What do we mean when we refer to a “healthcare M&A deal” and what are its specific features? In this article we will discuss a few key things you need to be aware of when doing an M&A transaction in this industry.
1. What is healthcare M&A?
First of all, when talking about healthcare M&A it is important to understand what we (M&A lawyers) mean by “healthcare” as definitions may vary. When referring to a transaction in the healthcare industry we usually talk about a sale or purchase of (or an investment in) a business in any of the four following subcategories: pharmaceuticals, biotech, medical devices and healthcare services.
Pharmaceutical companies are businesses focused on the discovery, development, evaluation, registration and monitoring of small molecular medicinal drugs. Pharmaceutical products are initially covered by patent protection. Once a patent expires, competitors can recreate the relevant product by manufacturing identical generic copies.
When talking about biotech, we refer to those companies that are focused on research and early stage development of technological applications of biological systems, living organisms or derivatives thereof, to make or modify products or processes for specific use. These products are also initially covered by patent protection. Once expired, they can be reproduced as so-called biosimilars.
The term "medical devices" covers a vast range of instruments, machines and implants for human use for specific medical purposes. Medical devices are categorized into different classes, each with their own regulatory requirements. This classification is a "risk-based" system based on the vulnerability of the human body, taking into account the potential risks associated with the devices and depending on a range of qualifications (e.g., implant vs. external use, duration of contact with the body, degree of invasiveness and local vs. systemic effect).
Finally, healthcare also covers companies involved in the provision of healthcare (physical or virtual) or that are involved in the provision of services to healthcare providers (HCPs).
A healthcare M&A transaction, similar to deals in other industries, can be structured as an asset transfer, a share transfer or a combination of the two. Later in this article we will address a few other combinations specific to deal-making in this industry. There is traditionally a lot of activity in healthcare M&A; the deal volume is high and takeover sums are usually large: it is a typical carve-out industry where big pharma, medtech and biotech companies are continuously re-evaluating their portfolio products. This is very often the case when companies face patent cliffs, meaning that soon they will have products whose patent protection will expire, or when companies have not been able to develop new products within their own R&D departments, with the risk of their pipeline running dry.
2. Key features of a healthcare M&A deal
Many of the common features in this contribution will apply to one or more subsectors. However, what may be relevant when acquiring one may not be applicable when purchasing a company in one of the other subsectors. For example, a medtech company and a pharmaceutical company operate in the same industry, however they are fundamentally distinguished businesses and differently regulated. Also healthcare deals often cover multiple jurisdictions so it is important to understand that requirements may vary per country and to engage specialists in each of the countries involved. In M&A, private equity buyers (with the exception of highly specialised healthcare investment funds) historically focus on medical devices and health services, as opposed to "higher risk" targets within the (bio) pharmaceutical industry (and in which case they often acquire stake in a consortium with other PE buyers).
Value drivers and deferred payments
The key areas of a healthcare due diligence process are IP, regulatory and compliance. This is because, commercially, irrelevant of whether the transaction is structured by a share deal or asset deal, the buyer is looking to acquire knowhow, IP and regulatory approvals. Further, since IP and knowhow are key value drivers in this industry, the buyer usually seeks to retain key employees and manufacturing personnel. Especially if the target is an early stage company of which regulatory approvals are still pending at the moment of sale, sellers often have a different valuation in mind than buyers.
Commonly applied valuation methods in other industries will not be appropriate and we see that forecasts are commonly used to arrive at the purchase price. Parties usually bridge such “valuation gap” by milestone and earn-out payments. The outcome of clinical trials, the moment of submitting requests to various regulators and the actual grant of marketing authorization of the product are usually triggers for those deferred payments. Obviously, the unambiguous drafting of such payment mechanisms is key in these type of deals.
Timing: Pre- or post-launch
Healthcare deals can involve products at various stages of development, and consideration should be given to the differences of each stage. A key point to consider before doing a deal is whether the product of the target company is pre- or post-launch. This basically determines whether or not money is already being made with that product. If the transaction is being done during the pre-launch phase this means that significant funding will be required for the further development of the product without any guaranteed income in the future.
