Due Diligence Concerns For the Buy-Side of Life Sciences Transactions

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Any transaction – whether it is a merger, acquisition, or strategic partnership – involving the acquisition of a company in the life sciences sector entails a uniquely rigorous due diligence process. From regulatory scrutiny to scientific validation, the stakes are high and the risks multifaceted. The following provides a high-level overview of the primary diligence areas that should be extensively reviewed by the buyer or new strategic partner for any life sciences company.

Regulatory Compliance

Regulatory compliance is a cornerstone of due diligence in the life sciences sector. As a preliminary matter, it is important to fully understand the nature and extent of the target company's operations. The business of a life science company can be complex, and in order to know the type of regulatory risks life sciences companies face, a buyer or strategic partner must understand the business.

Companies in the life science sector are subject to intense oversight from agencies like the FDA, EMA, and HHS. It is imperative that companies demonstrate compliance with all applicable international, federal, and state regulatory requirements; this is crucial for the success of a transaction. Effective regulatory due diligence can help identify significant liabilities and risks, inform transaction structure, and serve as a defense against potential negligence lawsuits.

The life sciences industry has a unique asset lifecycle with complex diligence and obligations for buyers and licensors. Specialized diligence is crucial in areas like FDA regulations, healthcare reimbursement, licensing, partnerships, solvency, and international compliance. Further, life sciences companies heavily rely on personal data, especially for clinical trials and data processing. Compliance with global data privacy regulations is crucial and can be a competitive advantage. Strong data protection policies are essential. Companies should know their data, its storage, access, flow, and protection. Best practices include documenting data processing, maintaining data inventories, mapping data, and regularly assessing data flows and risks.

Specifically, diligence must uncover and confirm product approvals, pending applications, and any warning letters.

Scientific and Technical Validation

The science behind a product must be sound and scalable, and buyers must understand the validity of the company's products or services. While these transactions often lead to growth and value creation opportunities, they can pose serious consequences when they are not vetted correctly. Due diligence as it relates to the science behind the company requires technical knowledge, which is why it's important to enlist specialists in the target company's field. These specialists can better facilitate the due diligence process by helping firms assess the rewards and industry-specific risks inherent to these acquisitions.

Specialists can help review items related to whether clinical results are statistically significant and reproducible, whether development timelines are feasible, and whether the company conforms with good manufacturing practices.

Intellectual Property (IP) Management

Intellectual property is often the most valuable asset of a life sciences company. Ensuring that all IP rights are properly documented and owned by the company is crucial. This includes conducting an internal audit of the IP portfolio, confirming inventorship and ownership, and addressing any joint ownership issues. For example, all code, trademarks, and patents should be owned by the company, not individuals. In addition, any compliance issues with data privacy regulations like General Data Protection Regulation (GDPR) or Consumer Privacy Act (CPA) should be addressed.

If there are any upstream agreements that control patients or other IP, these must be reviewed for obligations that may pass to licensees or sublicensees. Unlike standard M&A deals, these agreements allow for creative de-risking structures and are crucial for dealmakers. They are highly customized, with varying provisions, and a single asset may be governed by multiple agreements. Additionally, protecting proprietary drug formulas and medical devices through patents and trade secrets is essential to maintaining competitive advantage and maximizing deal value.

It is imperative to assess the patent strength, which includes evaluating the scope, enforceability, and expiration dates of all existing patents. Comprehensive diligence will also determine whether there are potential infringement risks. Further, if the company has third-party license agreements, understanding the royalty obligations and third-party rights is critical to determining the success of the transaction.

In the case of drugs and biologics, the other key determinant of a new product's prospects for market exclusivity in the United States is the regulatory exclusivity afforded to it in relation to its FDA approval. Developing new drugs and biologics often takes many years and involves enormous investments of money and resources. It is important for a buyer to understand the timing of any patents and the different scenarios for market exclusivity in order to assess (1) what forms of market exclusivity attach to a given product, (2) how much time remains on such exclusivity terms, and (3) whether there are possibilities for obtaining additional forms of exclusivity.

Litigation and Enforcement Exposure

It is imperative that a buyer understand the litigation exposure for any life sciences target. In a highly regulated industry that provides important patient care items and services, it is difficult to fully quantify the potential exposure. If the company bills for any items of services provided, diligence should be conducted on the company's billing practices and whether any government notice, inquiry, or investigation has occurred. Additionally, with respect to product liability, buyers should review adverse event reports and safety litigation.

