The Technology M&A Review: Israel
The Israeli M&A market is characterised by several unique attributes:
- While elsewhere in the world, M&As in the technology sector tend to consist of less than 20 per cent of overall M&A activity in terms of both volume and value of deals,2 with the majority of such transactions being in sectors covering heavy industries, services, manufacturing, finances, oil, gas, food and beverages, in Israel the overwhelming majority of deals in terms of both volume and value is in technology.
- Almost all such transactions are inbound, meaning that they consist of foreign buyers acquiring Israeli technology companies in their varying stages of development. Very few such transactions are intra-country, and even fewer are outbound.
- Most such transactions are acquisitions by multinational strategic buyers, as opposed to private equity firms (which is the next most popular form), management buyouts and public offerings.
The above is not surprising for a country known as the Startup Nation. Much of Israel's focus on the technology sector derives from its culture, which encourages innovation and entrepreneurship, and its high-level technology talent consisting of professionals who have received training in the Israel Defence Forces and its advanced intelligence units, and then further educated at Israel's premium schools for engineering such as the Hebrew University of Jerusalem, the Weizmann Institute of Science and the Technion.
Ironically, Israel's small size (less than nine million people) and small addressable market force local startups to develop products for the global market and to seek financing from global venture capital and other players, which makes them particularly appealing to foreign acquirers. Israel's technology talent is concentrated within a relatively small geographic area, and most of the world's largest multinational tech companies, including Intel, Cisco, Google, Microsoft, Apple, Amazon, Facebook, IBM and others, have a strong R&D presence in this area, so Israel's professionals gain valuable exposure and experience from working for international companies. In addition, there is an endless conveyer belt of talent between Israel and Silicon Valley, so best practices and exciting developments reach Israel quickly.
This past decade has been nothing short of miraculous for the Israeli technology M&A market. According to the 2019 PwC Israel Exit Report, the total value of Israeli high-tech companies acquired over the past decade was over US$70 billion paid for 587 deals.3 When including follow-on transactions, such as Mobileye, which first went public in 2014 and was then acquired by Intel in 2017 for US$15.3 billion, in the largest tech deal in Israeli history, the past decade provided US$107.8 billion in deals. The most prominent sectors were semiconductors, IT and enterprise software, and life sciences with 30.5 per cent, 28.5 per cent and 16.7 per cent, respectively.
The growing trend over the past decade has been that Israeli hi-tech companies no longer rush for the quick exit. Israeli entrepreneurs and their venture backers, with their ever-increasing exposure to the global market, have shown much more sophistication, confidence and patience before making the decision to exit. The willingness to run the longer distance before making such decisions has created an Israeli tech market with much higher-valued companies, including a significant number of unicorns.
Year in review
The year 2019 was an outstanding finale to an amazing decade for M&A in Israeli tech. According to the 2019 PwC Israel Exit Report, acquisitions and public offerings of Israeli technology companies in 2019 raked in US$9.9 billion, up 102 per cent from the previous year. The average amount paid per deal was US$124 million, up from US$81 million in 2018. The number of deals was at least 80 transactions, compared to 61 last year. If the 2019 figures were to include follow-on transactions involving companies that have already exited, the total number of exits would be 90, with a total value of US$23 billion.
The one acquisition of an Israeli tech company from private investors in 2019 for more than US$1 billion was the purchase of Habana Labs by Intel for US$2 billion. What was unique about that deal, but that is becoming more common, is that the acquirer was already a minority shareholder of the target, as it had invested in Habana as part of a financing round about a year prior to the exit. If we include follow-on deals of companies that had already gone public and were then fully purchased in 2019, there were five deals that crossed the billion-dollar mark, including the acquisition of Mellanox by Nvidia for US$6.9 billion, Click by Salesforce for US$1.35 billion, NSO Group by Novalpina Capital for US$1 billion and Lumenis by Barings, also for US$1 billion.
There were at least another 24 acquisitions for over US$100 million in 2019, up from 17 of such deals in 2018. According to the 2019 PwC Israel Exit Report, the US$10–US$50 million range continued to lead in 2019, as it had for at least the past six years, with 35 per cent of the acquisitions, followed by 25 per cent of the deals, which were in the US$100–US$500 million range.
This chapter would not be complete without mentioning the first half of 2020 and the huge impact of the covid-19 outbreak. Although the unprecedented blow to world economies has obviously also slowed down M&A, the tech sector continues to see interest. According to the Mergermarket 1H20 Global and Regional M&A Report, the negative impact was felt least worldwide by the tech sector. Certain sectors in hi-tech have even shown growth due to aspects of the pandemic demonstrating the continued push for digitalisation across various industries.
Mirroring trends in global transactions, the tech sector in Israel has remained active as well. According to Mergermarket, Israeli tech M&A reached US$2.3 billion with 21 deals in the first half of 2020, including Intel's US$900 million acquisition of Moovit, a provider of public transit information, in early May. On 2 July 2020, the Israeli business daily, Calcalist, reported an approximate 30 per cent annual growth in US–Israel acquisition deals, up from 16 deals three years ago to 27 deals in the past year, from mid-2019 to mid-2020.
