Chamber of Digital Commerce Releasing the First Ever Comprehensive Report on Canada’s Blockchain Ecosystem

Over the last decade in which the digital economy has grown at an unprecedented pace across industry sectors, blockchain technology and distributed ledger technology have shown the ability to reform the ways in which businesses and governments operate. To better understand Canada’s blockchain ecosystem, on October 4, 2019, the Chamber of Digital Commerce Canada released Canada’s first ever comprehensive report examining the country’s burgeoning blockchain ecosystem.

Through data collected from more than 150 stakeholders from industry, government and academia, this report serves as a baseline measurement of the Canadian blockchain ecosystem for tracking future growth and GDP impacts over the coming years.

On a global scale, spending on blockchain solutions by companies and governments is projected to hit almost USD$16 billion in 2023. Against this backdrop, Canada’s spending on blockchain solutions is expected to grow exponentially and reach USD$644 million by 2023, at a five-year compound annual growth rate of 73.3%, which is the highest growth rate of any country in the world.

Below are some of the key findings from the report:

  • High paying jobs: The average annual salary for a blockchain worker in Canada is pegged at CAD$98,423, which is nearly double the average Canadian salary. This compensation level makes the blockchain industry among the highest paying in Canada. Globally, the annual average salary for blockchain professionals range from CAD$83,958 to CAD$178,577.
  • Legal and regulatory issues: Almost half of survey participants listed “legal and regulatory challenges” at the top of barriers they faced. Survey results indicated that the federal and provincial policy and regulatory positions with respect to digital assets are vague and inconsistent. Larger corporations and startups alike pointed to the uncertainty and lack of harmonization in the regulatory sphere for causes behind hindered investments in blockchain innovation.
  • Canadian companies’ focus areas: The report identified nearly 400 Canadian companies that are currently active in advancing blockchain technology and contributing to the ecosystem. Blockchain-based products and services account for 34% of the Canadian blockchain ecosystem while digital asset infrastructure represents 30%. Enablers, which consist of blockchain consultancies and infrastructure and services, make up 29% of the ecosystem.
  • Innovation breakdown by region: Of the currently active 400 blockchain companies, Ontario emerges as the province which has the most innovators (at 52%), followed by British Columbia (at 29%). In terms of areas of focus, Western Canada provinces such as B.C. concentrate on providing financial services, building trading platforms and conducting crypto mining activities. Blockchain activities in Central Canada, particularly in Toronto as a financial hub, tend to focus on the investments in blockchain-based innovations. Meanwhile, Eastern Canada companies work primarily on supply-chain solutions.

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Emerging Trends in Information Technology (IT) Mergers and Acquisitions

Canada’s burgeoning information technology (IT) sector is a standout in the Canadian mergers and acquisitions landscape. A recent report by Duff & Phelps illustrates that in the first half of 2019, IT was the third most active deal-making sector in Canada with over 104 closed transactions. Against this backdrop, three trends emerge:

