Considerations for Structuring and Bridging the Valuation Gap in Life Sciences M&A Transactions

Two of the main issues that parties to life sciences transactions must consider at the outset of a transaction are how to structure the deal and what happens when the acquiror and seller have different valuations for the target.

Structuring the life sciences transaction

An acquiror of a life sciences target has a number of options to consider in structuring a deal. In deciding which structure to use, parties would typically consider:

  • Financial terms. How much does the acquiror willing to pay, when it is willing to pay, and how does it want to structure such payment or payments? 
  • Control. What type of control does the acquiror want to have, or do the sellers expect to have, over the target’s business after the closing? 
  • Risk allocation. How do the parties want to allocate risks of the transaction between them? 
  • Tax efficiency. How should the acquiror and seller structure the transaction in an effort to make it tax efficient for both?
  • Pipeline programs. What programs or products are under development by the target[, what stage of development are those programs or products at,] and how will the meshing together of the two companies affect those programs?
  • Financing. How is the acquiror financing the transaction, e.g., is it using cash on-hand; does it need to borrow money to acquire the target? 

The transaction profile developed by thinking through the above considerations will help to determine which of the four main life sciences structures to select, each of which has its own considerations that should be weighed.

1. License/Collaboration: The acquiror is not buying the target company or a specific asset, but entering into a contractual relationship with another party to conduct a business or help them develop a product, for themselves or for such other party.

  • IP rights. This structure brings the intellectual property underlying the life sciences product into the acquiror’s purview so that it has some say in the development, production, and sale of the product. 
  • Complexity. These agreements are highly negotiated and likely to have the most complicated structure. 
  • Control. This arrangement allows both the acquiror and seller to maintain a role in the future development of the drug or device.
  • Acquiror’s rights & liabilities. The acquiror gets to choose the particular assets/product line it is interested in pursuing, which is particularly beneficial when a company has a number of other assets or products that the acquiror does not want to own or control or otherwise be involved with. The acquiror also does not assume any liabilities of the seller that do not relate to the licensed asset or product, nor does it have responsibility for any liabilities other than as set forth in the agreement. 
  • Seller’s rights & liabilities. The seller retains ownership of other pipeline programs and products in its portfolio and receives payments from the acquiror for the licensing of the target product as a form of non-dilutive financing. On the downside, there is no exit or liquidity strategy for the investors of the target company because the product is not changing ownership through the license or collaboration agreement. 

2. Asset acquisition: The acquiror purchases a particular asset (e.g., intellectual property of the target or production of a certain type of drug or device) from the target company.

  • Taxes. Biotech/medtech sellers generally do not prefer these types of transactions because the target is often structured as a corporation, leading to adverse tax consequences if the seller wants to return capital to investors.
  • Acquiror’s rights & liabilities. The acquiror gets to choose the asset(s) it wants to own and obtains direct ownership of the product while also not assuming hidden/unknown liabilities of the seller; typically in this structure, the acquiror only assumes the liabilities related to the product(s) it purchases. 
    • Seller’s rights & liabilities. The seller has many of the same considerations for an asset acquisition as it does in a licensing/collaboration structure. That said, in a license/collaboration, the seller can often “take back” the program, product or asset at a future date if the acquiror breaches its obligations (e.g., does not use the required level of efforts to develop/commercialize the product). An asset deal is generally seen as a more permanent transfer, and the seller’s remedies generally would not include taking the program, product or asset back.

3. Mergers & Acquisitions: The acquiror buys an entire company or a majority stake either by buying all of the equity of the company or entering into a merger transaction.

  • Agreement to merge. These transactions are often structured as a merger because a merger does not typically require every equity holder to agree to the transaction. This is particularly useful when there are many equity holders (especially when such persons individually own very small percentages of the target), often with some that are not involved in the day-to-day operations of the target company. 
  • Acquiror’s rights & liabilities. This structure gives the acquiror 100% control of the company (vs having any seller involvement); as such, the acquiror has full control of the program or the product (subject to the terms of the merger or equity purchase agreement). Therefore, all of the risks, obligations, and liabilities (either anticipated or unanticipated) of the target company now pass to the acquiror.
    • Seller’s rights & liabilities. The seller has very little post-closing risk in an M&A transaction. This structure also creates an exit for the early round investors in the target.