Legal and regulatory framework
The main law that governs the behaviour of buyers and sellers of technology companies in Israel is the Companies Law,4 which governs not only the ongoing life of Israeli companies but also all corporate transactions involving such companies. Among many other areas, this Law governs the corporate approvals required from the board of directors and shareholders of a target company, including with respect to its varying classes of shares. The approvals required will vary based on the structure of a deal, such as whether it is a share deal or asset sale. The Law and its regulations also set forth the procedure, requirements and approvals required to effect a statutory merger and a forced sale (bring-along or drag-along) of recalcitrant shareholders. Many of the default provisions in the Law can be overridden by stipulations in the company's articles of association, which is the main governing document for Israeli companies.
The Economic Competition Law5 (formerly known as the Restrictive Trade Practices Law), governs all competition-related matters, including the approvals required for certain merger transactions as well as restrictive arrangements, such as non-compete commitments made by selling shareholders, which are common in such transactions. Although certain changes made to this Law in 2019 broadened the scope of transactions that require approval, in general, approval will still not be required if:
- as a result of the acquisition, the market share of the merging companies in Israel does not exceed 50 per cent;
- the joint sales turnover of the merging parties in the Israeli market, in the fiscal year preceding the merger, did not exceed US$107 million, and the turnover of each merging company in Israel is less than US$3 million;6 and
- neither merging company is a considered a monopoly.
As most (foreign) buyers of Israeli tech companies do not necessarily have sales or activity in Israel, it is less common for antitrust approval to be required in such deals. If required, companies are not permitted to merge unless all merging companies have filed the requisite merger notification with the General Director of the Competition Authority and received the General Director's approval. With some exceptions, the General Director is required to respond within 30 days, or the transaction is deemed approved.
The Israel Securities Law7 governs the trading of shares and acquisition of companies that are publicly traded in Israel (and going private). Acquisitions through tender offers, and squeezing out a minority, are governed by regulations promulgated under this Law. The Law considers an offer or sale to more than 35 offerees in Israel as a public offering, which has its own strict requirements such as filing a prospectus, so it is important to be mindful of these restrictions in the context of an M&A where the buyer uses stock to make the acquisition, or offers options to a large number of local employees.
The Law for the Encouragement of Industrial Research, Development and Innovation8 sets forth certain restrictions on the transfer of technology outside of Israel by companies that have obtained financing from the Israel Innovation Authority (formerly known as the Office of the Chief Scientist). The regulations under this Law provide ways for such government subsidies to be redeemed, thereby removing the restrictions. Such payments are often negotiated and settled as part of a transaction.
As in other jurisdictions, the Israeli Tax Ordinance [New Version] plays an important role in all M&A transactions. Aside from the general tax aspects that are relevant to all sellers, Israeli law has strict withholding provisions that place the burden on the buyer to withhold the sellers' tax liability. To that end, the parties and seller in these transactions will usually appoint a professional paying agent to handle such payments. This Law also plays a significant role in the treatment of employees' options that are sold in the context of such transactions. In almost all Israeli tech companies, part of the compensation offered to employees consists of options to buy shares. Such options are offered in accordance with the relevant provisions in the Tax Ordinance, which allow for the proceeds from the exercise of such options upon an exit to be treated as capital gains. Therefore, a major part of the due diligence process before M&A is making sure the issuance of such options complies with the requisite criteria under the Ordinance and regulations.
In addition, the Israeli Contracts Law (General Part),9 including its requirement to negotiate in good faith and the myriad case law on this provision, also governs the behaviour of the parties to technology M&A transactions and all their ancillary agreements.
Key transactional issues
i Company structures
ln substantially all private acquisitions of lsraeli entities, the target is an lsraeli private company whose shareholders enjoy limited liability. Private Israeli companies are subject to the Companies Law, regulations promulgated under such Law, and specific arrangements included in their respective articles of association as well as in other contractual shareholder agreements. While not subject to comprehensive public disclosure requirements, private Israeli companies must provide the Israeli Registrar of Companies (RoC) with notice of, inter alia, share transfers and changes in the composition of their boards of directors. In addition, companies are required to file at the RoC a copy of their articles of association, and any subsequent amendments, which is also quite common in the context of M&A. Any information filed with the RoC is public and, for a small fee, can be downloaded by anyone from their official website.
Publicly traded Israeli companies are subject, in addition to the Companies Law, to the Securities Law and the regulations promulgated thereunder, as well as to rules prescribed by the Tel Aviv Stock Exchange (TASE) (if a company is traded on the TASE), or the applicable laws of the relevant foreign jurisdictions and rules of the relevant foreign stock exchanges where they are listed. Many Israeli companies are publicly traded on the NASDAQ and other US markets. Publicly traded companies must comply with public reporting obligations (including financial reporting obligations) prescribed by law. In addition, publicly traded companies are subject to more scrutiny and robust transaction approval requirements, including by their statutorily appointed external (independent) directors, and various majority thresholds for approval of certain substantial or interested party transactions and the like.
ii Deal structures
Private company targets
There are three typical deal structures for the acquisition of private Israeli companies: mergers, share sales (including drag-alongs) and asset sales. We note with respect to merger transactions that an lsraeli company cannot merge with or into a foreign company, and therefore, mergers involving a foreign acquirer are commonly carried out by way of a reverse triangular merger, whereby the foreign acquirer incorporates a wholly-owned lsraeli subsidiary that merges into the lsraeli target, with the target surviving the merger and becoming a wholly owned subsidiary of the ultimate acquirer.