Post-launch means that the product has already generated revenue but also that there is a limited period of time left until its patent expires. Timing of deals involving (bio)pharmaceutical companies at a “late stage” of the drug’s lifecycle this means that the drug is soon facing loss of market exclusivity followed by the risk of generic competition, meaning that other companies can, upon obtaining the necessary regulatory approvals, start selling a generic version of the drug (chemically identical to the branded drug). Profits usually drop dramatically once a product falls over its patent cliff and loses patent protection.
Points of attention: development phase
If the target is in the development phase it is key to consider clinical trials in the due diligence exercise. This is relevant, for example, when we assist a buyer in acquiring a biotech company with one or two products in an early stage. The review will be primarily focused on CRO agreements, data protection, authorizations, insurance and any collaboration agreements whereby the target has agreed to pool research and share data. Under existing collaboration arrangements, it is important to determine to what extent the target's IP is restricted.
For a proper due diligence on the clinical trials, it is essential for the buyer to have access to the details and preliminary results of ongoing studies, such as laboratory data. It is crucial to understand where the data related to such clinical trials is located and whether the sponsor will be a transferring entity (also in light of insurance protection). A consequential issue is transitional services: where there is a long gap between signing and closing, it will, for example, be important for R&D to be maintained at the same level.
Points of attention: post market deals
A key M&A aspect once a drug or device is on the market is insuring that the right processes are in place for the buyer to take over the role of pharmacovigilance and understand whether any marketing authorization transfers with it. If market authorization needs to be transferred, this will usually be transferred post-closing as a separate asset. In the interim, a specific “marketing authorization services agreement" or a broader transitional services agreement will need to be put in place. During due diligence, re-labelling requirements must also be considered as well as identifying the API supplier and other chemical suppliers. The existing distribution channels are also critical: we need to understand how the product is currently being moved.
On a local level, wholesale distribution licenses will need to be considered, as these can be required, even if the company has outsourced parts of its business such as warehousing and logistics. The application for new licences can have a significant impact on timing and may result in a long transition time.
Long transitional periods
As previously mentioned, long transitional periods are common in healthcare deals, especially compared to deals in a less regulated industry and particularly if the transaction affects product-related licenses such as CE marks, marketing authorizations, distribution-related licenses, clinical trial licences or ethics committee approvals. Two kinds of transitional services agreements are very specific to the industry: a transactional distribution services agreement and the previously mentioned market authorization services agreement.
From a merger control perspective, there has been a high intervention rate in the healthcare sector. We have seen close scrutiny of pipeline products and the potential reduction of innovation that could be caused by an anticipated transaction, making innovation competition a key consideration when doing an M&A deal. The EU Commission has also applied a very narrow market definition, based on therapeutic substitutability. In recent cases, the EU Commission has defined the relevant market even at a molecular level. In the Netherlands, the Authority for Consumers and Markets (ACM) announced that it will further intensify merger control in hospital mergers and mergers of independent treatment centres and has put certain mergers under a stricter test.
The ACM also announced that it will investigate the effects of mergers in homecare and mental healthcare institutions. The Ministry of Health, Welfare and Sports is currently assessing whether healthcare mergers involving a party with significant market power can be blocked unless this would result in substantial advantages. At the same time, the Dutch government is working on new legislation to simplify the merger process for healthcare institutions by intending to bring all merger supervision into the sole authority of the ACM (currently parties have to complete the ACM track as well as the procedure with the Dutch Healthcare Authority).
Trend: Quick deals and combos
We see a trend for doing quick deals where parties wish to close as soon as possible, with upfront payment of the entire consideration (pharma M&A specifically), even when some markets are deferred. The concept of deferred territory is common in larger deals and, as a result, parties usually enter into a net economic benefit arrangement where the seller will continue to run the business in the deferred jurisdiction at the risk and benefit of the buyer and at the buyer's expense for a certain period of time. We have also seen an increase in popularity of combining licensing and collaboration deals with a smaller equity investment as well as option agreements, with an upfront payment and the option to acquire all of the shares in the target when certain milestones have been met.
In a highly regulated market, healthcare deals have specific characteristics that are not found in other deals and need to be considered carefully. Baker McKenzie represents the majority of healthcare industry players and has a global footprint with local specialists all over the world. Please feel free to reach out if you have any questions.Join key players from the medtech, biotech and pharma sector at our life sciences event, 'Hot in Healthcare', which takes place in Amsterdam on Thursday 19 September. Register here to secure your place.