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Focus on Regulation

German Federal Government intends a strengthening of merger control for the sale of start-ups

In June 2015 Microsoft paid between EUR 100-200 million for the relatively unknown “6Wunderkinder GmbH” – a company which generates its revenue primarily through the operation of “Wunderlist”, a to-do list app.

This acquisition is an example of the current practice of start-up acquisitions by established “big players”. Due to their low turnover, companies like 6Wunderkinder are not subject to German merger control. The “2016 Annual Economic Report” shows that the Federal Government wants to introduce an additional threshold within the scope of the 9th amendment to ARC (German: GWB). The threshold will create a notification requirement for acquisitions where the target company generates only a small turnover but has a high transaction value (for example a high purchase price) in comparison to that turnover. This is likely to be the case when it comes to buying and selling start-ups.

Status Quo – according to German law

An acquisition must currently be notified to the German Federal Cartel Office if the parties meet certain turnover thresholds. The Federal Cartel Office then decides whether the transaction is approved.

According to the current legal position, a so-called “merger privilege” applies for the purchase of companies with low turnover. Thus an acquisition is not subject to merger control provided that, in the last year, the global revenues of the company being sold amount to less than EUR 10 million. However, this applies only if the target company is not dependent on a third party or is a member of a larger corporate group. Acquisitions of startups typically take place when the company is just about to establish itself on the market. In this phase revenues are often below the threshold of EUR 10 million, consequently the acquisition of start-ups is not subject to merger control according to the current legal position.

If the acquisition of a start-up must be notified, the German Federal Cartel Office decides whether the merger significantly impedes competition and has to be prevented. As a rule start-ups will not be able to benefit from the so-called “minor market clause” (German: Bagatellmarktklausel), which prevents merger prohibitions if the target’s revenues in a market in the last year were less than EUR 15 million, and the respective market has existed for over five years. This is a result of the fact that start-ups often operate on markets which are still being formed.

Merger control applied to start-ups – the plans of the Federal Government

The example of 6Wunderkinder illustrates that large and established companies are willing to pay high purchase prices for successful start-ups. This results from the innovative strength of new business concepts, which can have a high economic value and enable acquiring parties to achieve or defend a dominant position. However, there is the possibility that this great economic significance is not represented sufficiently by the previous year’s revenues, e.g. where a start-up has not yet positioned itself optimally in the market. If such a company does manage to position itself optimally, it may be that the current or future revenue is significantly higher than the previous year and turnover thresholds fail to identify mergers which will affect competition.

That matter has been considered in other jurisdictions: in 1964 the Supreme Court of the United States ruled in Case “United States v Aluminum Co. of America” that a small company with a great innovative strength – regardless of its low turnover– could be of economic importance for competition. To resolve this difficulty the Federal Government relies on the transaction value as part of the notification requirement.

To resolve this difficulty, the Federal Government relies on the transaction value as part of the notification requirement. Thus, the new regulation would contradict the principle of the merger privilege, which is intended to expand the commercial freedom of business owners by exempting them from the notification requirement when selling companies with low turnover. By contrast, however, the potential new regulation is fully in line with the minor market clause, which is only relevant in a consolidated market. The requirement of a minor market being at least five years old prevents competition in important new macroeconomic markets being impeded in the formation phase due to high levels of market concentration.