In theory, there is no need for approval by the board of directors or a meeting of the shareholders of the target company to approve a share purchase transaction. lt is generally sufficient for all shareholders or the requisite majority of shareholders to execute the relevant transaction agreement to move forward with a share purchase, and even force the dissenting minority to sell (by application of a contractual or statutory bring-along or drag-along clause). In principle, the selling shareholders can effect the acquisition without additional corporate approvals; however, in practice, cooperation with the board of the target company is desirable, if not necessary, and often venture investors in the target company will have veto rights over an acquisition, and their approval (whether at the board or shareholders level) will be required in any event.
Bring-along clauses, mergers
Note that some acquirers may be reluctant to employ bring-along provisions that allow for a prescribed majority of shareholders to force the remaining shareholders to join the sale to the acquirer due, in part, to issues regarding the enforceability of such clauses under lsraeli law. Therefore, approval of 100 per cent of the shareholders is usually required to execute a share purchase, which may give minority shareholders an effective veto over a transaction. In such cases, where a share acquisition is impractical due to a dissenting shareholder or shareholder who cannot be located, the transaction can be structured as a merger with respect to which, in general, approval of a majority of the board of the directors and a majority of the shareholders (including individual class votes) would be sufficient to approve the transaction. It should be noted that there are special statutory majority requirements if the purchaser holds more than 25 per cent of the target's shares or is affiliated with such holder.
An asset purchase typically only requires approval of the board of directors of the target, although often investors in the target will have veto rights (whether at the board or shareholder level) over the sale of all or substantially all of the assets of the target.
From a timing perspective, if all shareholders agree, a share purchase can move forward relatively quickly. However, if a statutory or contractual bring-along (drag-along) is required, the transaction could take up to two to three months, or even more. Merger transactions are subject to statutory timelines mandated by the Companies Law and regulated by the RoC, such that a merger cannot become effective until the end of a waiting period, which is the later of (x) 50 days from the date of filing of merger proposals (a technical form prescribed by regulations) by the parties with the RoC (which typically takes place immediately after signing the merger agreement), and (y) 30 days from the shareholder approval of both merging entities. Asset sales, on the other hand, can move quite quickly once the board has approved the sale of assets, subject to any time constraints involved in transferring employees, and obtaining required third-party consents or including shareholder veto rights, or both.
Public company targets
Typical deal structures for the acquisition of publicly held Israeli companies include:
- mergers (typically, a reverse triangular merger), which is a common structure when the acquirer desires to acquire a company in full and take it private;
- tender offers (full or special);
- purchases of control from a controlling shareholder; and
- court-approved mergers.
See above for a description of merger transactions and associated corporate approvals.
In a tender offer, the acquirer makes an offer to purchase some or all of the shares of the target company, usually using cash or, less frequently, its own stock. The offer may be conditioned on the successful acquisition of all of the shares of the target company. If the requisite majority of target shareholders approves, then the acquirer can squeeze out the dissenting shareholders and acquire 100 per cent of the shares of the target. The requisite majority threshold is very high, requiring that holders of at least 95 per cent (and in some cases up to 98 per cent) of the issued and outstanding capital shares of the target company must accept the offer. The accepting responding holders must also comprise a majority of the shares held by offerees who do not have a personal interest in the tender offer, subject to certain exceptions. Where the acquirer completes a full tender offer and purchases 100 per cent of the shares, the target company's previous shareholders have a statutory six-month window commencing as of the completion of the tender offer to apply to the court to challenge the fairness of the price paid in the transaction. A special tender offer is, to our knowledge, a unique Israeli construction: a purchase of shares resulting in the acquirer holding post acquisition either 25 per cent of the voting rights in a company with no other shareholder holding 25 per cent or more; or 45 per cent of the voting rights in a company with no other shareholder holding 45 per cent or more. Such offer is made by offering all shareholders the right to sell shares to the acquirer under equal terms and can be accepted if the number of accepting shareholders exceeds the number of rejecting shareholders (certain shareholders with a personal interest are excluded from this count). The offeror in a special tender offer can offer to purchase at least 5 per cent of the outstanding shares of the company. If the acceptances exceed the amount the acquirer wishes to purchase, the purchase will be made pro rata from the accepting shareholders.
Off-market purchase of control
An acquirer can also gain control by purchasing shares from an existing controlling shareholder – this structure is available when the mandatory special tender offer requirements are not triggered. Under this alternative, a purchaser can gain control by a private secondary transaction, outside the TASE, purchasing shares directly from the controlling shareholder. While this method enables the purchase of control from individual sellers, it does not enable the acquisition of 100 per cent of the target.
