The war has dampened M&A (mergers and acquisitions) exit activity in Israel a bit, but deals are still being done. The recent Wiz acquisition by Google for $32 billion confirms that.

Here are a few points based on recent experience. Our remarks may be relevant to international M&A deals of all sizes in hi-tech and low-tech.

All negotiators have their own style. Here are a few tips to consider incorporating in your style:

First, decide who your negotiators are.

Second, decide your valuation (price) range.

Third, a letter of intent/term sheet and a nondisclosure agreement are needed when things get serious before the main agreement.

Fourth, prepare everything else and everyone on the M&A team and in the due diligence data room, including financial, contractual, and business items.

New Israeli Shekel bills are seen in front of an upwards-trending graph (illustration) (credit: HADAR YOUAVIAN/FLASH90)
New Israeli Shekel bills are seen in front of an upwards-trending graph (illustration) (credit: HADAR YOUAVIAN/FLASH90)

War issues

Typically, agreeing on the price valuation is the main sticking point.

In Israel, there is the added complication of the Israel-Hamas War. Is it business as usual in Israel? What do potential sellers and buyers need to consider?

For hi-tech start-ups, the motive in an M&A deal is generally to develop something good and sell it to a multinational group with better marketing abilities. For the multinational group, the motive in an M&A deal is often to avoid falling behind its competitors with the least risk.

The war is, therefore, problematic because it represents a risk factor. Even if the buyer intends to acquire Israeli technology and lay off the Israeli workforce, that is not the end of the story.

Technological development and supplies from Israel may become doubtful for an unknown time period. Some Israelis are still evacuated, many are serving as reservists in the IDF, and not all airlines are flying to and from Ben-Gurion Airport. The war has already lasted more than 600 days.

On the other hand, not all start-up personnel are drafted into the IDF, and some are able to work remotely or part-time at different hours of the day. Working nights is fine if you work with others in the US, which is seven to 10 hours behind Israel.

The art of the wartime deal

So, how is an Israeli start-up ripe for exit (M&A) valued, and how does the war affect the price valuation?

What we are seeing at present is the extensive use of earn-out clauses in Israeli M&A deals. That means part of the agreed-upon purchase price is conditional on business as usual and isn’t paid if something goes wrong. That way, all sides may be satisfied.

Israeli sellers may assume nothing will go wrong and that the war will soon end. The buyer knows the purchase price may be adjusted downward if there is a period of instability due to the fighting. Moreover, if this is a cash deal using borrowed money, the buyer’s source of finance might be reassured by an earn-out clause to limit the war risk.

In practice, the war presents greater inducement to pay for an M&A deal with share consideration rather than cash, i.e., shares/stock of the buyer. This is more likely if the buyer’s shares are publicly traded on a stock exchange.

The share consideration may, of course, be combined with an earn-out clause. This way, the seller shareholders lose less in tax, and the buyer doesn’t need to find cash.

Also, inventories, other assets, personnel, development, and production may all be partly or entirely shifted abroad, with the extent depending on individual circumstances.

The tax side

The tax side is complex in any M&A deal. There are several common problems.

First, if part of the consideration is variable depending on an earn-out clause, it is necessary to request a tax ruling from the Israel Tax Authority, allowing part of the capital-gains tax to be postponed.

Normally, Israel collects capital-gains tax within 30 days after a deal is done, even if the price is paid in installments (unlike the US). However, if part of the consideration may never be paid, the ITA has said that is different, but a tax ruling is highly advisable.

Second, if the buyer buys the shares of the Israeli seller only to shift the technology and business out of Israel (because of the war or another reason), that can trigger double capital-gains tax and dividend-withholding tax. The result can be 70%-90% Israeli tax if no action is taken). So, advance tax planning is legitimate and absolutely vital.

Third, don’t overlook other taxes in such situations: VAT, real-estate taxation, employee taxes on an ESOP (employee share option plan), etc.

As always, consult experienced advisers in each country at an early stage in specific cases.

leon@hcat.co

The writer is a certified public accountant at Harris Consulting & Tax Ltd.