The second half of 2022 continued many of the trends from the first half but, to us, felt less jarring. Despite continuing economic headwinds and talk of a slow-moving recession taking hold in 2023, there were some bright spots — including the potential for ChatGPT (and similar tools) and encouraging news about the prospects for nuclear fusion — that could provide the basis for transformative ventures of the future. Below we offer a few highlights of what we observed.
- Capital Markets. Traditional IPOs and their close cousins (de-SPACs and direct listings) fell precipitously in 2022 in the wake of stock market troubles. In many cases, the fall-off functionally closed one of the major liquidity event doors that had been available to companies — and coveted by founders and executives — over the prior few years. As timelines for exits were extended, companies and executives focused on various types of re-equitization, downside protection and nearer-term liquidity (when available) to keep them moving forward through choppier economic waters. The SPAC market virtually disappeared in 2022, as many post-de-SPAC companies struggled mightily in the public markets (and with litigation challenges from shareholders) after the boom of 2019–2021.
- M&A. While M&A fell significantly in 2022 compared to the historic highs of 2021, it was arguably more of a reversion to historical levels than a depression in deals. Reasons for deals varied — pivots to M&A given the state of the capital markets; as discussed in more detail below, carve-out deals to shore up balance sheets and/or refocus on key priorities; GP-led private equity transactions (e.g., fund-to-fund transactions); as well as “normal course” deals. Executives continue to be key to driving value through and following any transaction and should expect to engage in meaningful discussions regarding go-forward employment and compensation terms in the context of an M&A deal. While MMS does not have access to a crystal ball, we note that other market observers diverge significantly on prognostications for 2023 — some have suggested that the first half of 2023 may be relatively lighter on M&A deals, with those transactions gathering steam in the second half of 2023, while others are generally less bullish on 2023 overall.
- Carve-Out Deals. We saw an uptick in carve-out deals as companies tried to shore up balance sheets and focus on core businesses. Executives of carved-out businesses need to be sensitive to the dynamics of the transaction and market norms for a variety of reasons. Unlike in “whole company” transactions, executives of a carved-out business may not have been integrally involved in the business negotiations over deal terms (while being forced to live within the confines of those terms). In addition, executives of a carved-out business, while being relied on to lead the newly independent business and deliver on the value inspiring the deal, may not have as much experience with typical market practices and negotiations on “C-suite” executive compensation issues because of their prior roles within a larger organization and the nature of a carve-out transaction. Finally, treatment of parent–seller equity and other arrangements (e.g., rollover or co-investment requirements) may present issues that are unique to the carve-out context.
- Significant Regulatory Developments. The SEC finalized a number of key regulatory developments affecting executive compensation at public companies. First, new disclosure requirements illustrating the relationship between executive pay and performance became effective for fiscal years ending on or after December 16, 2022 (i.e., this year’s proxy season for calendar-year fiscal companies). It will be interesting to see whether this additional disclosure will affect executive compensation practices and negotiating dynamics (between public companies and their executives) over time. Second, mandatory clawback requirements related to erroneously awarded pay received due to misstated financials were finalized. Most large public companies had previously adopted clawback policies in expectation of these rules, but the rules will require clawbacks in more situations than many existing policies require. Third, the SEC tightened rules regarding 10b5-1 trading plans, narrowing the circumstances where they can be used. This reinforces the need for careful liquidity planning — and attention to liquidity rights — for executives of public companies (including newly IPO’d companies). Finally, although not a 2022 development, in the very early days of 2023 the Federal Trade Commission (the “FTC”) proposed a rule that, if finalized, would effectively invalidate all work-based non-competes (including for executives) and significantly limit deal-related non-competes for workers (including executives). We are continuing to analyze the FTC’s proposed rule and we anticipate providing further updates on this topic.
- Extraordinary Business Stories. Two extraordinary high-profile business stories with founders and executives at the center played out in the second half of 2022. Both seem destined to be case studies in how market dynamics can interact in complex ways with contractual arrangements and legal obligations. For client confidentiality reasons, we can comment only on one — FTX. While dramatic, the “lessons” to be drawn from FTX seem limited to us. While we do not know the details of the diligence process undertaken by investors in FTX — and hindsight is 20/20 — diligence is not and cannot be perfect, and those imperfections can clearly be exploited by bad actors. Nonetheless, we expect renewed investor scrutiny to be the norm in 2023, even for the most enticing investment targets. Additionally, we anticipate executives seeking operating positions with seemingly attractive emerging growth companies to be more inclined to explore ways to mitigate downside risks (e.g., financial employment-based protections and liability-shielding provisions) in the event of alleged bad-actor-fraud.
- Layoffs. Layoffs picked up steam — particularly in the tech industry — in 2022. Even for executives who may be relatively well-positioned to weather those events, separations can be moments of particular stress and dislocation. Restrictive covenants — which too often are given limited attention at the outset of an opportunity — can compound the impact of a layoff if overly broad (and often have operational “teeth” even where the ultimate enforceability of the restriction may be questionable). Further, at the executive level, economic downturns are often a difficult time to negotiate the terms of separations. While there are exceptions, in our experience, investing in negotiating for better protections at hiring or at other key inflection points is, in terms of results, generally more effective than relying on the dynamics at the time of a separation.
Please feel free to reach out if you have questions about these issues or others.