  • ‘Buying into’ privacy or cybersecurity risk. Buyers are becoming increasingly aware of the importance of conducting rigorous due diligence on a target company’s privacy and cybersecurity systems and practices. Marriott’s data breach in 2018, where about 383 million guest records globally were exposed to cybercriminals, highlights this. The Marriott breach occurred on IT infrastructure Marriott inherited through its acquisition of the Starwood hotels group in 2016. The vulnerability arose in 2014 when the Starwood hotels group’s IT systems were compromised by malware installed by cybercriminals. However, the exposure of customer information was not discovered until 2018. In handing Marriott a £99M fine for infringement of the European General Data Protection Regulation (GDPR), the UK Information Commissioner’s Office stated that organizations must be accountable for “carrying out proper due diligence when making a corporate acquisition, and putting in place proper accountability measures to assess not only what personal data has been acquired, but also how it is protected.” In Canada, generally, the Office of the Privacy Commissioner does not have the power to levy fines as large as what has been seen in the EU and US but has released its findings on several high profile data breaches. As a whole, these finding provide guidance, albeit limited, as to what Canadian regulators consider as reasonable security safeguards by accountable organizations. As privacy regulators globally align on stricter enforcement and larger penalties for data breaches, buyers of Canadian target companies will increasingly focus on mitigating privacy and cybersecurity deal risks.
  • Dealing with competition law. There is an emerging global trend of anti-trust authorities becoming more aggressive with the technology sector. The Canadian Competition Bureau is similarly scrutinizing mergers involving technology targets. Typically, in Canada, most mergers in the technology sector do not meet the financial thresholds that require merging parties of potential mergers to notify the Bureau. Nevertheless, all merger transactions, whether or not they are notifiable, are subject to examination by the Commissioner of the Competition Bureau to determine whether they have, or are likely to have, the effect of preventing or lessening substantially competition in a definable market. The Bureau recently expanded the role of its Merger Notification Unit (now referred to as the Merger Intelligence Notification Unit (MINU)) to focus on active intelligence gathering on non-notifiable merger transactions that may raise competition law concerns. The Bureau is also encouraging parties to such transactions to voluntarily engage with the MINU well in advance of closing. To date, the Commissioner has challenged at least one completed acquisition, the acquisition of Aucerna by the private equity firm Thoma Bravo. Aucerna is a Canadian software company operating in the “relatively modest” and specialized Canadian oil and gas software market with annual revenues in the “tens of millions of dollars,” per the Competition Bureau’s statement. Thoma Bravo also has a portfolio company Quorum Business Solutions, that competed vigorously with Aucerna and was the only other licensor, aside from Aucerna, of reserves software used by Canadian oil and gas firms. On the basis that the acquisition would lead to an effective monopoly, the Commissioner required Thoma Bravo to divest the related software business of Quorum Business Solutions. In that vein, Bureau personnel have been actively following up with parties to non-notifiable transactions to request confirmation of certain information.
  • ‘Acquiring’ an innovation strategy. Companies outside the technology sector are acquiring technology companies, whereas traditionally acquirers were large strategic technology companies. The motivation for this new breed of buyers is not consolidation, acceleration of market access, acquisition of cash-flows or any of the typical rationale for acquisitions. Rather, as part of their innovation strategies, these companies are realizing that it may often be cheaper or faster to acquire desired skills or technologies rather than building those, or having those built for, themselves. For example, significant deal activity in fintech can be attributed to financial institutions such as banks and insurance companies buying technology assets to transform their businesses and service offerings.

These trends are likely to shape IT transactions in several ways:

  • At the outset of an IT transaction, parties to a merger involving technology assets will want to consider whether or not to engage early with the Competition Bureau where a contemplated transaction is non-notifiable.
  • The due diligence stage will focus more deeply on a target company’s privacy and cybersecurity policies and practices. Given the scant guidance by Canadian regulators on what constitutes reasonable measures to avoid privacy and cybersecurity breaches, coordinated legal and technical due diligence is required to identify and analyze potential issues. Mitigation of these issues will involve strategic negotiation of the specific privacy and cybersecurity representations, warranties, covenants and indemnification, as well as pre-closing remediation of the same.
  • The negotiation of ancillary deal agreements, such as transition service agreements that provide for services by the seller post-closing will should be considered early in the deal timeline where a buyer, outside the tech sector acquires a technology company as part of its innovation strategy. Typically, this buyer will lack the resources to quickly integrate the acquired assets within its infrastructure while the seller most likely will not want to provide transition services and such negotiation are likely to be lengthy.

In short, these emerging trends are likely to deepen and broaden the scope of due diligence, especially regarding privacy and cybersecurity and will likely impact the deal timeline if parties need to account for competition law issues or transition services.

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New guidance on material climate change disclosure for reporting issuers

On August 1, 2019, the Canadian Securities Administrators (CSA) released CSA Staff Notice 51-358 in efforts to clarify the scope of disclosure for reporting issuers, specifically for smaller issuers. Securities law in Canada requires reporting issuers to disclose material risks affecting their business and, where applicable, the financial impacts of such risks.

While this notice does not produce any new legal ramifications, it is intended to reinforce and expand upon the guidance provided in CSA Staff Notice 51-333 Environmental Reporting Guidance. The driving factor to release this notice was motivated by the following considerations:

  • Increased investor interest. Many investors, particularly institutional investors, have become increasingly focused on insufficient disclosure on climate change-related risks.
  • Room for improvement in disclosure. Based on CSA’s review of the disclosure of a sample of TSX-listed issuers, they noted that many provided boilerplate disclosure on climate-change related risks or no disclosure at all.
  • Domestic and global developments. There have been global and domestic initiatives for voluntary disclosure frameworks, such as the Climate Risk Technical Bulletin published by the Sustainability Accounting Standard Board.

