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Despite global economic conditions, deal-making by large pharmaceutical companies has remained relatively buoyant, say Daniel Pavin, Grant Castle and Alexandra Pygall.
Acquisitions in the pharmaceuticals sector are being driven by factors such as the need to replenish shrinking product pipelines, the need to maintain revenues as patents on top-selling products expire, and the strategic diversification of business lines and expansion into emerging markets.
Two general trends that may be observed, each of which is largely independent of underlying deal imperatives, are that buyers are becoming more risk averse and deal terms are becoming more complex. An illustration of the latter being driven by the former is the increasing use in life sciences M&A deals of structured or deferred consideration, payable only on the achievement of certain events or performance targets. Common terminology used in such acquisitions is ’earn-outs’, ’contingent value rights’ (CVRs) and ’contingent payment rights’.
Without a crystal ball, the outcome of future events crucial to the value of a target often cannot be determined, but the seller wants reward for its investment and the buyer does not want to pay over the odds. Contingent consideration structures based around milestones in the life of the target’s key products can help to bridge the ‘expectation gap’.
In the life sciences industry, milestones are typically categorised as either regulatory milestones or commercial milestones. In both cases it is important that the milestones are clearly defined so that there can be no debate as to whether or not a milestone has been achieved. In the case of regulatory milestones, it is critical to involve a regulatory specialist in crafting the milestone definitions and in conducting appropriate due diligence to assess the risks associated with the milestones. Increased regulatory transparency means it has become easier for regulatory specialists to identify likely issues or pitfalls associated with regulatory milestones.
Regulatory approval is a key milestone in the life of a product as a product cannot normally be prescribed or sold without such approval, granted in the form of a ‘marketing authorisation’. Approval will not be granted unless the regulator is satisfied that the product meets the required standards of safety, quality and efficacy. However, gone are the days when approval turned on a revenue stream that continued to grow until generic competition entered the market. The need for government pricing and reimbursement approval and the proliferation of cost-effectiveness assessments by bodies such as the UK’s NICE (National Institute of health and Clinical Excellence) means that a product may never generate meaningful revenues.
Authorities increasingly view marketing authorisations as public health tools, rather than purely commercial assets, which means that some approvals may be both vulnerable and burdensome, and commercial flexibility is reduced. Regulators often impose post-approval commitments or attach conditions or restrictions to authorisations, such as the need to conduct post-approval safety studies.
This is particularly true where small patient populations mean that the applicant has been unable to submit a large clinical data package. Ironically, it is these products that typically produce modest returns and whose high cost means that reimbursement is not guaranteed. A buyer may, therefore, seek to agree that the size of a deferred consideration payment triggered by the grant of a marketing authorisation should be dependent on whether the product is approved with or without a “boxed warning” (in the United States) and/or on the significance of any post-approval or risk management commitments.
The milestones to which one links payments of deferred consideration will vary depending on whether the target’s products of interest are still in development or are already on the market. If a product is still in development, in addition to or in the alternative to the obtaining of a marketing authorisation, milestones might include success in clinical trials or the achievement of reimbursement status (ie agreement that a health service will meet the cost of the product). Milestones most suited to a product already on the market include the achievement of sales targets and/or regulatory approval for a second use of the product.
No seller, however, will want to have part of the purchase price tied up in the achievement of milestones without having some comfort that the buyer will try hard to achieve those milestones. Conversely, a buyer will not be willing to accept performance obligations that are unrealistic. Such concerns are not new to the life science industry; they are most frequently encountered in the context of collaboration and exclusive licensing agreements.
Obligations on the licensee (analogous to the buyer in an acquisition scenario) to use ’commercially reasonable endeavours’ and/or to make a minimum financial investment in seeking to achieve milestones, coupled with means of auditing performance and sanctions for non-compliance, are commonly seen. Negotiations regarding these terms can be lengthy and complex, and the skills of experienced licensing and collaboration practitioners are transferable to M&A deals featuring analogous concepts in the context of contingent consideration structures.
Therefore, parties should ensure that their respective deal teams contain, or can draw on, the necessary regulatory and collaboration/licensing expertise to enable effective negotiation and execution.
Daniel Pavin and Grant Castle are partners and Alexandra Pygall is an associate in the European life sciences group, Covington & Burling