Anatomy of a Biotech Merger

Transcription

1 Special Report: Corporate Law Legal Times (October 12, 1998) Anatomy of a Biotech Merger How to build a better biotech business: Don't treat it like just another company. By Edward Britton and John Hurvitz Merger and acquisition activity is a defining attribute of the biotechnology industry. Established companies seek access to new technologies and products through acquisitions, while smaller firms are forced by the formidable capital requirements of the industry to seek partners to in order to continue development of their technologies and deliver value to their shareholders. Factors that can determine the success or failure of an acquisition transaction are therefore of key importance to virtually every participant in the biotech field. In acquiring a biotech company, an acquirer must be sensitive to the special factors that defined this industry: In many instances biotech companies have no customer base; instead, they have academic and strategic collaborations through which, depending on their stage of development, they acquire technology, conduct research-and-development activities, and fund their operations. Biotech companies generally have little or nothing by way of fixed assets or inventory; instead, their value is found in their intellectual property, scientific and regulatory data, collaborative arrangements, and employees. Finally, and unlike start-ups in other intellectual property-based industries, biotech companies do not have direct access to the marketplace; instead, the road to commercial success lies only through the regulatory channels prescribed by the federal Food, Drug, and Cosmetic Act and the federal Biologics Act. The unique attributes of the biotech business require a multidisciplinary approach to evaluate, negotiate, and document biotech transactions properly. In addition to the routine legal and business issues raised in acquisition transactions generally, biotech transactions give rise to special issues that require corporate, commercial, regulatory, and intellectual property law expertise. These issues need to be properly addressed in the evaluation and negotiation of a proposed transaction. INTELLECTUAL PROPERTY

2 The principal value of a biotech company in almost all cases resides in its intellectual property. Proper examination and analysis of the biotech target's intellectual property is therefore key to a successful acquisition. All too often, an acquirer focuses exclusively on the target's patent-related assets, which represent only a portion of the total value of the target's intellectual property. Patents may provide an acquirer with the right to exclude others from making, using, selling, offering for sale, or importing the target's products--but they do not, standing alone, necessarily enable the acquirer to make, use, or sell such products itself. The actual commercialization of a biotech target's technology (patented or not) typically requires know-how and other expertise plus access to and control of relevant scientific and regulatory data. Such data include preclinical and clinical study results and information on the manufacturing processes for active ingredients and finished products. By focusing too narrowly on a target's patent rights, to the exclusion of the target's broader intellectual property estate, acquirers may leave themselves exposed to developments that may hinder or even prevent the successful commercialization of the target's technology. An acquirer should carefully review the know-how and other trade secrets on which exploitation of the target's technology is dependent. An acquirer should ensure that the target's standard operating and other procedures, as well as its other know-how and trade secrets, are properly documented. Techniques and procedures must be reproducible. To the extent the target's business relies on the expertise of particular scientists, the acquirer should ensure that the substance of that expertise is documented to the extent possible and that other employees of the target have been trained to perform the activities that are necessary to conduct the target's business. As discussed below, the acquirer must also take care to ensure that it will continue to have access to essential employees. The acquirer should verify that there are appropriate nondisclosure and assignment agreements with all relevant employees, consultants, and third parties who may have received access to the target's technology. In papering a transaction, an acquirer must ensure it obtains rights to the target's scientific and regulatory data adequate to permit not only development of the target's technology but also regulatory approval for resulting products. At a minimum, the acquirer needs the right to reference the target's scientific and regulatory data in applications for regulatory approval. Ideally, the acquirer will want to acquire exclusive ownership of the target's scientific and regulatory data. LICENSES IN Licenses in -- that is, arrangements in which the target company is a licensee--constitute an important part of the target's intellectual property. Many acquirers, however, focus only on the scope of the licensed rights (specifically, whether the rights are exclusive/nonexclusive, the field of use, and the territory) and fail to examine adequately the business terms of such licenses. They thereby overlook aspects of licenses that can dramatically affect the prospects for successful commercialization of the acquired technology and the financial viability of the acquired business. Biotech companies are frequently parties to license agreements that contain commercially unreasonable provisions. Such licenses reflect the quite reasonable readiness of a precommercial entity, with limited financial resources, to focus on acquiring rights to core technology to pursue immediate research-and-development activities, with only minimal