The CSA guidance reminds issuers of the disclosure required in their Annual Information Forms and Management Discussion and Analysis, specifically reiterating the materiality threshold. Information is likely material, and therefore disclosable, if a reasonable investor’s decision to buy, sell, or hold a company’s securities would be affected if the information was omitted or misstated; and the materiality of a known trend, demand, commitment, event or uncertainty turns on an analysis of probability of its occurrence. The guidance notes that issuers will be exposed to climate change-related risks uniquely and will affect issuers in different ways. While there is no bright-line threshold for materiality, the guidance suggests that issuers consider both quantitative and qualitative factors in determining materiality, that they look at overall context, that timing is considered, and that trends, demand, commitments, events and uncertainties are assessed.

The role of the board of directors & management

The board has a role in strategic planning, risk oversight and the review and approval of an issuer’s annual and interim regulatory findings. Management also has a key role to play in risk management and the preparation of annual and interim regulatory filings. With regards to risk oversight specifically, boards and management should be taking appropriate steps to understand and assess climate change risk and the materiality of this to their business. Some specific examples of questions that board and management should consider include:

  • Is oversight and management of climate change-related risks and opportunities integrated into the issuer’s strategic plan, and if so, to what extent?
  • Has management appropriately considered how each of the different categories of climate change-related risks may affect the issuer (e.g., physical and transition risks)?
  • Has management considered which business divisions or units have responsibility for identifying, disclosing and managing material climate change-related risks and what their reporting lines are to senior management? To what extent are these responsibilities integrated with mainstream business processes and decision-making?

What are Climate Change-related Risks?

The following are the types of climate change-related risks that issuers may face:

  • Physical risks. These can be acute or long-term shifts in climate patterns. Examples include changes in water availability, sourcing and quality, or extreme temperature changes affecting operations and supply chain.
  • Transition risks. These are reputational, market, regulatory, policy, legal and technology-related risks. An example of a regulatory risk would be increased regulation of climate change-related matters, such as enhanced disclosure requirements.
  • Opportunities. Efforts to mitigate and adapt to climate change also produces new opportunities to issuers, such as the development of new products and services.

In conclusion, reporting issuers should use this guideline to ensure that they are complying with disclosure requirements required by securities law in Canada. As more investors focus on climate change-related risk and environmental, social and governance (ESG), the more relevant the subject matter becomes.

The author would like to thank Nazish Mirza, articling student, for her assistance in preparing this blog post.

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Ethical consumerism: a new driver of M&A in the beauty and clothing industries

In a previous post, we discussed the rise of M&A activity in the meat and dairy sector as consumer tastes change and concern for the environment becomes more widespread.

Industry experts believe that this trend, namely of ethical brands driving M&A, is much broader than the food and beverage space. Beauty, clothing and apparel and other consumer brands focusing on natural and sustainable products are also driving M&A activity. As the 2019 year end rapidly approaches, a reflection on some of these larger trends may shed some light on what may come in 2020.

Beauty and cosmetics

  • The research and development costs of creating effective all-natural products are high and existing organic beauty brands have the advantage of being first-to-market. For this reason, many large cosmetic companies are looking to acquire existing businesses that have captured market share in the space, rather than developing their own products to compete.
  • While consumer desire for natural products is certainly a factor spurring M&A activity, companies are also making strategic acquisitions to develop new and innovative products. A number of natural beauty brands are expected to start releasing alternative cannabis products, such as creams and topicals, once these products become legal in Canada later this month. This innovation in the beauty space has the potential to spur M&A activity not only by providing larger beauty companies with the ideal entry point into the cannabis space, but it may also create new synergies between cosmetic and cannabis companies.

Clothing and Apparel

  • A recent report states that in the past two years, the number of sustainable apparel products available to consumers have increased by an astounding 139% and vegan products available have increased by 116%. Some of these numbers are attributable to new companies and products. However, certain existing brands are also switching to sustainable fabrics for their clothing.
  • Technological innovation may have huge potential for driving M&A in this space. Sustainable clothing companies are developing the technology to make fabrics from materials like vegetable-tanned and pineapple leathers, alpaca wool, non-violent silk and other materials. Large retailers may look to these companies for strategic acquisitions and partnerships as the demand for sustainable clothing increases.

As ethical consumerism becomes more mainstream, one might expect to see more strategic acquisitions of all-natural beauty and clothing companies and/or the acquisition of technology companies that make the creation of sustainable products more profitable.