Finally, if none of the aforesaid alternatives are feasible, Sections 350 and 351 of the Companies Law (which deal primarily with arrangements between companies and their creditors and shareholders in insolvency scenarios) can be used to effect mergers between two companies, requiring the submission of two applications to the court: one to authorise the convening of a special meeting of the shareholders and creditors of the target company; and a second to approve the arrangement reached by the creditors and shareholders. Under this procedure, the threshold for approving a merger in the target's shareholders' meeting is 75 per cent of the shares present and voting at the meeting, together with a majority of the shareholders present and voting.
We note that transactions for the sale of assets are also available for publicly traded companies.
In addition to the distinctive corporate consents and timing requirements required in each structure, as described above, the following are some of the key factors that should generally be considered when determining the appropriate acquisition structure (irrespective of whether the target is private or publicly traded):
- Third-party consents: in a share purchase and reverse triangular merger where the target is the surviving legal entity, all assets, rights, debts and liabilities (including employment agreements) of the target remain in the same legal entity. Accordingly, unless any specific agreement relating to such assets, rights, debts and liabilities provides otherwise (for example, a change of control clause), no third-party consents are required for a share purchase or merger. ln contrast, in an asset sale, the assets, rights, debts and liabilities are transferred to the acquirer, and such transfer may require the consent of counterparties to all relevant agreements.
- Cherry picking: the major advantage of an asset purchase, as opposed to a share purchase or merger, is that the acquirer can choose which asset it buys and which liabilities it assumes. The purchaser can, in effect, cherry pick only the desired assets. All other assets and liabilities remain with the target company. Accordingly, this is often the more favourable way to purchase a distressed company. Israel does not have a doctrine of successor liability.
- Tax: there is only one layer of taxation in a share purchase and merger: the shareholders are subject to capital gains tax on the disposition of their shares, and there is no tax at the corporate level of the target. For the most part, foreign (non-lsraeli) shareholders are not taxed at all on the disposition of shares in an lsraeli company. By contrast, an asset sale attracts taxation on two levels: capital gains tax at the company level on the disposition of the assets, and a dividend (or similar) tax on the distribution of the proceeds of the asset sale to the shareholders of the target. ln some cases, the first tax (capital gains on the sale of the assets) can be set off against the company's net operating losses.
Bankers typically assist the target in connection with acquisition bidding processes and, once relevant in the negotiation process between the parties, in trying to bridge any financial or other commercial gaps that may arise in the context of the transaction. Attorneys and accountants are heavily involved in the preparation and negotiation of the applicable transaction documents (including preparation of the required financial reports involved with acquisitions of publicly traded companies) as well as any preliminary due diligence processes.
iii Acquisition agreement terms
Basic terms of share purchase, asset sale and merger agreements (focusing on privately held technology companies, which are typically acquired by a foreign entity)
The main documents governing such transaction agreements would consist of the following:
- A share purchase agreement or merger agreement governing the terms of the respective purchase, which would include:
- clauses describing the sale and purchase of the shares and other securities convertible into shares, the consideration, payment terms and responsibility for taxes (including a mechanism for withholding tax) associated with the purchase;
- representations and warranties by shareholders, mostly relating to their ownership of the shares;
- representations and warranties by the target company with respect to the target (authority, capital structure, financial reports, litigation, contracts, tax, employees, intellectual property (IP), regulatory compliance, privacy and data protection, etc.)
- in the event that the transaction does not contemplate a simultaneous sign and close, covenants relating to conduct of business in the ordinary course during the period between signing and closing, and pre-closing termination provisions;
- closing deliverables and closing conditions;
- broad waivers of rights and claims on the part of the selling shareholders;
- post-closing obligations of the parties to include a confidentiality undertaking, and non-compete and non-solicitation obligations on the part of the selling shareholders; and
- in transactions involving privately held companies, indemnification by the shareholders for breach of representations, either by the target or the sellers, typically with each seller responsible for its individual representations, and with all sellers as a group responsible for the target's representations.
- Most transactions will also include an escrow or holdback component designed to secure any indemnity claims by the acquirer. An escrow arrangement will involve the deposit by the acquirer of a portion of the consideration with a third-party escrow agent at closing to be held for an agreed-upon duration of time pending release of any unpaid amounts to the shareholders. Under a holdback arrangement, the acquirer retains the amounts held back from the consideration, pending payment (if applicable) after a prescribed time.
- Retention or holdback agreements are common in the event that certain shareholders, typically founders or key employees, are to be retained post-completion, and a certain part of their consideration or a certain additional retention bonus is conditional on such employment. Care needs to be taken in structuring the retention arrangements so as to avoid the imposition of ordinary income tax instead of the preferred capital gains treatment.
