Why EU state aid is an important element of transaction strategy

It is important for businesses to make sure that the implementation of their transaction strategy is not negatively impacted by state aid. 

As the world is grappling with the response to the COVID-19 pandemic, many assume that the outlook for business is distinctly negative. Nearly three-quarters (73%) of C-suite respondents expect the impact from COVID-19 on the global economy to be severe, according to the latest EY Capital Confidence Barometer survey. However, businesses are thinking about the medium term and beyond. EY Capital Confidence Barometer survey shows 56% of businesses are opting to transform through transactions and plan an acquisition in the next 12 months. Two additional indicators validate this C-suite outlook.

First, historically, M&A activity has correlated strongly with the evolution of stock prices and risk, as measured by implied volatility. From 2000 through 2019, the correlation between the value of the MSCI World Index, drawn from stocks in developed countries, and M&A volume was approximately 80%.1 That Index was at a low on 23 March 2020, having dropped to where it was in June 2016. As of June 2020, it had returned to June 2019 levels.2

Second, although 2019 saw a lower level of M&A activity compared to 2018, it was higher than the levels in 2016 and 2017.3 Absent the COVID-19 pandemic, this suggests there is a high level of latent M&A appetite. Reports suggest that there is currently an abundance of cash ready to be invested by private equity and sovereign wealth funds. According to M&A Review, “…That ‘dry powder’ has increased steadily over the past years, reaching USD 2500 billion in 2019 (roughly a third of which is in buyout funds).”4

Possible targets are financially weak

Many businesses are facing financial distress and have turned to the state to provide financial support. Such support may have conditions attached to it – organizations must remember the obvious: Loans must be repaid. State money in exchange for equity in a business (whether directly or via a hybrid loan) means a change in the shareholder mix. In some areas, notably the EU, state-funded recapitalization includes a number of measures that impose a “ratchet rule” to encourage repayment of the state’s injection of funds by increasing the cost of repayment over time. Specifically for the EU, the ratchet applies four years from the equity funding and increases again in year six. For state-funded recapitalization that occurs in 2020, this means important decisions need to be taken before 2024 and 2026 by organizations receiving EU aid concerning their capital agenda.

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EY Law key contacts:

Kiran Desai

EY EU Competition Law Leader