3 regard for issues relevant to the distant goal of commercialization. LICENSING PITFALLS These early licenses frequently represent little more than a lightly negotiated version of the licensor's form document. For the acquirer of a biotech company, who often purchases when commercialization is more imminent, such license agreements can present serious pitfalls. The acquirer should carefully review the target's license portfolio to determine which licenses, if any, are relevant to the target's ongoing business or the acquirer's existing business. Those licenses that will be relevant to the acquirer's post-closing operations should then be subjected to careful review for terms that are unreasonable or that may be incompatible with the acquirer's plans and forecasts. For example, it may be that an agreement imposes a commercially unreasonable royalty rate; that a number of independently negotiated license agreements apply to a single product, imposing multiple royalty obligations without a right of offset or reduction (royalty stacking); that a license agreement does not provide for royalty offset if a blocking patent issues; or than an acquired license imposes unexpected obligations with respect to an acquirer's existing technology. Other provisions that require careful scrutiny, and possibly renegotiation, prior to an acquisition include: Milestone payments due to the licensor (whether amounts and timing are commercially reasonable, whether the acquirer will have financial resources to make the milestone payments); and, performance obligations of the licensee (whether the target has met all performance obligations to date, whether the acquirer will be able to continue to meet performance obligations, what penalties apply if performance obligations are not met). Attention should also be given to sublicensing and assignment provisions. Acquirers should examine how payment arising out of sub-licenses (sub-licensing fees, milestone payments, and royalties) are allocated between the licensor and the license. Acquirers should also examine the assignment and sub-licensing provisions of the target's licenses in. Most license agreements permit assignment with the consent of the licensor, which may be unreasonably withheld. Other license agreements, however, impose tight restrictions on assignment and sub-licensing. The provisions of license agreements that deal with patent prosecution and infringement matters may also be of significant importance in relevant situations. Such provisions determine who (the licensor or the licensee) controls patent prosecution and infringement proceedings, bears the costs of litigation and damages, and enjoys the fruits of successful litigation. Acquirers should review the target's collaboration agreements and any licenses granted by the target. Even if these agreements are not to be assumed or do not directly involve the technology to be acquired, they may present problems for the acquirer. Among relevant issues are whether technology related to the acquired technology has been disclosed to others; whether technology related to the acquired technology has been disclosed to others; whether the target is subject to noncompetition agreements or other arrangements that could restrict the ability of the acquirer to exploit the acquired technology. 'OFF-LABEL' USE