- In the context of a tender offer involving a publicly traded company, the offeror must submit the tender offer in accordance with the requirements of the Securities Regulations (Tender Offer),10 which include details regarding, inter alia:
- the type of offer (regular, special or full);
- the consideration;
- the percentage of holdings held by the offeror on the date of the offering;
- the acceptance threshold;
- the last day for accepting the offer;
- the identity of the Tel Aviv Stock Exchange member providing the guarantee for payment of the price;
- the shareholders who have already confirmed their intention to accept the offer; and
- various details regarding the offeror.
Type of consideration
Other than cash, the most common consideration used in the acquisition of Israeli companies is the acquirer's publicly-traded securities. The use of the acquirer's securities as the currency for the acquisition raises issues under the Securities Laws depending on the number of shareholders in the target who receive the acquirer's securities as consideration. Generally, unless an exemption is available, the offer of securities (including the acquirer's securities) to more than 35 Israeli resident offerees (including the target's shareholders and option holders) requires an Israeli prospectus, which is a costly and time-consuming exercise. Israeli-resident classified investors, as defined in the Securities Law (e.g., institutional investors, high-net-worth individuals, insurance and other large companies, broadly similar to accredited investors in the United States), are not included in the 35 offerees count. In addition, it should be noted that the sale of shares of the target in consideration for the stock of the acquirer without the shareholders receiving any cash to allow them to satisfy the tax liability can create an adverse tax consequence for the shareholders. This issue is somewhat remedied as in general, under such circumstances, lsraeli law requires that taxes are paid with respect to one half of the consideration only after two years, and the balance of the consideration only after four years. As a result, cash is usually the preferred form of consideration for sellers.
The main limitations on liability negotiated in the context of transactions involving private companies relate to:
- survival periods, limiting the time period during which claims can be made by the acquirer against the target or shareholders in connection with a breach of warranties, which limitations vary with respect to different categories of representations – where general representations typically survive for a shorter period than fundamental representations, such as with respect to share capital, taxes (and to a certain extent even IP), which often survive until the lapse of the applicable statute of limitations;
- indemnity cap, which sets the maximum amount of indemnification that the target or shareholders, as applicable, may be required to make; here too, various caps will apply for different representations, with the general representations typically subject to a lower cap (escrow or holdback amount), IP and other specific items subject to a secondary cap higher than the general escrow amount but lower than the purchase price, and fundamental representations and other specified matters capped at the purchase price;
- basket threshold, which sets the minimum amount of damage that must be incurred in order for the acquirer to seek indemnification from the target or the shareholders, as applicable (a basket can be a tipping basket such that once the basket amount is reached, all claims can be submitted, or a deductible basket where all claims less than the basket are ignored); and
- ensuring the heavily negotiated indemnity provisions are the sole and exclusive remedy that the acquirer may exercise in the event of breach of the agreement.
Typically, no limitation would apply in the event of fraud or specific indemnification items identified during due diligence. There is no established Israeli practice with respect to materiality scrapes or sandbagging provisions, all of which are subject to commercial negotiation.
No shop provisions and fiduciary out clauses
Binding no shop provisions, under which the target company must not solicit or respond to other offers during an agreed-upon period of time, are enforceable. In Israel, there is no statutory basis or established case law for fiduciary out clauses, particularly in a private company. Remedies for breach of a no shop undertaking can be agreed, including reasonable break up fees or indemnification for damages payable by the target company if it accepts a competing offer or by a shareholder who fails to vote as promised in favour of a transaction. Although not mandated by law, most agreements for the acquisition of an Israeli public company will include US-style fiduciary outs based on Delaware law practice. While Delaware law clearly does not govern in Israel, there is some thought among practitioners that Israeli courts would be influenced, indirectly, by Delaware precedent.
There is no general financing guideline. Financing is made on a case-by-case basis and depending on an acquirer's specific financial capabilities. Leveraged buyouts and management buyouts run into complexities in Israel due to both tax and corporate considerations, and these also need to be considered on a case-by-case basis.
v Tax and accounting
Share sales (inclusive of mergers)
Subject to certain exemptions, capital gains tax is imposed on the disposition of capital assets (including shares) by an lsraeli resident, and on disposal of capital assets by a non-lsraeli resident, if the assets are located in lsrael, are shares or rights to shares in an lsraeli resident company, or represent, directly or indirectly, rights to assets located in lsrael. A capital gain derived by a corporation is subject to corporate tax (at a rate of 23 per cent, as of 1 January 2020). For individuals, the rate can range from 25 to 50 per cent (if the gain is taxed as earned income). However, in general, non-lsraeli residents may be exempt from tax on capital gains derived from the sale of shares in an lsraeli company. This exemption is conditional on a number of requirements, including that the gain is not attributable to a permanent establishment of the non-lsraeli seller in lsrael. As mentioned above, non-Israeli buyers are subject to withholding obligations, which apply even when purchasing shares of Israeli companies held by non-Israelis.
ln general, a sale of assets located in lsrael by a non-Israeli resident, other than shares or securities, is subject to lsraeli tax. Certain tax treaties signed by lsrael provide, under certain conditions, an exemption from lsraeli tax for gains derived from a sale of assets located in lsrael; however, in general, a capital gain derived by a corporation from a sale of an asset is subject to tax at the applicable corporate tax rates (23 per cent as of 1 January 2020).