While meat and dairy alternatives have been responsible for a significant amount of M&A activity, we will be watching with interest to see whether ethical consumerism will continue to drive M&A the consumer product space, and the type of trends that emerge as ethical brands mature.

The author would like to thank Tegan Raco, articling student, for her assistance in preparing this blog post.

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Canadian credit market overview: despite slowing growth, many aspects still on the rise

The Bank of Canada (BoC) recently announced its decision to maintain the overnight rate target at 1 ¾%– while the Bank Rate and deposit rate are 2% and 1 ½% respectively – resulting in no shortage of backlash. In its press release, the BoC cites the escalation of international trade conflict as a factor in the constricting of business investment, and thus, is a heavy blow to the global economic momentum that it had projected to be an influential growth factor in its Monetary Policy Report (MPR) back in July. Uniquely, the BoC remains the only hawkish major central bank in the world, as all of its global counterparts continue to exercise dovish policies aimed at lowering various interest rates. Of course, the Canadian dollar – and the Canadian Credit Market (CCM) as a whole – will continue to move based on expectations of BoC’s next announcement.

With a focus on these mixed feelings towards what the future of the CCM may look like, it is worthwhile to take a closer look at the CCM’s overall performance as of late. Ernst & Young’s Credit Market Barometer provides an overview of the CCM’s 2019 year-to-date statistics and gives annual/quarterly comparative performance metrics based on analysis of various credit market conditions and indicators. It also gives some insight into the CCM’s outlook going forward, with its trends and statistics sourced from different credit market and governmental entities.

Key Takeaways

A review of the increasing trends in the CCM reveal that over the past year, the growth in total credit outstanding in Canada has somewhat slowed, but the quality of new borrowers has improved, which is linked (in part) to the marked decline in gross impaired loans (GILs). Impaired loans statistics are representations of delinquency probabilities (for example, GIL represents the gross value of loans that are deemed improbable for full collection of both principal and interest). The GIL ratio (which is simply GIL as a percentage of gross loans and acceptances) has improved to its lowest level in over six years, last recorded at approximately 0.53%, which is partially due to progression of the wholesale loan delinquency rate. In terms of the growth slowdown, one of the reasons for this might simply be Canada’s sluggish Gross Domestic Product (GDP), a direct result of falling commodity prices. Another attribution of this is certainly the slowing advancement of personal loans and credit cards, which is down from about 4% to roughly 2% over the past year. In terms of other standout numbers, these trends have translated to a 5.8% year-over-year rise in total credit outstanding (which is down from 6.3% a year earlier), and a 3.8% rise in the credit-to-GDP ratio. Despite consumer growth ringing in lower than the BoC had projected, the past year has still seen an increase in mortgages and stable credit quality overall (which continues to surpass historical levels),helping the positive light continue to shine on the CCM.

Categorically, this past year has also revealed growth on higher deposit margins, loan and deposit volume growth, fee income growth, and a lower corporate tax rate, which has all led to growth in overall revenue. On the whole, there have also been indications that Canadians are cutting back their debt levels due to higher interest rates, and that the growth of deposits has surpassed the growth of loans.

Conclusion

The next scheduled overnight rate target announcement is October 30, 2019, which will include a full update of the BoC’s outlook for the economy and inflation. It will be interesting to track these and other constant changes in the CCM (and its ongoing performance) moving forward.

The author would like to thank Daniel Lupinacci, articling student, for his assistance in preparing this blog post.

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(Un)masking value: how the data masking market can impact M&A activity

Recent rumblings about the “data masking” market have put this concept on the radar of many, which warrants a closer look at the relevant trends and the potential of data masking. The information age has made cybersecurity a necessity and the increase of data breaches and malware attacks have led to calls for greater data protection.

What is data masking?

Perhaps surprisingly, the purpose of data masking is more than just obfuscating original data in order to protect it. An additional layer is the process of creating a structurally similar, yet inauthentic version, of an organization’s data that can be used for purposes such as software testing and user training. This is done to safeguard the actual data, but also have a functional substitute for occasions when the real data is not required.

Data masking maintains the format of the data, but changes the values. While several methods may be adopted to “mask” the data, such as encryption, character shuffling, and character or word substitution, the value must be changed in such a way so as to prevent detection or reverse engineering.

Why is it important?

