Health Care Transactions for Life Sciences Companies

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In the dynamic and highly regulated life sciences sector, the process of selling a company involves complicated and unique considerations and intricate due diligence that can significantly impact the transaction's success. For sell-side owners, understanding the landscape and preparation are essential to navigating potential challenges and maximizing the company's value. This article explores the considerations that life sciences companies face when preparing for a sale and provides insights into how to effectively manage these complexities.

Preparing for the Sale

In preparing for a sale, organizations must consider the following factors:

Goals

Before even entering into a letter of intent, the owners must clarify motivations for selling, whether it's geographic growth, maximizing profit, ensuring employee well-being, or securing a legacy. Establishing a clear goal can inform expectations.

Valuation

It is important to obtain a professional valuation to understand the company's worth, market position, financials, strengths, and weaknesses. The opinion should be unbiased and disconnected from the company, as emotional attachment can cause owners to overvalue their companies, leading to failed negotiations. They may compare their expectations to others' sales, assuming similar outcomes, which wastes time and can hinder deals from progressing. In the life sciences industry, traditional valuation methods like EBITDA are less relevant because many companies are pre-revenue, making these traditional methods less applicable.

Further, differences between enterprise value and purchase price can arise due to factors like debt, cash on hand, and net working capital adjustments. Thus, understanding the net working capital target and negotiating terms early is essential to align expectations.

Working Capital Requirements

Buyers may require the company to be sold with enough working capital for the buyer to resume operation once the deal is finalized. It can be challenging to determine the appropriate amount of working capital to include in the purchase price. One common way to determine working capital is to calculate it on the last day of every month for a year and average those calculations out.

Regulatory Standards

Regulatory approvals are essential for market trustworthiness, as they indicate rigorous due diligence and high-quality science (Nathan Martinsberg, Scientific due diligence: A handbook for investigators and investors, 2018). Ensuring that the life sciences company maintains all required approvals and certifications and holds exclusive rights to the technology is crucial. Meeting regulatory requirements enhances the value of the deal, making it more secure and appealing to investors (Nathan Martinsberg, Scientific due diligence: A handbook for investigators and investors, 2018).

Navigating Due Diligence

Due diligence is a critical phase of the transaction, and the inability to produce adequate documentation or responses to a buyer's diligence inquiries can kill a deal. Owners of a life sciences company can begin preparing for diligence even before a potential buyer expresses interest in the company.

Financial Analysis

Prepare detailed financial statements and forecasts, allowing buyers to assess working capital, gross margins, sales drivers, and potential operational efficiencies. Buyers may require the company to be sold with enough working capital for the buyer to resume operation once the deal is finalized. It can be challenging to determine the appropriate amount of working capital to include in the purchase price. One common way to determine working capital is to calculate it on the last day of every month for a year and average those calculations out.

Intellectual Property

A life sciences company's IP is its most valuable asset, and ownership disputes and regulatory non-compliance can scare off potential buyers. It is imperative for sellers to secure and organize the company's patents, trademarks, and other IP assets, as they are crucial for competitive advantage and buyer confidence. Ensuring correct patent rights flow between parent companies and subsidiaries is crucial, especially in complex corporate structures. Additional assignments may be needed to consolidate rights. In university collaborations, assignments directly from inventors may be invalid if rights automatically vest with the institution. Proper assignments from the university are essential.

Regulatory Compliance

Regulatory diligence is multifaceted and varies by deal types, structures, and the nature of the counterparty. It can become complicated when involving multiple product lines, corporate entities, and geographies. Gaps in compliance with relevant regulations or incomplete regulatory documentation can raise red flags.

Key Contracts

Life science company owners should review and organize all material agreements, including licensing, collaboration, and research agreements. An organized system of contracts provides clarity of and support for other diligence regulatory considerations.

Data Privacy and Security

Life sciences companies, which handle sensitive data, should enforce strong data protection policies. Understanding data flow and protection, and complying with privacy regulations, can enhance appeal during transactions. Ignoring data security requirements can create exposure that potential buyers are unwilling to assume.

Manufacturing and Supply Chain

A strict policy on compliance with Good Manufacturing Practices will provide potential buyers confidence in the company's operations. Sellers should also review adverse experience reports and periodically assess supplier quality agreements.

Structure of the Transaction

Life sciences companies must also consider the structure of the transaction, including:

Deal Structure

It is important for sellers to understand the entire deal structure and not just the bottom-line financial outcome. Sellers may not fully grasp how a deal's structure affects the final amount received after adjustments for cash, debt, and taxes. A poor structure could leave sellers with less than expected, potentially halting a deal or tainting post-close relationships.

Performance Dips Post-LOI

A decline in performance after signing a letter of intent (LOI) can raise concerns for buyers, potentially delaying or derailing the deal. Performance dips may be the result of economic factors or the seller prioritizing the sale, which, depending on the size of the company, can lead to neglect of sales or operations. To avoid post-LOI performance dips, sellers should continue running the business as if the deal were not in progress and avoid neglecting operational responsibilities.

Confidentiality

Legal risks associated with confidentiality agreements and the potential for contamination of internal research and development efforts are significant. Sellers are sharing a lot of proprietary information with potential buyers, and this is especially true in the life sciences industry. Sellers should never sign a Non-Disclosure Agreement (NDA) without knowing what all it entails and how long the buyer is subject to the confidentiality requirements of an NDA. It should ensure confidentiality and restrict information use to defined purposes. For companies in active research and development, minimizing contamination risk is crucial. If misuse is alleged, the receiving party must prove independent knowledge. To mitigate risks, clarify internal know-how and narrow the information scope in the NDA.

Negotiate Carefully

It is common for a seller's excitement about the pending transaction to cloud judgment and result in hurried acceptance of the buyer's terms. Sellers should understand with clarity milestone events in the transaction process, payment amounts, and buyer obligations. Creating understandable expectations before the transaction closes can help to avoid post-closing confusion and disputes.

Employment Issues

In a life sciences company, the owners, scientists, clinicians, and development employees are often essential to the company's continued success. Sellers who want to continue with the company and have their team in place should ensure the transaction structure includes attractive incentives and compensation structures to retain key employees post-acquisition. Similarly, for employees generally, sellers should pay heightened attention to the employment aspects of the transaction as it applies to all employees, including potential headcount reductions and restrictive covenants for departing employees.

Selling a life sciences company requires thorough preparation and a well-structured approach. By comprehensively addressing legal, regulatory, commercial, and financial aspects as well as assembling a team of experienced advisors, companies can navigate the complexities of this process and achieve a successful outcome.