Value added tax
The sale of an asset in lsrael is generally subject to value added tax (VAT), currently at a rate of 17 per cent. ln general, a sale of shares is not subject to lsraeli VAT. There are certain transactions that may be subject to VAT at a rate of zero per cent, such as the export of goods and a sale of intangible assets to a foreign resident. The availability of the zero-rate VAT regime is conditional on the satisfaction of certain conditions and requirements provided under law and regulations.
ln general, under lsraeli law there are no transfer taxes applicable with respect to a sale of shares or assets of a company. However, certain transfer taxes may apply in a sale of real estate assets or a sale of shares in a real estate association (at a certain percentage of the value of the real estate assets owned or sold by the real estate association).
Israeli companies whose securities trade only on the TASE (except for banking institutions) are required to use International Financial Reporting Standards standards, while privately held companies that are not subject to reporting requirements under the Securities Law report mainly in accordance with Israeli or US GAAP.
vi Cross-border issues
See Section VII for restrictions on the transfer of Israel National Technological Innovation Authority (IIA)-funded IP outside of Israel.
Israeli law does not impose specific restrictions on the transfer of shares to, or holding of shares by, a foreign buyer. Notwithstanding, irrespective of whether a company is privately or publicly held, lsraeli law imposes restrictions on dealings with persons or entities residing in countries that are in a state of war with lsrael (namely, lran, Syria and Lebanon).
The obligation to withhold applicable taxes arising on account of an acquisition vests with the acquirer. Foreign acquirers may not be able to formally carry out such obligation as they are usually not registered with the Israeli Tax Authorities (ITA) and not able to remit any withheld amounts to the ITA. To solve this technical obstacle, Israeli law allows an acquirer to retain the services of an Israeli paying agent, which assumes the acquirer's withholding obligations. This process has become standard practice in most acquisitions involving a non-Israeli acquirer.
Israel is a party to most major international IP treaties, including the World Intellectual Property Organization (WIPO) Agreement on Trade-Related Aspects of Intellectual Property Rights and other treaties administered by WIPO. Israel, under various statutory regimes, provides protection to the most common forms of IP, including patents, copyrights, trade secrets and trademarks. Specific statutory frameworks also provide protection for plant breeds and semiconductor topography. In addition, the Unjust Enrichment Law 1979 may also under current case law provide an important source of IP protection in addition to more traditional forms of IP. Israeli courts generally recognise the importance of such IP rights to technological investment and economic growth. M&A transactions involving companies holding IP assets do not materially differ in structure or enforcement from other categories of M&A transactions, although such transactions often address unique aspects of Israeli law. For example, as discussed in more detail in Section VIII, to the extent a target company has developed its IP assets with funding from the Israeli Innovation Authority, transfer abroad of the ownership of such IP assets may be restricted without regulatory approval and accompanying payment. In addition, while Israeli export control law generally follows the restrictions of the Wassenaar Arrangement, Israel also imposes distinctive controls on the export of encryption technology. As such, restrictions on the transfer abroad of encryption technology may exceed restrictions imposed by other developed economies.
Israeli courts will generally not enforce employee non-competes or similar arrangements restricting employees' ability to be employed unless necessary in order to protect a trade secret of the employer. Even when enforced, the non-compete will be limited in time and scope, and the employee will need to be compensated for the time he or she is prevented from working.
Pursuant to the Israeli Patents Law,11 ownership of IP developed by an employee during the period of his or her employment automatically vests with the employer; however, the allocation of economic rights (e.g., royalties) is subject to agreement between the parties. Typically, employment agreements entered into by employees in the high-tech sector include waivers of economic rights in IP developed during an employment. In this regard, typical employee IP assignment agreements may need to be reviewed and revised to be sure that the employee is not accidentally left with economic rates relating to IP that he or she developed.
Litigation would depend on specific circumstances, but when it does arise it very often involves the termination process and events leading up to such termination. When a company's employees are subject to employment agreements containing industry standard provisions, litigation regarding the ownership of IP or economic rights therein is not frequent. Israeli law imposes a hearing requirement with respect to the termination of employees, and the process of termination should be supervised by counsel.
In the context of an asset sale or a merger where the employing entity (target) does not survive the transaction, employees of the target are not automatically transferred to the employ of the acquirer. There are two options for transferring the employment. The first (continuity of employment) is to have a tripartite transfer agreement between the new employer, previous employer and employees, in which the new employer undertakes all liabilities of the former employer and maintains the continuity of the employees' employment. The employees' consent is required for such transfer. The other option (fire/rehire) is that the employees' existing employment arrangement will need to be terminated, and the employees are rehired by the acquirer. Upon termination, the employees will be entitled to certain severance rights, including statutory severance pay, payment for or in lieu of notice and certain other benefits. Assuming they remain employed in substantially similar positions and in the same offices, any rights dependent on seniority will continue to apply with respect to their new employment as if they continued their prior employment. In a share sale there is no need for fire/rehire procedures, as the employing entity (target) continues to operate, albeit with different shareholders. However, a change of control may, under certain circumstances, allow employees to resign and be deemed as if terminated under constructive dismissal, thus entitling them to severance payments and certain other benefits.
