2025 Mid-market M&A Update: Holding for Take-off?

As the half-way mark of 2025 approaches, mergers and acquisitions activity remains in a state of fitful growth, marked by a number of offsetting market forces and uneven levels of activity. This stands in sharp contrast to the lofty expectations held at the start of the year, when the stage appeared set for a significant resurgence in M&A, driven by a confluence of favourable market conditions, including: an improving macroeconomic environment, with a stabilization in inflation, lower interest rates and a weaker Canadian dollar; narrowing valuation gaps between buyers and sellers; significant and growing dry powder among private investor groups, who face increasing pressure to deploy capital; a backlog of portfolio companies amid a challenging exit market; an expected wave of succession-driven sales by entrepreneur founders; and growth in transactions involving public companies – including mergers, take-privates, spin-offs and asset sales – in response to activist shareholder campaigns. But so far this year, these forces have been meaningfully offset by a number of unexpected headwinds, mostly emanating from south of the border, including adverse and unpredictable trade policy and increasing geopolitical uncertainty. These, in turn, have served to highlight our own domestic economic shortcomings in relation to productivity growth, internal trade barriers, large-scale project development and fiscal management.

Finding M&A Opportunities in an Uncertain Environment

While market turbulence has sidelined many transactions, particularly those facing valuation uncertainty due to potential tariff exposure, dealmakers have adjusted to pursue emerging opportunities in this new context. This has included a focus on domestic transactions, supported in part by a withdrawal of U.S. private equity investors that has prompted greater engagement by Canadian PE groups, as well as increased investment by Canadian pension funds and other domestic public investor groups. There also has been a greater interest in sectors with limited trade exposure or that represent growth opportunities supported by strong macro-trends, including technology and artificial intelligence, energy and infrastructure, mining and critical minerals, healthcare and financial services. Finally, companies and investors are adopting several mitigation strategies to navigate the current trade environment. These include defensive investments to reconfigure supply chains or reduce the impact of tariffs, as well as a focus on businesses with strong domestic sales, service-based business models or sufficient pricing power to withstand tariff impacts.

M&A in 2025: Key Legal Developments

Four key legal trends have been shaping deal practice in 2025: a more challenging regulatory environment, including for mid-market deals; more creative deal structuring in response to market uncertainty; continued growth in the use of representation and warranty insurance across a broadening range of transactions; and a heightened focus on due diligence.

More Challenging Regulatory Environment

Recent substantial updates to Canada’s competition and foreign investment laws are resulting in greater scrutiny of transactions, requiring more up-front planning, potentially longer timelines, and careful negotiation of related contractual provisions. And while it is typically only larger deals that trigger mandatory notification thresholds, it is important to note that these laws apply to all transactions regardless of the size of the deal or of the parties involved.

2024 saw a number of significant changes to the Competition Act whose effect will be to subject more transactions to approval requirements and mandatory filings, likely involve lengthier review processes for transactions in concentrated markets, and potentially apply more onerous remedial measures. In addition, these changes will extend the “look-back” period during which the Competition Bureau can retroactively challenge unreported transactions from one year to three years, a change designed in part to address “roll-up” strategies whose potential anti-competitive impacts may develop gradually over time.

Within this context, deal-makers will be required to focus more on early stage due diligence and strategy development around competition risk to confirm transaction viability. For deals that proceed, the negotiation of interim covenants, including with respect to the efforts the buyer must take to obtain competition approval, as well as related closing conditions, will be a key area of focus. Parties will also need to carefully tailor outside date and related time extension provisions to accommodate anticipated approval timing and potential contingencies. Finally, the use of termination and/or reverse termination fees in the event the deal fails to close is critical to properly incentivizing the parties while allocating the risk of non-completion.

2024 also witnessed a significant transformation of our foreign investment laws, which more recently have increased their focus on national security matters. Recent amendments to the Investment Canada Act include an expansion of ministerial powers to review and take action in relation to transactions raising national security concerns. Now more than ever, key considerations for any proposed cross-border transaction include the identity of the acquiror in relation to its jurisdiction of origin and its ultimate owners, as well as any related political or reputational issues, and the nature of the target company’s business, including whether it operates in any sector deemed sensitive by the Canadian government. This can include critical goods and services, minerals and infrastructure as well as sensitive technologies.

