Founder Series: Managing Investment Control Risk in the UK

Orrick's Founder Series offers monthly top tips for UK startups on key considerations at each stage of their lifecycle, from incorporating a company through to possible exit strategies. The Series is written by members of our market-leading London Technology Companies Group (TCG), with contributions from other specialists. Our Band 1 ranked London TCG team closed over 200 growth financings and tech M&A deals totalling $3bn in 2023 and has dominated the European venture capital tech market for 34 quarters in a row (PitchBook, Q2 2024). View previous series instalments here.

As your company grows, understanding regulatory and antitrust issues becomes increasingly important, especially when preparing for exits or new investment rounds. An informed approach to compliance can help you navigate key considerations, such as the National Security and Investment Act (NSIA) and upcoming changes to the UK merger control regime through the Digital Markets, Competition and Consumers Act (expected to come into force later this year). Our Antitrust & Competition team share insights on these topics, highlighting recent decisions on minority investments and other critical areas to help you stay ahead in a complex regulatory environment.

Along with merger control and subsidy control, deal makers increasingly need to navigate the ever-evolving world of foreign investment control. In the UK, that means complying with the National Security and Investment Act 2021 (NSIA).

Acquiring an interest in a business active in one or more of the 17 “sensitive areas” of the economy identified under the NSIA (a “qualifying entity”) may require a government national-security review before the transaction closes. In addition, the Secretary of State can review qualifying transactions in any sector (including asset deals) where there is a reasonable suspicion of a risk to national security.  The regime is agnostic to deal value.

In the EU, 24 countries screen foreign direct investments. Three other countries – Croatia, Cyprus and Greece – have taken steps toward introducing screening mechanisms. The UK regime is somewhat of an outlier globally in its breadth and scope.

Here are 10 things to know, to navigate the UK regime and manage risk.

1. Acquisitions of a controlling interest can fall short of legal control. NSIA applies to an acquisition of “control,” which includes minority interests. For example, acquirers need to notify and obtain clearance for the following transactions:

• The acquisition of shares or voting rights in a qualifying entity that passes any of the following thresholds: 25%, 50% or 75%.
• The acquisition of voting rights in a qualifying entity allows the acquirer to block or secure any class of resolution governing how the entity operates.
• “Voting rights” in this context means rights that are given to shareholders or members to vote at general meetings on all, or substantially all, matters.
• In the case of minority veto rights, the voting rights only count where they provide the holder with a right to vote on all or substantially all matters governing the affairs of the entity.

The UK also can seek national security reviews for transactions that fall short of the above triggers:

• The acquisition of a right or interest in a qualifying entity that allows the acquirer to “materially influence” the policy of the entity.
• The material influence test used here is the same as that used by the Competition and Markets Authority (CMA) for merger control purposes.
• It would capture, for example, acquiring the right to appoint members of the board, which enables the acquirer to influence its strategic direction.
• The acquisition of a right or interest in a qualifying asset to use it or use it to a greater extent than prior to the acquisition.
• The acquisition of a right or interest in a qualifying asset to direct or control how the asset is used, or direct or control how it is used to a greater extent than prior to the acquisition.

2. It is not always necessary for the acquirer to be foreign. In contrast to most foreign direct investment regimes, the nationality of the acquirer is not relevant to the question of whether a mandatory notification will be required in the UK. UK investors are subject to the same notification requirements as overseas investors.

However, investor origin will matter to the Investment Security Unit’s decision of whether to call a transaction in for an in-depth national security review. While China is the country of origin seeing the most call-ins, 39% of call-ins concerned UK acquirers in 2023-24, and 22% were from the U.S.

Of five final orders issued in this period, two concerned investors from the UK, two from the U.S. and one each related to investors from the UAE, France and Canada.

3. There are no exemptions for funds. The government recognises funds may present less of a risk to national security. It notes “a history of passive or long-term investments may indicate low or no acquirer risk” but emphasises that it assesses acquisitions on a case-by-case basis.

