Investment Screening – The Decisive Factor for Transaction Success?

1. Classification

Cross-sector investment screening should be considered for every acquisition by a non-EU/EFTA acquirer (third-country acquirer), as it is not linked to the size of the target company. Reporting obligations arise based on the specific activities of the target company in certain technology-intensive or security-relevant sectors.

This particularly affects startups and research-intensive companies. A reporting obligation entails a prohibition on closing—subject to fines and, if applicable, criminal penalties—as long as clearance has not been granted. This already impacts the due diligence phase, as certain information may not be shared prior to closing.

However, even outside of reporting obligations, a transaction can be picked up for review by the BMWK (Federal Ministry for Economic Affairs and Climate Action) if there are security concerns. Parties involved in a transaction should be aware of this early on, as the success of a transaction—especially in critical infrastructure sectors, innovative technologies (high-tech and deep-tech), and sensitive sectors (certain areas of mechanical engineering, but also within the supply chain in sensitive areas such as automotive)—is increasingly dependent on security and geopolitical considerations.

Focus on the Target Company

In practice, (technical) classification is not always clear and unambiguous, so it can happen that a company is only qualified as subject to reporting during an investment proceeding—for example, when applying for a certificate of non-objection. This may relate to a (possibly only subordinate) sub-area of business activity that does not have to represent the main focus of the activity, or it may result from the technological development potential of the target company.

Particularly relevant fields of activity include the development and manufacture of IT security products, software or hardware for operators of critical infrastructures, and cloud-based services of significant systemic importance. In addition, there are activities in the areas of Artificial Intelligence, cybersecurity, data analysis, semiconductor technology, digital platforms, and networked communication.

Outside of reporting obligations, an acquisition can be picked up for review if there are indications that the acquisition is likely to impair the public order or security of the Federal Republic of Germany or another member state, or in relation to programs or projects of Union interest. In practice, the creation of dependencies within a sensitive supply chain (e.g., raw materials such as rare earths) and the potential outflow of technology with unique selling points (e.g., in connection with national and EU funding projects) play a particularly important role.

Acquirer-Related Aspects

Constellations in which the acquirer or its controlling shareholders come from geopolitically relevant third countries or are state-influenced are particularly sensitive. In such cases, an intensive review is typically to be expected and—unless a prohibition should occur in individual cases as a worst-case scenario—there is a higher probability of conditions or secondary obligations, especially for tech targets.

Against this background, the identity of the ultimate beneficial owner (UBO) plays a key role, as the entire chain of acquirers is considered. The decisive factor is who ultimately controls the acquirer or can exercise comparable influence. The UBO is relevant under investment control law if they are in a position to influence or block strategic decisions, gain access to sensitive information, or control the technological direction of the target company. Control is understood broadly in this context.

Even a single third-country (indirect) investor or buyer can become relevant under investment control law if they are granted special rights of influence. Minority holdings are therefore by no means unproblematic per se. Especially in the tech sector, holdings below classic control thresholds can be subject to reporting or at least review if they are associated with substantial voting rights.

Conclusion

Investment screening is not a niche topic, but a central factor in deal structuring. From the perspective of the parties involved, an in-depth analysis of business activities should be carried out early on in the event of a (possibly only indirect) third-party acquisition, considering potential reporting obligations or intervention risks, so that investment screening can be integratively included in transaction planning.

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