The increasing concern for cyber attacks for enterprises has made data masking a significant asset. The data masking market size is expected to grow from USD 384.8 million in 2017 to USD 767.0 million by 2022, at a rate of 14.8%. Additionally, North America is projected to maintain its leading position during the forecast period.

Today’s complex business operations, as well as rising customers and enterprise data, result in various data related threats such as cyber attacks and internal data breaches. In fact, 40% of acquiring companies that engaged in an M&A transaction said they came across a cybersecurity problem during the post-acquisition integration of the acquired company. As such, data breaches are a major concern encouraging enterprises to safeguard their data at every possible level. To do this, major vendors providing data masking solutions have formed strategic partnerships or merged with local players as a primary strategy. Essentially, acquiring smaller data masking companies means acquiring a valuable asset that will set an enterprise apart as one that likely will not fall victim to cybersecurity disasters or data breaches. This, at least in part, explains the data masking market’s projected growth, and will sustain this market in the coming years.

The data masking market, and its projected exponential growth, has the ability to change the M&A landscape by creating tiers of enterprises that have data masking abilities and ones that do not. The former would, of course, be preferable. Nevertheless, the precise impact of this market and its sustainability potential is still uncertain and, therefore, requires a watchful eye.

The author would like to thank Saba Samianpour, articling student, for her assistance in preparing this blog post.

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Venture capital investment once again shows strong year-over-year growth in H1 2019

The Canadian Venture Capital & Private Equity Association (the CVCA) recently published its 2019 first half (H1 2019) report on Canadian venture capital (VC) and Canadian private equity (PE) investment. Over the past year, Canadian VC investment has continued its ascent, reaching unprecedented heights and experiencing its strongest first half performance on record. Conversely, Canadian PE investment remains feeble, posting its lowest first half performance since the CVCA began collecting data in 2013.

A review of the increasing trends in the Canadian market reveals that VC investment in Canada is very robust and showing virtually no signs of slowing down. With H1 2019 setting record highs, VC-seekers should be excited and motivated by the current state of VC investment in Canada and the innovative environment that it is cultivating.

Key takeaways

  • Canadian VC investment experiences strongest first half on record: At the close of Q2, the year-to-date Canadian VC investment has hit CAD $2.15B, surpassing the previous first half high of CAD $1.67B in 2018.
  • ICT sector continues to receive majority of Canadian VC funding: Information and communication technology (ICT) attracted 54% of total VC dollars invested in H1 2019.
  • Shifting back to increased investment in early-stage businesses: Early-stage companies received 45% (CAD $973M) of total VC dollars invested in H1 2019, an 8% increase year-over-year (up from CAD $612M representing 37% last year).

Overview of Canadian VC investment activity

In H1 2019, approximately CAD $2.15B had been invested across 256 deals, representing an average deal value of approximately CAD $8.4M. Despite this marked year-over-year decline in deal volume in H1 2018 (down from 308 deals), the positive result was bolstered by the significant rise in average deal size (from CAD $6M in H1 2018). In total, there were eleven CAD $50M+ mega deals which accounted for a 42% share of total VC dollars invested. Four of these deals exceeded CAD $100M. Making these results even more impressive is the fact that the overall Canadian VC activity numbers for this report do not include VC debt deals, which represented an additional 59 deals in H1 2019.

Ontario continues to be the number one jurisdiction for deal activity with both the quantity of investments (94 deals) and deal size (CAD $1.1B) exceeding the combined total for all other provinces. Toronto-based companies accounted for CAD $741M over 76 deals exceeding the total funding of the next top 9 Canadian cites outside of Montreal. Montreal (CAD $473M over 67 deals) and Vancouver (CAD $158M over 27 deals) rounded out the top three cities, both with respect to deal volume and total investment.

Canadian VC investment by sector and stage

Canadian VC investment continues to be concentrated in the ICT sector, accounting for 54% (CAD $1.2B over 144 deals) of total dollars invested in H1 2019, with life sciences receiving a 27% share (CAD $586M over 55 deals), and agribusiness companies receiving an 11% share (CAD $243M over 20 deals). In fact, of the nine largest deals by value in H1 2018, six were within the ICT sector.

In H1 2019, later-stage companies accounted for 40% ($862M over 44 deals) of total investment. This is a reversal of a trend that appeared to be developing in H1 2018 where later-stage companies received 54% (CAD $901M) of total dollars invested compared to only 41% in 2017. It followed that early-stage companies increased there share to 45% ($973M over 111 deals) of total investment. This is an 8% increase from H1 2018, but still a decline.