4. Option to acquire: The acquiror pays money upfront to potentially acquire the product or target company in the future.

  • Middle-ground pathway. This arrangement is an additional layer to add on to the other structures and can be used if the parties are unsure whether they are ready to strike a deal.
    • Benefits to target. An option to acquire provides some undiluted financing to the target company. It also allows the target to continue to develop the product without significant interference because the controls that the option acquiror has over the business during the option period are relatively low compared to the other types of transactions.
    • Benefits to target. Allows a potential acquirer to “de risk” an early-stage program, product or asset before determining whether to acquire it, while ensuring that a competitor won’t acquire the program, product or asset during the option period.

Bridging the valuation gap between acquirors and sellers in life sciences transactions

In life sciences transactions, there tends to be a valuation gap between what an acquiror wants to pay for a company or an asset and what a seller thinks the company or asset is worth. As a result, parties in transactions in this industry tend to include a form of contingent consideration, commonly referred to as “earnout payments,” to bridge that gap.

For example, while a seller may be optimistic about obtaining regulatory approval for their product or the revenue they are going to generate from that product, an acquiror may have a markedly different view of such outcome from the seller. One way parties bridge these different viewpoints is by agreeing that the acquiror will pay an upfront amount at closing and then will pay additional money (or other consideration) if certain events occur. These events, referred to as “milestones,” typically can include:

  • Completion of a phase of a trial study; 
  • Receipt of regulatory approvals;
  • Development of an appropriate sales pipeline;; or
  • Achieving specified levels of sales.

This type of contingent consideration is present in many life sciences transactions because they tend to involve acquisitions of companies at an early phase in their lifespan, and, as a result, the ability of a target company to generate sales or earnings is often speculative at the time of transaction.

Negotiating the earnout payment

Earnout payment terms are typically the subject of significant, and contentious, negotiations due to the implications for both the acquiror and seller.

While there is often some alignment between the acquiror and seller regarding how to achieve the relevant milestones, the types of efforts that the acquiror would expend to achieve such milestone may be different than the types of efforts that the seller would employ. Acquirors are typically concerned about the costs associated with achieving such milestones post-closing and will try and negotiate how much time, money, and effort they must invest.

Key issues that the parties should consider in transactions with an earnout, include:

  • Efforts standards. What efforts standards, if any, must the acquiror adhere to in order to achieve the milestones? For example, in developing and commercializing the product, will the acquiror be held to the standard of efforts generally used by the specific acquiror (subjective standard) or efforts generally used by similarly situated companies (objective standard)?
  • Definitions. For financial and regulatory milestones, how should certain metrics, such as “net sales,” or “pricing approvals” be defined?
  • Control. Who has control over development and commercialization post-closing? Will the acquiror have sole discretion? Will a committee including representatives from the acquiror and seller have control? Will there be a pre-agreed-upon “Development Plan” or set of criteria?
  • Duty to report. What ongoing reporting obligations, if any, does the acquiror have to the seller relating to the product or program and the achievement of the milestones?
  • Caps. Are there aggregate caps for percentage-based milestones (i.e. maximum amount that can be achieved on any one or combination of milestone achievements)?
  • Dispute resolution. If disputes arise between the parties relating to achievement (or value) of milestone payments, will they be addressed through alternative dispute resolution or litigation? 
  • Right to offset. Will the acquiror be permitted to reduce the earnout payments, i.e., “offset,” for any other payments, e.g., indemnification or subsequently-incurred transaction expenses, it is obligated to make under the transaction agreement? 
  • Breach consequences. What happens to the acquiror’s payment obligations if there is a breach by the acquiror or the acquiror enters into a subsequent transaction? For example, will the milestone payments accelerate and become immediately payable by the acquiror, if the acquiror fails to use applicable efforts, or if there is a sale/out-license of the target company, business, product, technology, or IP?
  • Assignability of rights. Does the seller have any rights to sell or assign its rights to the contingent consideration?


Authored by Michael Szlamkowicz and Lu Zhou 


© 2020 Hogan Lovells. All rights reserved. "Hogan Lovells" or the “firm” refers to the international legal practice that comprises Hogan Lovells International LLP,Hogan Lovells US LLP and their affiliated businesses, each of which is a separate legal entity. Attorney advertising. Prior results do not guarantee a similar outcome.