Given the tepid market for dealmaking in the tech and healthcare sector we’ve seen lately, it’s easy to be nostalgic for days, not all that long ago, when valuations in the industry were booming and M&A activity was buoyant.
But tech and healthcare M&A lawyers say it’s not all gloom and doom. They see the downturn as more of a return to historical levels of dealmaking. They also point out that tech – and healthcare-related tech in particular – benefited disproportionately during COVID-19, so it is not surprising that valuations fell disproportionately as concerns over interest rates, inflation, and the economy overtook the exuberance.
“It’s probably fair to say that tech and healthcare was the biggest beneficiary of the boom cycle that occurred during COVID, and probably among the hardest hit in the bust that has followed,” says Aaron Sonshine, partner with the M&A practice at Bennett Jones LLP.
John Norman, partner and leader of the life science group at Gowling WLG (Canada) LLP, notes, “Overall, M&A deals tend to slow during times of uncertainty and market volatility.”
He adds that during the pandemic, low interest rates led to an increase in all cash offerings. As interest rates started to climb, cash-and-stock deals became more common. He says that with higher interest rates, some companies begin to appear less attractive.
Robert Carelli, Stikeman Elliott LLP, Andrew Hennigar, Borden Ladner Gervais LLP, John Norman, Gowling WLG (Canada) LLP and Aaron Sonshine, Bennett Jones LLP
Sonshine describes some of what we’re seeing in healthcare and tech as a “flight to quality,” with investors placing less value on future-growth forecasts. “There’s limited appetite today for emerging-growth-stage names.” Venture capital may also prefer to stick to the names they’ve already invested in rather than moving outside their portfolios.
Robert Carelli, partner and head of the Montreal office corporate group at Stikeman Elliott LLP, says that given interest rates, inflation, and volatile stock markets, buyers are “more cautious” and take longer to do deals. Still, he doesn’t think it is much different in the tech and healthcare space compared to other sectors.
“There’s more time spent on diligence. Buyers are just being careful and taking things one step at a time. I think that’s a common trend across multiple industries. I don’t think it’s specific to healthcare and technology.”
Andrew Hennigar, technology lead at Borden Ladner Gervais LLP, agrees that venture capital and investors are looking for “best of breed” names to put in their portfolios – those that are “cash-flow positive” or closest to it. They are also making “some difficult decisions” on companies that don’t fit that profile.
However, Hennigar notes, “We haven’t yet seen a rush of insolvency in the technology sector.” He adds: “I wouldn’t say there’s been a crash in tech M&A at all. It’s just come from two and a half years of breakneck pace.”
Inflation can also throw cold water on M&A activity, discouraging potential buyers because it increases the risk and cost of doing a deal. The result is that the cost of doing transactions is becoming increasingly essential in the decision-making behind M&A deals.
Norman points out that life sciences deals tend to be more costly than technology deals because of the additional regulatory compliance due diligence required, and, as in many sectors, severance packages and other employee-related costs can be another driver of increased costs.
However, “M&A deals are still occurring,” says Norman, pointing out that one of the biggest deals this year is Glaxo Smith Kline agreeing in April to buy Canadian late-stage biopharmaceutical company BELLUS Health for more than $2 billion.
While there has been a downward trend in investments in the technology and life sciences sector in 2023, this trend does not tell the whole story, says Norman, noting that “life science companies in their seed stage have had a record number of deals thus far in 2023.”
In contrast, tech-bio companies have seen a decrease in investment in 2023, which is “likely more of a correction as these companies were well funded in previous years.”
Carelli at Stikeman Elliott says that despite the decline in valuations, he still considers the tech space vibrant, pointing to the Montreal-based Bellus deal – where Stikeman acted for Bellus – as an excellent example of the strength of innovation in Canada.
“COVID definitely helped put some healthcare and biotech firms on that map,” he says, but Canada “has a long history of strength” in this area.
While Carelli points to the substantial technology and biotech sector in Montreal, thanks partly to provincial incentives, “there’s also a lot of dynamic companies” in Vancouver and Ottawa, the Toronto area, and Waterloo in Ontario.
With lower valuations than we’ve seen recently in the sector, M&A lawyers point out that this is a good time for some companies to look for unique opportunities to acquire a discount firm that may be struggling.
Norman at Gowling notes that while the tech market might be lukewarm due to high interest rates, life sciences is doing better. This is partly due to the hold-over influence of the COVID-19 pandemic and related funding. And as capital becomes harder to raise, more life science companies are considering selling at least a portion of the business, if not all. Life science company valuations haven’t decreased as much as tech.
Like Norman, lawyers in this practice area are seeing several tech and life science M&A trends. These include:
- Privatization: Companies that launched IPOs at high valuations in 2021 or early 2022 are worth less. Share prices have decreased, and these companies now require capital to continue through further investment. For some companies, privatization is the answer. Some are also choosing to buy back stock at a discount.
- Pivoting: with mergers allowing companies to focus on adjacent areas.
- Diversifying: an especially valuable tool if a company can acquire another specializing in an area of interest.
- Acquiring the competition: a viable option, provided the combined company can realize efficiencies and not run afoul of anti-trust concerns.
Another trend is the higher frequency of minority shareholders involved in deals. Institutional investors like banks still have capital and seek minority interests in growing companies. Tech companies like this trend since institutional investors are also inherently more stable.
Sonshine sees the concerns around dealmaking as short term. “There’s just so much more opportunity to be explored in this space,” he says, especially with the growth of artificial intelligence technology. “Remote medicine, digital health, data and records, agri-tech – these are all things to look forward to in both health-related tech and tech in general.”
Hennigar at BLG says that debt financing is a challenge for growth-stage companies in Canada, given that banks here are generally more conservative than in the US. Potential buyers’ lack of enthusiasm to take on debt as part of a leveraged buyout also has a “dampening effect on those deals that just can’t be financed off the balance sheet.”
Initial public offering activity has also dried up for tech and healthcare companies, along with the rest of the market, as there aren’t a lot of great candidates in Canada for attracting investment dollars by going public or who can sustain the pressure of being a reporting issuer.
“The tech sector, I think, will continue to see muted availability of the IPO as a common exit strategy,” Hennigar says.
Carelli at Stikeman says that “strong, healthy, and mature” tech companies are still aiming for IPOs, though perhaps more likely in 2024. In the meantime, they will likely look for one more pre-IPO raise to get them through this next period, looking for private equity, pension funds, and institutional investors for that last push over the next 12–16 months.
Despite the current downturn, M&A lawyers are bullish on the Canadian tech and healthcare sector. Says Sonshine: “There are some really smart minds focused on tech. And regardless of current challenges, strategic buyers, VC, and investor money will always take interest.”
Hennigar agrees that Canada has an amazing repository of top-flight research in the tech and biotech sectors. “But Canada’s problem has historically been how do we get over the hump to commercialize the great technology coming out of our research centres. And often it is strategic investors from outside Canada that buy and develop these assets.”
“There’s lots of potential for great Canadian technologies to be commercialized. It would just be really nice to see them commercialized by Canadian resident companies when they get to that stage.”