More recently, in response to recent actions taken by the U.S. administration, the Canadian government has expressly included “economic security” as a component of national security reviews. In assessing whether an investment has the potential to undermine Canada’s economic security, the government will consider, among other things, the size of the Canadian target business, its place in the innovation ecosystem, and the impact of the transaction on Canadian supply chains.

While not yet in effect, foreign investments in to-be prescribed business sectors will be subject to a mandatory pre-closing notification to head off any national security inquiry. The government has yet to identify the business sectors that will be subject to this new mandatory regime, but we can expect to see an increasing number of national security reviews initiated in these sectors, particularly where the foreign investor has material ownership interests from, or the potential to be influenced by, hostile foreign states.

This new environment will require dealmakers to conduct an early stage assessment for potential national security implications. Given the increased ministerial powers described above, parties will be incentivized to address potential issues proactively in order to avoid costly interim measures being imposed by government, such as actions to prevent an investor from accessing the Canadian business’s business sites or intellectual property. Similarly, transaction agreements are likely to include more explicit risk allocation on foreign investment and national security matters, along with more prescriptive provisions in relation to any anticipated review process and related timing issues. Finally, dealmakers must take into account the fact that “national security” is an evolving and highly politicized concept, and accordingly the regulatory landscape can shift quickly.

More Creative Deal Structuring

For those transactions going ahead notwithstanding current market challenges, dealmakers have engaged in more creative deal structuring to address key stumbling blocks, whether in relation to value, risk allocation or deal certainty. Approaches to bridge valuation gaps – whether due to a bid-ask spread or uncertainty regarding value caused by external or contingent factors – include earn-outs tied to future financial performance and/or the achievement of specified business milestones, as well as equity roll-overs and other deferred compensation arrangements to reduce the upfront purchase price and align incentives for future performance. Similarly, buyers and sellers are more carefully allocating specified risks between themselves (and to third party insurers, as described below) through the tailoring of representations and warranties, and an increased focus on what does or does not constitute a “material adverse effect” and trigger related termination rights. For transactions that have a delay between signing and closing due to the need to obtain shareholder approval or third party consents from contractual counterparties or regulators, parties have made efforts to enhance deal certainty by carefully specifying the level of effort each party must use in seeking required approvals and consent, including specific closing conditions, and imposing termination or reverse termination fees or expense reimbursement obligations in the event that a transaction fails to close.

Continued Growth in the use of Representation & Warranty Insurance

The use of representation and warranty insurance (RWI) continues to grow across an increasingly broad array of transaction sizes, industries and models: by one estimate, 75% of private equity transactions and 64% of larger strategic acquirers now use transactional insurance. RWI derives much of its appeal by enabling sellers to make a “clean exit” while providing buyers with meaningful, creditworthy recourse. The use of RWI also allows parties to avoid lengthy indemnity negotiations and the potential for conflict where the sellers include a continuing management team. Notwithstanding these benefits, RWI generally insures only unknown risks, and accordingly the underwriting process typically requires a robust financial and legal due diligence process. Where material risk items are identified, they may require separate indemnity and escrow structures to protect buyers.

Increased Focus on Due Diligence

Together, the three trends described above are driving a fourth one: an increased focus on the due diligence process. This includes: preliminary investigations around threshold issues such as regulatory risk, including competition or foreign investment review matters; traditional due diligence in relation to financial, operational and legal matters; and a new focus on emerging categories of risk driven by technological developments, increased regulation and other market developments, including in relation to cybersecurity, artificial intelligence, privacy, anti-money laundering and foreign corrupt practices, supply chain matters and environmental, social and governance matters.

The Road Ahead: All-Clear for an M&A Launch?

Despite a number of unpredictable headwinds, the medium-term outlook for M&A remains favourable given a confluence of longer-term forces that are strongly supportive of dealmaking on both the buy-side and the sell-side. However, a significant, broad-based resurgence in M&A will depend in large part on achieving a more stable and predictable geopolitical and trade policy environment. In the meantime, expect to see more targeted M&A continue, with dealmakers exhibiting creativity and resilience as they pivot toward the narrower set of opportunities that remain in spite of, or that have arisen due to, the current market uncertainty.

This article originally appeared in Business in Vancouver.