To make matters worse, the most common solutions for driving liquidity are not easily available for pre-revenue life sciences companies. By comparison, companies that generate revenue, for obvious reasons, have more options available to them, including through traditional debt markets, and specifically through receivables-based or asset-based financing. And, even that has become more challenging in the wake of the run on Silicon Valley Bank (SVB) and its take-over by the U.S. Federal Deposit Insurance Corporation (FDIC). So, a different, more nimble and perhaps more drastic approach may be required.
What other options are available for pre-revenue life sciences companies, including those with assets in the clinic? Here are the most utilized alternatives:
Cut costs dramatically
In uncertain times, remember the adage “Cash is King.” No cash means no ability to pay employees, rents, and other core corporate existence obligations – let alone continue with expensive research and development and clinical trials. So, the first thing to consider is whether the bulk of employees can be eliminated entirely, or furloughed, or other cost-cutting measures can be used. The sooner this is considered and implemented, the faster the cash burn can be reduced. Additionally, consideration should be given to reducing footprint, through termination or sub-leasing of non-critical rented space. If the rent cannot be mitigated but is eating the company alive, consider negotiating an exit from the lease and stretching vendors and suppliers. These actions can have an enormous effect on the ability to stretch cash for many months, or longer, in which time the equity markets might begin to recover and future financing become more likely. In view of the SVB fallout, companies should also consider diversification strategies to guarantee that more of their cash remains FDIC insured.
Look for debt financing
When equity is not available, debt might be an option to bridge to the next development phase, when equity markets might open up again. Secured debt should be a consideration, as it is typically at a lower cost, especially if there is unencumbered collateral such as real estate or valuable intellectual property (IP) assets. Yes, there is a risk that a default on the secured debt could result in a foreclosure on those assets, destroying the company and shareholder equity, but it might be a necessary risk, and preferrable to simply shutting down and walking away. Also, it is important to note that this sort of financing for a pre-revenue business is not going to come from your neighborhood banker or traditional lending source – the market here is direct lending or special situations funds, which look for high risk high/reward situations with equity-like returns for their loans. That means not only a high interest rate, but might also involve warrants or other equity kickers to drive up the yield. Under any of these scenarios, talking to a special situations banker is advisable as they will have knowledge of the special lending market and connections with those who might be interested, which may be outside the ambit of the traditional life sciences banking community. To get the best visibility into the market, consider interviewing a few candidates. This is free and might give you insights into the market not otherwise readily available.
Find a commercial partner
When equity or debt are not available, a commercial partner for one of your company’s programs might be an option for non-dilutive financing. There are a wide spectrum of potential commercial transactions, ranging from a full out-license or collaboration of one of the company’s product candidates to an out-license or collaboration for a particular geographic location or indication for a product candidate the company intends to keep in its portfolio of assets. There are also other sorts of commercial transactions that can generate cash for the company, such as a royalty or revenue interest financing. All of these transactions will be able to generate additional cash so the company can live another day until the equity and debt markets come back. There are specialized investment banks that specialize in these types of transactions. These transactions can also take an extended period of time to close so getting started early is warranted.
Find a merger partner or tee up a sales process
If you’ve cut costs but can’t make it with your existing cash; the equity markets are closed to your company, and debt is not available – you are near the end of the road, and really only two options remain: shut down or merge/sell. A shut down is Armageddon, and to be avoided unless all other options have been explored, but we will discuss that below. From a fiduciary perspective, which requires the officers and directors to exercise the “duty of care,” maximizing company value means a sale or merger must be explored at this point, to generate as high a recovery as possible for shareholders. Again, traditional bankers may or may not be the right option here – the kinds of buyers for distressed and failing businesses might come from non-traditional perspectives, and not be within the ambit of more traditional bankers. It is possible, and likely probable, that – if not already – soon enough one or more private equity funds or special situations investors will consider acquiring and then rolling-up a number of failing life sciences businesses, looking for synergies based on promising early clinical data and also big ticket victories if success is achieved. The boutique investment banks serving the distressed market (and mentioned above) will be more attuned to this category of investor.
The end of the road: furlough and moth-balling or ABC
If all going-concern options fall away, then the officers and directors will be faced with the painful decision of whether to try to furlough employees (this is not a firing; employees are simply told that there is no more money to pay them and therefore no work that they can or are allowed to do), “moth-ball” IP assets, and go dark essentially at a sustainably low level of cost to try and lay dormant until the market rebounds or a buyer arrives or permanently shut down the business. One way to shut down the business is by using a statutory tool available under applicable state law where the officers and directors would engage in what is called an Assignment for the Benefit of Creditors (ABC) and transfer the company’s assets to an assignee of its choosing, who is charged with liquidating the assets and distributing proceeds out to the creditors. In simple terms, this is similar to a chapter 7 bankruptcy without the inception of a federal bankruptcy case, and depending on the jurisdiction, without any court oversight. ABCs are most common in companies where their primary asset is IP, and it can be held as an intangible and sold for value to a third party through a marketing and sale process run by the assignee. Operating locations and related leases are almost always left behind, unless there is a market for them. The ABC ends the primary obligations of the officers and directors (but does NOT provide them with a release), almost always results in all employees being fired, and leaves the “cleanup” to the assignee, creating a clean-ish break. ABCs were seldom used in the past, but they are growing in popularity and there is enough precedent for a reasonable level of predictability in the outcome. Other options include chapter 7 liquidations and state law dissolutions and wind-downs.
Nothing about this is easy, or fun. We recommend that you bring into the discussion as early as possible people with experience in governance and distress and restructuring – that can be an existing executive, an existing or newly seated independent board member (a very useful person for a fresh perspective with a valuable skill set) or outside counsel. This is no time for pride or ego – this is high stakes liability time, and experience can make a massive difference in outcomes.
With inherent uncertainties in their lengthy development timelines, clinical stage life sciences companies have unique challenges requiring a special type of strategic business partner. If the Life Sciences and Restructuring teams at Hogan Lovells can be of any further help or guidance, we welcome the opportunity to speak with you. Please contact the authors of this alert or the Hogan Lovells attorneys with whom you regularly work to discuss your specific financing needs.
Authored by Christopher Donoho, Steve Abrams, and Christopher Bryant.