Biotech and pharma merger activity poised to take off

August 22, 2008 by dadmin

Just a few years ago, the main exit strategy for venture-backed biotechnology companies was an IPO or a creative variation thereof. Rarely did early-stage biotech companies envision a near-term sale to a large pharmaceutical company — until now.

Traditionally, early-stage biotech companies developed their candidate drugs through Phase 2 clinical trials, then sought a big pharma partner to assume responsibility for commercialization of the drug. Biotech companies rarely undertake the expense and risk of a major Phase 3 trial on their own, and indeed the failure to find a big pharma partner by that stage may be a red flag to investors. Big pharma and biotechs have thus established a model that allows biotechs to tap into the development, marketing and financial resources of big pharma, while giving pharmaceuticals a cost-effective, off-the-balance-sheet method for acquiring rights to promising drug candidates.

While that remains the prominent strategy for commercializing biotech drugs, there is a new merger and acquisition model. Pharmaceutical companies are more willing than ever to acquire biotech companies outright. This change is evolutionary: The science, technology and track record of the biotech industry have matured to gain acceptance by the once-skeptical and risk-adverse pharmaceutical industry. At the same time, big pharma desperately needs to increase the number of viable drug candidates in their pipelines and to acquire new blockbuster drugs to replace those going off patent. The collision of these factors has created an environment for M&A.

The recent entry of private equity firms into the mix will fuel further M&A activity in the space. As part of aggressive cost-cutting and corporate reorganization mandates, many big pharmas are spinning off non-core assets, drugs and divisions. The PE firms have been acquiring these assets under a classic “buy and build” strategy, using the acquired entity as a platform for additional acquisitions.

In light of these trends, if your biotech company has a hot technology or a potential blockbuster drug, you may be able to skip the interim step of a big pharma partnering deal, and go straight to a lucrative M&A exit. To capture the most value for investors in anticipation of a possible sale transaction, biotech companies should consider the following actions:

Risk mitigation. Big pharma M&A valuations of biotech targets are driven by formulas that include variables assessing the likelihood of obtaining U.S. Food and Drug Administration approval; reimbursement strategies, legal compliance and patent/IP protections. Any serious problems found in these areas could kill an M&A deal. The more money that a big pharma is asked to pay up front, the higher its expectation that risks have been eliminated or mitigated. That means many biotechs need to devote more resources than in the past to their clinical, IP and legal compliance programs to place them on a par with big pharma expectations. Pushing off to Phase 3 fundamental safety studies might be a good strategy if a big pharma partnering deal is your goal, but it can hurt your ability to consummate an M&A deal, or lead to contingent payment terms that reduce the amount paid at closing.

Toxic contract terms. Some biotechs with limited leverage have agreed to terms in licensing and other agreements that would be toxic if acquired by a big pharma. Examples include overly broad non-competes, grant-backs, change in control limitations and non-assignment clauses. If improperly drafted, these could kill an M&A deal.

Stock option plans. Many stock option plans provide for automatic acceleration and vesting upon a change in control, while other plans grant the board discretion to roll over or accelerate options. There are compromises that accommodate the needs of the employees, stockholders and the acquirer which should be considered well in advance of any M&A transaction.

The time may be right for your biotech company to take the steps necessary to maximize its value for a possible acquisition.

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