U.S. Life Sciences M&A: Key Trends and Their Impact on Dealmaking

As we wind down the fourth quarter of 2022 and head into 2023, M&A in the U.S. life sciences industry continues to be active, albeit not at the record-setting pace experienced in 2021. Looking ahead, we expect continued M&A activity throughout the life sciences industry, in many cases with increased emphasis on deal terms that in prior years would not have received as much attention. We highlight below key trends we are seeing in U.S. strategic life sciences M&A transactions, and their impact on dealmaking and deal terms.

The current backlog of life sciences companies waiting to go public has created opportunities for both buyers and investors who consider an M&A exit as an alternative to an IPO or a deSPAC transaction. In our experience, investors in companies with a potential IPO or deSPAC option are keenly focused on deal certainty, particularly given the current antitrust environment, and on limiting clawbacks of deal consideration – whether through limiting the buyer’s recourse to a representations and warranties insurance policy or a limited scope indemnity, where recovery for claims other than fraud is limited to an escrow and potentially setoff against future payments that are part of the deferred deal consideration.

We continue to see acquisitions of companies across the life sciences industry at earlier and earlier stages of drug or device development. To balance the increased risk of development and regulatory failure borne by earlier stage companies, buyers increasingly are implementing contingent payment structures – milestones based on development and regulatory events, commercial launch, royalties and net sales related payments – that traditionally are seen in collaboration and licensing deals. Where contingent payments are accepted by target companies, we are seeing significant negotiation over the details of the contingent payment triggering events and the level of diligence efforts the buyer must use to achieve those events. Key issues include whether to include an efforts standard, whether the “commercially reasonable efforts” standard is objective (i.e., the level of effort required is compared to similarly situated companies in the industry) or subjective (i.e., the level of effort required is compared to the buyer’s effort to pursue its other internal programs), the types of products subject to contingent payments (e.g., to what extent buyer improvements are taken into account), the duration of the efforts obligation and reporting and audit rights.

The regulatory environment in the U.S., UK and EU remains somewhat unsettled, with antitrust and foreign direct investment enforcers becoming increasingly active and focused on the life sciences industry. We see both buyers and target companies focusing early in the deal process on potential regulatory hurdles in order to assess the likelihood of regulatory challenges and the most advantageous deal structure given the perceived regulatory risk to deal certainty and timing. Regulatory covenants, the interim operating covenants under which the target company (and, in some cases, the buyer) must operate between signing the acquisition agreement and closing, and termination rights and associated termination fees are the subject of increasingly nuanced negotiation, as parties attempt to balance who bears both known and unknown regulatory risk, and navigate potentially extended deal timelines. For buyers who require acquisition financing or representation and warranty insurance, regulatory risk also impacts the duration and cost of debt commitments and representations and warranties insurance policies.     

We are seeing both public and private target companies with any perceived leverage seek to carve out of the heavily-negotiated “material adverse effect” definition the impact of various developmental, regulatory and commercialization events, thereby shifting the risks associated with those impacts to buyers. Increasingly common proposed carve-outs include the impact of actions by FDA and comparable regulatory authorities (including failures to obtain marketing approvals), governmental actions on drug and device pricing, generic competition, issues with clinical trial enrollment and progression, adverse clinical data and other adverse events. From the sellers’ perspective, these risks are “part and parcel” of the business of developing, seeking regulatory approval for and commercializing drugs and devices. In negotiating the “material adverse effect” definition, buyers should consider, especially in deals where the target company’s product portfolio is limited, the impact of the events excluded, if any were to occur, on the overall deal value to the buyer and, although very rare, whether the occurrence of certain product-specific events should constitute a material adverse effect.

For acquisitions of companies where much of the value is in the pipeline, we see buyers focusing early in due diligence on the timeline and pathway to marketing approval and launch, and pricing and reimbursement potential, as these factors can significantly impact valuation. In the medical device sector in particular, choices regarding the first jurisdiction in which to seek approval are not always straightforward, and pricing and reimbursement pressures from CMS and private payors are significant. Recent governmental action in the U.S. and Germany to reduce drug costs likely will only increase the attention paid to these issues in acquisitions of biopharmaceutical companies.

The pharmaceutical, medical device and biotech sectors, and particularly biotech, have been hard hit by the 2022 stock market downturn. For opportunistic buyers with sufficient cash, lower valuations can lead to attractive deals. Boards of directors of potential target companies, conversely, must assess, consistent with their state law fiduciary duties, whether a deal at an attractive premium relative to the current market price is a better outcome for stockholders than holding out for a potential share price rebound. These decisions are especially challenging in light of the current fundraising environment, uncertainty in the timing of share price rebounds and macro factors, including continued supply chain disruptions, the rising interest rate environment and geopolitical issues, such as the war in Ukraine and increasing political tensions between the United States and China. Public company boards of directors faced with these decisions are well-advised to focus on their decision-making process, including understanding management’s view of the company’s long-term prospects, having a clear understanding of their duties under relevant state law and carefully considering the advice of their outside financial and legal advisors.

If you have any questions concerning the material discussed in this advisory, please contact the members of our M&A practice group.