4 Additionally issues may arise if the target has licensed technology to a third party for specified indications, but has retained the right to use the same technology for other indications. With few exceptions, the Food and Drug Administration does not regulate how physicians prescribe approved products. Therefore, a physician may prescribe a product for the treatment of diseases that are not included on the approved product labeling. The potential for off-label use may present problems if a compound in substantially the same formulation (e.g., oral, topical, injectable) can be used to treat different diseases, especially if the diseases have widely disparate commercial potential. For example, if the acquirer wishes to develop a compound for the treatment of cancer the target has already licensed out for the treatment of rashes, the commercial value of the technology to the acquirer could be significantly compromised. Because the course of treatment for a rash probably could not command the same price as for cancer, the acquirer's cancer sales could be seriously affected by physicians' use of the less expensive rash product off-label for the treatment of cancer. Conversely, if the target already has entered into a collaboration with respect to a compound for a potentially higher priced indication than the indications the acquirer intends to exploit, the acquirer should ensure that the collaboration agreement does not include cross-over protections or other provisions designed to protect the profits of the collaborative partner on the indications for which it holds rights. Depending on the facts, cross-over protections for indications to which a collaborative partner has rights could make it commercially impracticable for the acquirer to develop and market the subject compound for other indications. In the highly regulated world of biotechnology, an acquirer must give careful attention to the target's compliance with applicable industry standards and governmental regulatory requirements. The value of a biotech business could be significantly compromised if the acquirer must repeat or perform additional clinical tests, studies, and other development activities that were not performed additional clinical tests, studies, and other development activities that were not performed or documented in accordance with applicable standards and requirements. The acquirer must confirm that the target's development activities--including its operating, data collection, manufacturing and record-keeping procedures--conform to industry standards and regulatory requirements. It is particularly important to gain a full understanding of the course of the target's dealings with the Food and Drug Administration and of whether the target's predicted approval dates are realistic. In addition to the rules and regulations of the Food and Drug Administration, requirements imposed by other agencies, including the Nuclear Regulatory Commission, the Environmental Protection Agency, and the Occupational Safety and Health Administration, may be applicable. The acquirer should ensure that the target has obtained appropriate permits to conduct its business and that these permits are transferred to the acquirer to the extent permissible. In addition, the acquirer should confirm that neither the target nor any of its key employees has been disbarred by the Food and Drug Administration or cited for any significant failure to comply with applicable legal or regulatory requirements. Supply arrangements can be a stumbling block for biotech companies and, as a result, require examination in the context of an acquisition. The problem may be as simple as a supply chain that is inadequate to support the intended commercialization of the target's products by the acquirer.

5 More serious problems may arise if the target has committed to supply product to a collaborative partner responsible for its marketing and distribution. The target may in turn have entered into agreements with contract manufacturers to supply raw material, bulk active ingredients, or finished product. It is important that the acquirer verify that the terms of the target's contractual supply arrangements mesh seamlessly with the target's obligations to its collaborative partner. A target could encounter serious financial consequences if, for example, it has committed to supply specific quantities of product to a collaborative partner, to provide warranties or indemnities with respect to products, or to undertake other obligations in connection therewith, without first obtaining substantially similar commitments from its contract manufacturers. PERSONNEL As with companies in other knowledge-intensive industries, the value of a biotech company is often associated with the scientific expertise of company founders or a limited circle of scientists immersed in the company's technology. Ensuring that this expertise will remain available to and can be fully exploited by the acquirer is often crucial to the future success of the acquired business. The acquirer should identify the target's key employees and analyze the methods being used to motivate them to stay with the target and, after the acquisition, the acquirer. This entails review of employment and consulting contracts, noncompete covenants, equity compensation plans and awards, and other relevant materials. It also requires consideration of any differences in the corporate cultures of the acquirer and target and other similar factors. It is critical not to underestimate the role that intangibles may play in motivation highly talented individuals. The acquirer should also ensure that there will be no unexpected restrictions on the ability of the target's personnel to provide services to the acquirer after closing. Obviously, the acquirer will need to verify that there are no existing breaches of third-party noncompete covenants by the target's personnel by virtue of their involvement in the target's business. In addition, however, the acquirer needs to consider whether the affiliation of the target's personnel with the acquirer (whose business may be more extensive or differently oriented than the target's business) could result in problems under third-party noncompete covenants to which the target's personnel may be subject. Successful biotech acquisitions depend on an appreciation by the acquirer and its counsel of the special attributes of the biotech business. Proper analysis and negotiation of issues involving intellectual property, licenses and collaborations, and regulatory and personnel matters can substantially enhance an acquirer's likelihood of success. Edward Britton is a partner and John Hurvitz an associate with DC's Covington & Burling. They are both members of the firm's corporate practice group and work extensively on matters involving the biotech and pharmaceutical industries. Reprinted with permission of Legal Times, 1730 M St., N.W., Suite 802, Washington, DC Phone: Copyright, Legal Times, Covington & Burling. All rights reserved site tools contact us search privacy policy & legal notices return home