Cultural and Integration Challenges

A successful cultural integration is important to any transaction but may be especially true for companies operating in the life sciences industry. Buyers should undertake diligence to assess the Seller's scientific leadership and whether post-transaction collaboration and buy-in will occur. A strong compliance culture is also important, and buyers should look for strength in internal investigations and whether there is owner and/or board-level buy-in related to compliance.

Deal Structure and Enterprise Value

The structure of a deal can significantly impact the final amount received by the seller. Buyers must understand how a deal's structure affects the final amount received after adjustments for cash, debt, and taxes. A well-structured agreement can provide valuable tax benefits for buyers and maximize value at closing. For example, a share sale generally benefits the seller with tax advantages, while an asset sale generally benefits the buyer by providing a step-up in basis and leaving legal and tax risks with the seller. Sellers may ask buyers to cover extra taxes from asset sales, known as the gross-up amount.

Additionally, understanding and negotiating terms like working capital adjustments, earnouts, and tax implications early can help reduce risks and enhance value. In life sciences M&A transactions, enterprise value differs from the purchase price due to factors such as debt, cash, and net working capital adjustments. If net working capital at closing is below the target, the buyer may seek compensation, while exceeding the target can increase the purchase price. It's essential to understand and negotiate net working capital targets early to align expectations and maximize value. Collaborate with advisors to monitor these factors and avoid last-minute adjustments that could reduce proceeds.

Supply Chain and Manufacturing

Supply chain and manufacturing readiness are crucial for life sciences companies. Buyers should assess supply chain resilience and readiness for both commercial and clinical needs. Ensuring the success of a post-transaction pipeline or commercial sales via a flexible, low-cost manufacturing operation is critical for valuing the long-term prospect of any transaction. Additionally, addressing any potential supply chain issues, especially for a life sciences company's initial product launch, is essential to avoid delays. Buyers will evaluate how the supply chain handles current and future network and demand complexities. Therefore, building backup suppliers and maintaining inventory stability are key strategies. Further, having contract development and manufacturing organizations (CDMOs) allows for scalable production. Finally, leveraging data analytics helps identify surge capacity in the manufacturing network.

Data Privacy and Protection

Data privacy and protection are crucial in the life sciences sector. Companies must implement and enforce strong data protection and data governance policies and procedures to comply with regulations such as HIPAA and GDPR, as well as state laws. Life sciences companies rely heavily on personal data for clinical trials and other processes, making compliance a key differentiator in sales. Companies should know their data, its storage, access, flow, and protection. Additionally, ensuring that data is securely and confidentially retrievable is part of the readiness process. Best practices include documenting data activities, inventories, and regular assessments.

For due diligence, a well-organized data room with strict access controls is vital. Virtual data rooms (VDRs) use advanced security measures to provide a centralized and organized platform to store, manage, and access documents, reassuring investors of a secure due diligence process.

Antitrust and Competition Oversight

Antitrust and competition oversight are critical considerations in life sciences transactions. Increased antitrust/anticompetition oversight and enforcement action by US and EU federal agencies can impact deal negotiations and outcomes. Companies must be prepared to address potential antitrust issues and ensure compliance with relevant regulations. Engaging experienced legal counsel to navigate these complexities is recommended.

Non-Disclosure and Confidentiality Issues

Non-disclosure and confidentiality issues are paramount in all transactions. Ensuring that sensitive information, such as customer names, pricing, and details of unregistered intellectual property, is withheld until the later stages of the sale process is crucial. Confidentiality or nondisclosure agreements may need to be in place to protect the confidentiality of the information provided during the diligence process. These may include broad information-sharing requirements, burdensome milestone and royalty obligations, and issues with diligence obligations. If the risks are too high or renegotiation isn't possible, future acquirers or partners might avoid the deal to prevent potential litigation or platform risks.

Conclusion

Preparing for a transaction in the life sciences sector requires a comprehensive and strategic approach to due diligence. Engaging experienced legal and financial advisors to guide a potential buyer through the process is essential to navigating the complexities of a sale and achieving your strategic objectives.