The author would like to thank Joshua Hoffman and Daniel Lupinacci, articling students, for their assistance in preparing this blog post.

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A no-shop provision can be a buyer’s best friend, while exceptions may be the target’s best friend

Deal protections are an important aspect of M&A transactions. Buyers will typically negotiate with the target of the transaction to include all kinds of deal protections mechanisms, including no-shop provisions, matching rights, and break fees payable to the buyer. No-shop provisions in particular restrict the ability of the target board to solicit alternative proposals (including negotiations with third parties) and recommend alternative transactions to shareholders. Receipt of an unsolicited proposal may trigger a notice requirement. However, no-shop provisions can be limited in scope. Three common and interrelated “exceptions” to no-shop provisions are fiduciary out, go-shop, and window-shop provisions. While the actions of the directors of the target company are restricted by the no-shop provisions with regard to soliciting and negotiating competing bids, the restriction remains subject to the directors’ fiduciary duties.

So, how common are no-shop covenants? According to the What’s Market: Legal Trends in Canadian Private M&A report published in July 2019:

  • 62% of agreements which were not sign-and-close transactions included a form of no-shop covenant – compared to 58% and 53% from 2016 and 2017, respectively.
  • No-shop covenants were more common in share purchases when compared to asset purchases.
  • 93% of merger agreements in 2018 that were not sign-and-close included no-shop clauses.

The prevalence of no-shop provisions makes it imperative that the target and the buyer consider exceptions. If thoughtfully considered, exceptions to the no-shop clause will ultimately protect the target’s board and their shareholders, while also ensuring that the no-shop clause and other deal-protective covenants remain enforceable by the buyer:

  • Fiduciary out provisions: typically allow the target board to consider a “superior proposal” that would be more favourable to shareholders. Directors are allowed to maximize shareholder value in a change of control transaction in realization of their fiduciary obligations. However, not all alternatives constitute a superior proposal and not all superior proposals may be considered. Upon designating a superior proposal, the board may enter into an agreement with the third party and make a change of recommendation to the shareholders. Fiduciary out provisions provide limitations for valid competing offers and as such, the breadth of the fiduciary out exception is often the subject of significant negotiation. Such provisions do not give the board the right to openly solicit additional proposals but may require that the alternative bid not result from a breach of the agreement, be reasonably capable of being completed, not be subject to a financing condition or a due diligence condition or require the board of directors to determine that the transaction was more favourable to the shareholders. Less common are requirements are that the bid be compliant with all applicable laws and that the board of directors determine that a failure to recommend the alternative would be inconsistent with fiduciary duties.
  • Window shop exceptions: typically allow the target company to entertain and negotiate alternative proposals, generally as long as they are unsolicited. Often, these exceptions may have a threshold for the assets or equity to be acquired in order to meet the definition of “acquisition proposal” and therefore fall within the exception. Usually, there is some level of determination made by the board of directors related to the whether it is within their fiduciary duty to enter discussions with the third party.
  • Go-shop provisions: unlike window-shop exceptions, go-shop provisions allow the target to do a post-acquisition agreement market check. Go-shop provisions may be utilized for a specified period of time, after which the no-shop covenant applies. Go-shop provisions typically contain protections for the buyer. For example, matching rights and break fees can be negotiated into the go-shop provision. Nevertheless, go-shop provisions are relatively rare in the Canadian M&A landscape, as only one deal from 2018 contained such a provision.

Deal protecting covenants are important to protect the buyer. However, the prevalence of exceptions demonstrates the importance of the target board’s ongoing commitment to the interests of the company’s shareholders, specifically by maximizing shareholder value. The inclusion of exceptions which allow the board to meet its fiduciary obligations equally protect the buyer by providing for more certainty in contract.

Canadian courts have consistently recognized the requirement for boards to meet their fiduciary duties in the context of a M&A transaction, although they will not go as far as their American counterparts to say that fiduciary out provisions are required and it is not always clear to whom those fiduciary duties are owed. In pursuit of that duty, at the very least and except in very rare circumstances, agreements should include fiduciary out provisions.

The author would like to thank Kiri Buchanan, articling student, for her assistance in preparing this blog post.

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Both sides of the same coin? Examining the rise of sponsor-to-sponsor deals

As competition and asset multiples increase, private equity (“PE”) firms must find new ways to put their money to work. One way to create new value is through a sponsor-to-sponsor deal.

