State aid in due diligence: What to know before conducting an M&A transaction | In Principle

Usually, before a business decision is made to merge with or acquire a company, its financial and legal situation is analysed. In this assessment, sometimes state aid is overlooked and not considered a significant risk factor. However, M&A transactions almost always affect the conditions of aid obtained by the company from public funds. The most common source of risk is a change in the status of the business entity (which could mean that the aid becomes improper) or failure to comply with procedures under aid agreements. A finding that state aid was undue or misused may result in an obligation to repay the aid, as well as other legal and financial consequences.

Due diligence is aimed at identifying potential risks and assessing the value of a company before making an investment or an M&A decision. This process includes an examination of the company’s financial, legal, tax and operational aspects. A proper analysis allows investors and purchasers to make an informed decision and minimise transaction risks.

An integral part of any due diligence process should also be an analysis of assistance obtained from public funds, for both large companies and SMEs, which often benefit from various forms of assistance.

Why is it worth including state aid in due diligence?

The main reason it is essential to assess the impact of the planned transaction on assistance funds, even if the funds were granted some time in the past, is the risk that the funds will have to be repaid. The analysis of the impact of the transaction should include:

• A change in the status of the business entity, including its size and capital ties
• Impact on future obligations—some forms of assistance impose certain obligations on the beneficiary, for example maintaining employment or restructuring restrictions
• Impact on business strategy—state aid restrictions may affect a company’s development and expansion plans
• Consequences for the company’s value—if there is a risk that aid will have to be repaid, this can materially affect the company’s valuation and the terms of the transaction.

Analysis of public assistance not constituting state aid

It is worth remembering that the due diligence process should evaluate not only financial measures constituting “state aid” as defined by state aid law, but also other forms of public assistance that may affect the company’s activity. Some measures, such as structural funds, tax credits or innovation support programmes, although not constituting state aid as such, may entail certain obligations for the beneficiaries. Failure to include them in the analysis may overlook a repayment risk, especially if the terms for award of the funds under the agreement or administrative decision imposed specific obligations on the beneficiary in the event of a change in the ownership structure or organisational and legal changes within the enterprise. It may turn out that prior notification of the authorities and obtaining approval for the transaction is insufficient.

The risk of losing SME status as the result of a transaction

In due diligence, one of the most often overlooked issues is the risk of losing SME status as a result of a merger or acquisition, circumstances that create linkages between companies. This status is not lost automatically, but should be reviewed taking into account the employment ceilings and financial thresholds, in accordance with the two-fiscal-year rule. Although the scope of application of this rule is limited to nuclear research and training activities (as the General Court held in T-745/17, Kerkosand, par. 89), the Polish authorities often erroneously follow it also in a situation when an SME is merged with or acquired by a capital group.

SME status can determine access to preferential assistance and credit programmes, and losing it can mean having to repay previously obtained aid. Therefore, it is necessary to:

• Analyse the ownership structure—whether the planned transaction will affect the fulfilment of SME criteria (employment, turnover, capital ties), i.e. the beneficiary’s eligibility
• Assess the impact of the transaction on assistance already received—whether a change in beneficiary status results in a loss of eligibility for certain forms of state aid
• Protect against risks by taking necessary measures, e.g. clearing assistance in advance or adjusting the company’s organisational structure.

Foreign subsidies in the due diligence process

The evaluation of foreign subsidies became an important part of due diligence after the EU’s Foreign Subsidies Regulation (2022/2560) came into effect. Companies receiving financing from third countries must take into account the reporting obligations under the FSR. Failure to comply may result in sanctions and even invalidation of the transaction. For this reason, verification of foreign subsidies is a key part of the decision-making process accompanying M&A transactions.

Pursuant to the FSR, the obligation to report a transaction arises if two conditions are met:

• Total turnover in the EU—at least one of the merging companies generates annual turnover of EUR 500 million or more
• Foreign assistance—in the past three years, the companies have received subsidies of more than EUR 50 million from third countries.

Although these thresholds are high, a preliminary subsidy analysis should always be conducted whenever a transaction involves non-EU-owned entities.

What transactions are subject to the FSR?

The FSR is applicable in the event of a permanent change of control, including:

• Merger—when two previously independent undertakings combine into one structure
• Takeover—when one undertaking or entity (e.g. an investment fund) acquires control of another, e.g. through the purchase of shares, assets or otherwise
• Establishment of a joint venture, if it meets the FSR criteria.

The evaluation should determine whether the acquired entities, their investors or dominant companies in a group have benefited from foreign subsidies that may be reportable.

What are the risks posed by the FSR?

Companies planning M&A transactions in the EU must pay close attention to several key aspects:

• The obligation to report foreign subsidies—transactions subject to the FSR must be reported to the European Commission, which can prolong the transaction
• The impact of the FSR on transactions—non-EU investors who plan to acquire European companies may be subject to additional scrutiny, especially if subsidies may have affected their ability to carry out transactions
• Potential consequences—failure to report foreign subsidies can result in sanctions, including invalidation of the transaction or the need to repay the assistance
• Securing the transaction—introducing clauses in agreements to address the potential effects of the FSR, e.g. requiring parties to report the transaction if necessary.

What issues should be examined?

All things considered, due diligence should pay attention to:

• Types of state aid received—grants, tax breaks, loan guarantees, preferential loans, etc
• Compliance with EU and national provisions—whether the assistance was granted in accordance with state aid regulations
• Whether the beneficiary has complied with the conditions for receipt of aid, for example whether an obligation to maintain jobs or carry out certain projects has been violated
• Oversight proceedings or audit risks, for example whether the company is under investigation by the Commission or national authorities
• Impact of aid on future development plans—for SMEs, if aid was not properly accounted for, it may exclude the company from seeking further funds for expansion.

Conclusion

A state aid assessment should be a key component of any due diligence for M&A transactions. Overlooking this issue can generate significant financial and legal risks that could materially affect the value of the transaction. Failure to conduct a full analysis can not only give rise to a risk of having to repay state aid, but may also affect the financing structure of the transaction, reduce the target’s value, or lead to unexpected post-acquisition liabilities.

Particularly in the case of cross-border transactions or those involving non-EU capital, it is also necessary to analyse foreign support that may be subject to the Foreign Subsidies Regulation. Taking these aspects into account at an early stage allows the parties to avoid costly mistakes and ensure the predictability of the transaction.

Dr Anna Kulińska, State Aid practice, Wardyński & Partners