4. It is not necessary for the target to have a UK place of business. Most foreign direct investment regimes affect deals where the target has a subsidiary or local entity/activities. NSIA also can apply to outward direct investment where an overseas entity being acquired carries on activities in the UK. That includes R&D (or where the target company supplies goods or services to the UK) or where an asset being acquired from outside the UK is used in connection with carrying on activities in the UK (or supplying goods and services to the UK).

In practice, this means UK-based investors seeking to acquire interests in foreign entities or assets could find that their transactions require an NSIA notification. That could happen if a foreign target has a subsidiary providing services to a UK-based defence company or if the foreign target provides products and support services in sensitive sectors in the UK.

5. The NSIA has a broad sector focus. The UK government scrutinizes deals involving companies supplying critical technology, dual use items (typically those, subject to export control rules), artificial intelligence and government contracts, particularly in defence. While there is a similar sector focus to many EU screening regimes, the definitions of relevant sectors for NSIA can be much broader in scope.

In the UK, 17 sectors fall within the mandatory regime, with the most common sectors subject to call-in being defence, military and dual use communications, academic research and advanced materials and energy and data infrastructure. Computing hardware, advanced robotics and artificial intelligence also accounted for several call-ins.  

6. Watch out for internal re-orgs/restructures. Where the relevant control thresholds are met, there is no exemption to the need to notify under the NSIA if a transaction involves the internal restructuring of an entity or corporate group. That’s true even where there is no change in ultimate controller and where no new shareholders come into the structure.

In practice, this means that crucial transaction planning steps can be caught by the UK regime and may require separate notification. While the government has rejected calls to exclude these types of deals from the mandatory regime, it has published enhanced guidance on how companies must notify such transactions.  

7. Be aware that FDI screening agencies talk to merger control agencies. For example, in the UK, the Investment Security Unit has an agreement with the Competition and Markets Authority that allows the agencies to share information, including on key milestones and decisions.

That partly reflects the fact that many of the Secretary of State’s powers to intervene in a UK merger review for national security public interest considerations were removed from the Enterprise Act 2002 at the commencement of the NSIA. (Public interest intervention grounds relating to media plurality, financial stability and public health emergencies remain in place).

8. Where necessary, ensure transaction documents allow enough time to obtain any necessary suspensory clearances. The initial review period for the NSIA mandatory review is 30 working days. After that, the transaction will be cleared or undergo a full national security assessment. However, deal makers will also need to allow time for the Investment Security Unit to accept the notification form. That time can vary from a few days to over two weeks (although the process can be expedited for targets in material financial distress).

9. Remember that risk is carried by both buyer and seller. Although the risk of penalties and other sanctions for closing a transaction without clearance is borne primarily by the acquirer, a key consequence of closing in breach of the NSIA is that the transaction would be legally void, a risk for both buyer and seller.

10. Be prepared to negotiate attribution of this risk in transaction documentation. Acquirers may seek to push risk onto sellers by asking them to warrant that the target is not engaged in relevant sector activities. As ever, negotiating power will usually drive the parties’ approach in this regard, but your M&A adviser can counsel on the best way to manage this tension.

What’s Next?

The UK government sought views last year on how the NSIA regime is working.

Responses were largely positive, although some expressed concern about the scope of the sector definitions. A number of respondents said they would welcome clearer definitions for the artificial intelligence and advanced material areas and additional or clarified guidance for the defence and critical suppliers to government areas. 

In response, the government said it would launch a consultation on updating the sector definitions. This consultation was expected to happen in the summer 2024. As yet, though, the Government has not said when the consultation will take place, with the delay no doubt the result of the recent change in government. 

Orrick’s Antitrust and Competition Group offers innovative solutions on complex, cross-border matters involving merger control and clearance aspects of transactions, private damages actions, behavioural cases and investigations. We are a leading authority on private damages actions and advised on the first private antitrust damages action to reach trial in the UK. Our London Antitrust & Competition teams would be delighted to discuss the application of these issues to your business. If you would like more details on how we can help, please contact Vic Newbold.