These days, nearly all M&A transactions are technology driven. Previously, risk assessment was more on operational issues but there has been a shift towards risk assessment of technology. This affects legal advice in M&A especially if you are in transactions with immature technology which often is the case in Life Science. To succeed you need to understand the technology and recent developments. What is going on and why?
For example, in Life Science M&A you need to understand that when a patent expires the price of the product generally drops by 80 per cent and an original player therefore may need to find emerging markets in order to compensate by differentiation or they may need to refurnish the product pipeline. Strategic buyers may also be looking for transition to new products and faster return on investments.
The core technology-driven deals (typically Life Science startups) are often done through licensing and extensive escrow protection rather than through purchase of shares or assets. Clinical trials are where this happens since that is where the first large chunk of big money is needed.
At the same time, smaller companies also have access to venture capital these days so the game has slightly changed. In some European countries there is now plenty of money in the market for Life Science investments and it is not only strategic players who are taking part in acquisitions.
As a transaction lawyer, how do I help our clients make sure that they get what they want in these deals? One frequent challenge is work performed by third party. In such context you should ensure unrestricted ownership and ability to use core technology. Verify the title chain and go as far back as possible. In this context you often need to encourage the target to make changes to existing contracts before signing any deal. A hive-down might help but cannot fix the title chain, so stay alert. Another risk is that the patent is voidable which, for example, could be the case if the target’s proud professor has been travelling to conferences and showing slides before the patent was filed. These things tend to be difficult to analyse in full before signing.
Sleeping dogs do exist. Your fear is that having incorporated what you bought, developed it into a block-buster, someone says they have a right to the patent or product. Normally representations and warranties do not help much since customary warranty periods do not exceed two years from closing and are capped.
As a parallell, if it is an IT M&A transaction, and in particular if it is in a cloud industry, you also need to look at open source issues. Tests like Blackduck are not hard to do but analyzing them is another thing. Has the code been distributed to someone else? Has it been modified? Also here, problems generally show up much later than warranty periods. The Cloud is also a hot topic, and here data protection is key. Look at where the service providers are located. Most of the providers are located in the States since there is not so much restrictions as in Europe. These things are only examples of M&A becoming increasingly tech driven in all sectors.
So how do you act as a buyer in this competitive environment? Obviously you need to take some risk to be able to do M&A. But you should never take direct title risk. From experience, if you are buying, the seller’s reaction to your findings is often far more interesting than the findings themselves. There are ways to fix things but if you have a seller whose reaction is to refuse to understand the problem, then you should be ready to walk away if it is a direct title risk.
One common technique to seek some kind of protection is to establish milestones for further payments of the purchase price. Here the practice is different in IT deals where both milestone payments and earn-outs are less frequent compared with Life Science deals. In IT, earn-outs could work if the product is really isolated but not if it’s intended to be merged with another product-offer in the market. In general a very small portion of global M&A have earn-outs these days.
If used, earn-outs are where you really need proper drafting. In Life Science M&A earn-outs are typically used when a product is in an early stage. The use of earn-outs is declining due to the dynamics behind it, for example that the drafting can never cover all events and a buyer normally has nothing to lose in questioning an earn-out well after closing. He or she may use a variety of arguments. Many deals therefore have milestones instead, which could be approval by public authorities, certain sale levels etc. As a seller you will need covenant protection that the buyer will try to reach the milestones and protection if the buyer in its turn divests the assets. Normally the latter should, if you’re acting for the original seller, be covered by an obligation for the new buyer to stand guarantor.
All in all, modern M&A requires that you understand the hurdles technology world behind. It is not advisable to simply move standard “operational asset M&A-techniques” straight over to modern M&A.