Israeli law requires employers to fund their employees' pension schemes calculated based on their respective salaries. In a transaction involving a transfer of employees from the employ of the target to the employ of the acquirer with continuous employment (e.g., an asset deal), a (routinely obtained) permit from the tax authorities is required for transfer of the pension funds from the control of the initial employer to the new employer. This step is not required in the context of a share sale or merger where the target survives, or where the employees' employment is terminated by the current employer and they are rehired by the new entity.
While it is quite rare for employees in the Israeli high-tech sector to be part of a union, if that is indeed the case, Israeli law would impose an obligation on the target to inform employees (through the union) of the pending acquisition and in some circumstances consult with the union regarding the terms thereof.
The Protection of Privacy Law 1981 (Privacy Law) is the main Israeli law dealing with the collection and use of personal data. The Privacy Law is supplemented by various regulations, including the Protection of Privacy Regulations (Transfer of Information to Databases outside of the State's Boundaries) 2001 (Data Transfer Regulations).
The Privacy Law stipulates that no person shall infringe the privacy of another without his or her consent. Section 2 of the Privacy Law lists 11 activities, each of which constitute an infringement of privacy if carried out without consent. One of these activities is 'using, or passing on to another, information on a person's private affairs otherwise than for the purpose for which it was given'. Section 8(b) also restricts the use of data included in a database to the purposes for which it was provided. Since processing of the data must be consistent with the purpose limitation – that is, the data may only be used for the purposes for which it was provided by the data subject – any use of data beyond the purpose limitation would generally require consent. Seeing as an employee or contractor does not generally intend to provide personal data in the context of entry into an engagement arrangement for purposes relating to due diligence activities, their specific consent to share such information with a prospective investor or acquirer should be obtained. Moreover, written consent is generally required when personal data is collected within an employment context, because of the imbalance of power between the employer and employee. Accordingly, many companies include a specific provision in their standard for engagement agreements, pursuant to which the applicable service provider clearly consents to the transfer of its personal data in the context of a due diligence inquiry undertaking by the company.
In addition to the foregoing, the Data Transfer Regulations stipulate that the transfer of data from databases within Israel to a location outside Israel is strictly prohibited unless the database owner secures the written undertaking of the recipient of the transferred data that the latter will take sufficient precautions to protect the privacy of the data subjects and will not transfer the data to anyone else. In addition, an international transfer may not be made unless one (or more) of the legal grounds specified in the Data Transfer Regulations exist. Generally speaking, obtaining data subject consent, or transferring the data to the EU or to a recipient who undertakes to comply with the laws regarding the holding and use of such data, would constitute a legal basis for international transfers of data. In the context of due diligence reviews prior to the closing of M&A transactions, one of the above criteria is typically relied upon to transfer employment-related data to foreign acquirers.
It is quite common for technology startups in Israel to have received government subsidies, but they are not the majority. If a promising startup has access to private funding from the outset, it will usually prefer to forgo government subsidies, which come with strings attached. The most common source of government subsidies for Israeli tech companies is the IIA (formerly known as the Office of the Chief Scientist of the Ministry of Economy and Industry). The official website of the IIA provides that 300 such research and development (R&D) projects were approved in 2019 and were granted subsidies in the aggregate amount of approximately 325 million shekels.
Upon an acquisition of a company that was the recipient of IIA funding, in a share deal where the IP will remain in Israel, the company is only required to notify the IIA, and the foreign acquirer must sign a standard form of undertaking to observe the Law for the Encouragement of Reserach, Development and Technological Innovation in the Industry.12 However, very often the buyer wishes to transfer the IP outside of Israel (post-closing), or wants the flexibility to do so, and one of the main restrictions imposed by IIA funding is that the funded IP must remain in Israel. Therefore, the IIA is authorised, at its discretion, to approve the transfer of know-how abroad subject to the receipt of certain upfront payments.
Obtaining approval for such transfer is often a condition to closing, but even when handled post-closing, the parties will often negotiate which party covers such IIA redemption fee – the outcome of those negotiations ranges from the fees being paid solely by the buyer or solely by the seller, or somehow split. The IIA regulations provide formulae for determining the price of such fee, which roughly reflects the value of the portion of the IP that was developed by such IIA funding; however, it is capped at six times the amount of the grant or, if the buyer commits to maintain 75 per cent of such R&D operations in Israel for three years, the multiple can be reduced to three times the amount. The amount of the fee can vary tremendously depending on various factors (amount of the grants, timing of the grants, amount of additional R&D investment by the company) so that the fee is at times a minor nuisance and at other times a significant commercial issue.
While approvals for transfers of IP outside of Israel are granted as a matter of course, and subject to payment of the redemption fee, it is important to note that under the applicable law, the unauthorised transfer of know-how abroad is a criminal offence.
Due diligence is typically conducted in the context of acquiring technology companies, and while not unheard of, it is unusual to consummate an acquisition on an as-is basis or solely based on representations given by the target and its respective sellers.