Sponsor-to-sponsor deals involve PE firms on both sides of a transaction – buy side and sell side. Due to their high cost and complexity, there is a general view that sponsor-to-sponsor deals tend to be inefficient. However, a recent report by Bain & Company’s Annual Global Private Equity Report 2019 (Report) found that sponsor-to-sponsor deals are on the rise, which implicitly suggests that these deals may not be as inefficient as otherwise thought. The following are some of the potential benefits of sponsor-to-sponsor deals.

  1. Sponsor-to-sponsor deals provide opportunities for PE firms to be more creative in generating value. While such deals have previously been viewed as inefficient due to repeated transaction fees and other costs, engaging PE firms on both sides of a deal has the benefit of speeding up the entire transaction process. On a more granular level, the due diligence process in sponsor-to-sponsor deals can be completed at a faster pace compared to other transactions and as such, the extra time saved allows PE firms to focus more on strategy and creative solutions.
  2. Sponsor-to-sponsor deals remain an important exit option. In 2018, Sponsor-to-sponsor deals provided PE firms with great opportunities to increase returns. According to the Report, for the year 2018, most deals in Europe were PE sponsored deals and their exits generated the third-strongest year for the industry. In addition, deal count and deal value for that year were dominated by sponsor-to-sponsor deals.
  3. Current market conditions encourage large investors to focus on investing capital in private instead of public companies. Recently, private company multiples have been equivalent to or higher than those of public companies, making IPOs a less attractive exit option than before. Instead, the best option may be to sell to a strategic buyer that is looking for growth. Alternatively, the investor could sell to another PE firm that has the ability to capitalize on synergies and take the company to a new performance level. As a result, sponsor-to-sponsor exits may soon become the new normal and limited partnerships should work towards being more comfortable with the idea that sponsor-to-sponsor transactions may become a bigger part of the deal market.

Overall, sponsor-to-sponsor deals are increasing in popularity. The benefits are evident especially in the current deal market. Where assets may approaching an overpriced valuation, or dealmakers grow hungrier to put their money to work, sponsor-to-sponsor deals may soon become thrive in the marketplace.

The author would like to thank Bikaramjit Sandhu, articling student, for his assistance in preparing this blog post.

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“Weeding out the competition” – an update on M&A activity in the cannabis sector

As discussed in previously, the legalization of cannabis in October 2018 sparked a flurry of activity in the Canadian market, as both foreign and domestic investors were eager to enter the space. Notably, in 2018, M&A transactions peaked with over 700 deals completed in the cannabis sector, the total value of which exceeded US$12 billion.

While high entry costs and capital expenditures may continue to be drivers of consolidation in the cannabis sector, there are other emerging factors that may significantly impact the trajectory of M&A activity. With the 2019 year-end rapidly approaching, a reflection on some of these significant changes may shed some light on what’s to come for the Canadian cannabis sector.

Legalization of Alternative Cannabis Products

The Government of Canada announced that the production and sale of edible cannabis, cannabis extracts and cannabis topicals will be legal in Canada, as of October 17th, 2019. We expect that this diversification of cannabis products will both spur market growth and drive M&A activity. However, there are other important implications of this change:

  1. As legal cannabis products diversify, so too will the parties of major M&A transactions. A recent report by Deloitte suggests that cosmetic, alcohol, food and beverage, and consumer packaged goods companies are all likely to enter the space to avoid outside encroachments on their respective market shares. This development may not only bring new companies into the market, but change the hierarchy of big players.
  2. Alternative cannabis products may also blur the lines between the current market segments. The divide between recreational and strictly medicinal use products will likely become less clear once cannabis food and drink products become available.

While M&A activity in the space is likely to decrease as the industry matures, we expect this maturation to be delayed by the legalization of alternative cannabis products this fall.

Supply Issues

Cannabis producers have had difficulty keeping up with the current market demand, and this issue may be exacerbated by the emergence of new cannabis products. Cannabis shortages may also continue to impact the way cannabis companies scale their businesses. Vertical integration between retailers and producers will likely continue to be a common strategy driving future M&A deals.

For the past two years, the cannabis industry has been a significant driver of the Canadian economy, but the industry is already on the precipice of drastic change. We will be watching with interest to see how these new countervailing forces impact M&A activity, and the cannabis sector more generally.

The author would like to thank Tegan Raco, articling student, for her assistance in preparing this blog post.

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