysed, acquirers may need to take a pragmatic approach to make this financial assessment. If acquihires are to be a focus area for the Commission in future, clarity on this assessment would be useful.
Despite this uncertainty, it is apparent that, depending on the facts at hand, acquihires can amount to a merger for the purposes of the Competition Act and large-scale key employee acquisitions (especially from competitors) should be closely scrutinised going forward as acquihires may be on the Commission’s radar in future.
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