There are typically three categories of due diligence conducted by acquirers of technology companies in Israel: financial and tax due diligence, typically handled by the acquirer's accounting firm; patent and IP due diligence, typically handled by patent counsel and the acquirer's R&D teams; and legal due diligence, handled by the acquirer's (outside and local Israeli) legal counsel. Legal diligence is generally all-inclusive, focusing mainly on matters relating to:
- the share capital structure and rights attached to shares or awarded to specific shareholders;
- IP ownership;
- restrictions on changes of control;
- assignments and third-party consents required to effect the acquisition;
- material agreements; and
- compliance with legal requirements and obligations that survive the closing.
Due diligence findings will often highlight certain items of exposure for which the buyer will require specific indemnity in the context of the transaction agreement.
While patent counsel will review all registered patents and applications associated with a target's technology, legal IP diligence will focus mainly on ensuring the target's full ownership of IP. Accordingly, attorneys will review:
- all employment and consulting agreements to confirm sufficient IP assignments;
- all inbound and outbound licence agreements to ensure the use and ownership of all target IP is duly protected;
- licences of open-source components included in the target's IP to ensure no exposure on account of copyleft licences and the like;
- whether it has been ensured that all employees and consultants who contributed to target's IP were not, at the time of their engagement with target, also employed or otherwise engaged by:
- any academic institution, medical facilities, governmental or military bodies (which entities are subject to statutory or internal policies granting such institutions rights in IP developed by their employees, consultants, faculty members and students); or
- other companies who may have a claim to any IP developed by such employee even if for a different employer.
According to Israeli law, the default forum for the adjudication of disputes are the competent courts of Israel, and the applicable law is Israeli law. However, it is not unusual, particularly in the context of an M&A with a strong foreign buyer, for transaction agreements to apply foreign law, or make disputes subject to foreign jurisdiction or arbitration, or both. However, irrespective of the law governing the agreement, when the target is an Israeli company, the Companies Law will apply to all internal corporate matters of the transaction.
If the parties agreed to apply foreign law and the matter reaches an Israeli court, the foreign law must be proven, and in the absence of proof to the contrary, it will be deemed to be identical to Israeli law. It should be noted, however, that some aspects of Israeli public policy cannot be avoided by resort to foreign law.
The Foreign Judgments Enforcement Law13 provides the framework for enforcing and recognising foreign judgments in Israel. In general, to enforce a foreign judgment in Israel, the following conditions must be met:
- the judgment was rendered by a competent foreign court and is not subject to appeal;
- such judgment would be enforceable if rendered in Israel;
- the judgment is executable in the foreign jurisdiction; and
- the motion to enforce the judgment was submitted within five years of the judgment date.
It should also be noted that in recent years there has been an increase in alternative methods for dispute resolution, such as arbitration and mediation, which are particularly prominent when parties wish to ensure an expedited resolution or avoid the publicity of litigation. According to the Israeli Arbitration Law,14 Israeli courts will also enforce foreign arbitration judgments pursuant to the applicable international treaty.
As fertile ground for investment and innovation, Israel continues to be one of the world's stunning success stories. Although small in population, Israel is a frontrunner in technological prowess, which continues to attract the interest of strategic buyers even in the midst of the covid-19 pandemic.
M&A involving Israeli technology companies continue to grow in terms of both volume and value. This huge investment of funds and the maturing market have allowed Israeli companies the opportunity to be patient and wait for higher valuations in their M&A exits. This has also been attracting new types of investors, such as more private equity firms and venture capital investors from Europe, as well as China and East Asia. Recent years have also seen more interest from Australian and Canadian companies and investors. The new trend of using a merger into a special purpose acquisition company to go public in the United States has already reached Israel, and we can expect it to grow.
The pandemic has certainly shaken up the world markets. Nevertheless, with increased digitisation and the need for creative technological solutions worldwide, we expect large corporates and private equity funds to continue looking to Israel for acquisition opportunities.
1 Liron Hacohen and Ezra Gross are partners and Barry Levenfeld is a senior partner at Yigal Arnon & Co.
2 According to surveys published in the Global and Regional M&A Report 1H20, of Mergermarket (an Acuris company) covering the M&A markets in Europe, the US, Latin America, Asia Pacific, Japan, and the Middle East and Africa.
3 Only including acquisitions for US$5 million or more.
4 Companies Law, 5759-1999.
5 Economic Competition Law, 5748-1988.
6 These amounts are approximate figures based on the current US dollar to shekel exchange rate.
7 Israel Securities Law, 5728-1968.
8 Law for the Encouragement of Industrial Research, Development and Innovation, 5744-1984.
9 Israeli Contracts Law (General Part), 5733-1973.
10 Securities Regulations (Tender Offer) 5760-2000.
11 Israeli Patents Law, 5727–1967.
12 Law for the Encouragement of Research, Development and Technological Innovation in the Industry, 5744-1984.
13 Foreign Judgments Enforcement Law, 5718-1958.
14 Israeli Arbitration Law, 5728-1968.