The life sciences M&A sector keeps growing—even with rising interest rates, high inflation, the war in Ukraine, and the lasting effects of the COVID pandemic creating uncertainty for broader M&A deals. The 2021 SRS Acquiom Life Sciences M&A Study revealed 30% growth in this category between 2019 and 2021. In this article, life sciences M&A deal experts at SRS Acquiom—Casey McTigue, managing director of the Professional Services Group, and Ann Byers, director, Shareholder Advisory—offer perspectives on the market forces at play and emerging trends.

Q: What are you seeing on life sciences M&A deals so far this year?

Casey McTigue: It is fair to say that early-stage life sciences companies who might have been seeking additional rounds of financing have been having a harder time acquiring that funding, so buyers may be poised to acquire those companies at a bargain. We are already starting to see more buyer-friendly terms on deals in life sciences and elsewhere.

Ann Byers: Our role as the post-closing shareholder representative tends to experience market effects about one to three years out. For example, we are just starting to witness the impact of the COVID-19 pandemic on life sciences M&A post-closing activity.

Q: How did the pandemic change M&A approaches to life sciences deals?

Ann Byers: The market will feel the effects for some time to come. For example, there has been a significant impact on contingent payments resulting from clinical trial challenges and, in some cases, renegotiations to extend milestone payments or pursue earnout buyouts. To further explain, many early-stage companies rely upon access to doctors, patients, and equipment to support clinical trials. The availability of patients in a lockdown scenario was severely constricted, while doctors were diverted to COVID patient care. The supply chain also notably slowed, so equipment was not available. Personal protective equipment (PPE), for example, has yet to regain full capacity. Hence, contingent payments on milestones could not be achieved.

In the early days of COVID, there was considerable flexibility around earnout achievement. If a deadline was missed, it was often accommodated by the general belief that it was the right thing to do, with deadlines shifting slightly (three to six months out) and with the total payment amount changing or new conditions introduced (such as reporting or claims). These negotiations depended on the relationship between buyers and sellers and the likelihood of market success for the drug or device. Buyers with good relationships and prospects were more likely to be flexible on milestone terms.

Casey McTigue: With the pandemic, we saw a rise in “Act of God” provisions and Material Adverse Effect (MAE) clauses that were not prevalent before the pandemic. Life sciences deals were not negotiated differently, but there has been a trend toward more significant percentages of deals being deferred or including contingent consideration— shifting risk from buyers to sellers. The pandemic hasn’t significantly changed the structure of life sciences M&A deals, but it created more leverage for buyers.

Q: How would you characterize the tolerance for risk in the life sciences M&A sector?

Casey McTigue: In the life sciences sector, M&A deal parties generally tolerate risk or they would not be in life sciences. Buyers are typically not interested in large, up-front payments and prefer milestones tied to payouts over time. Sellers are attracted to the prospect of larger payouts tied to milestones. They would rather capture the “10x” return later than the “1x” return now.

Ann Byers: Risk is an inherent aspect of the life sciences sector. All parties take a chance on the outcome when contingent milestones are involved.

Q: Is the development cycle phase of the biotech firm a key factor in earnout achievement?

Casey McTigue: Our 2021 Life Sciences M&A Deal Terms Study yielded the insight that deals with large, up-front payments tended to also have larger earnouts—the stage of the company was not a factor. Milestone tables are getting larger and longer, with very large milestones added to later years— but actual achievement is often delayed. Our data from this study showed that $55.1 billion in milestone achievements were potentially available, but only a fraction of that amount ($4.7 billion) was earned.

Ann Byers: The development stage matters in the size of the consideration, as many do not ever reach Stage 3. There is a steep decline in payouts associated with earlier phases of development. The phase itself does not impact the earnouts, as Casey mentioned.

Q: Are life sciences companies having difficulty hiring and retaining talent? How is this impacting M&A activity?

Ann Byers: The talent question is an interesting one. It isn’t a question of recruiting but retention. When key employees remain at an entity, post-closing litigation rarely occurs. Key witnesses, for example, are former employees of the seller now working for the buyer. These scientists benefit from milestone achievement as they are also likely to receive sizeable compensation if it occurs.

Q: Are you seeing an increase in life sciences litigation activities?

Ann Byers: An increase in “suspicion” will precede the uptick in litigation: It is important to bring the buyer and seller together to talk, if that is possible. If they would sit down and talk, most litigation would not happen. We are seeing a trend toward legal representatives of the buyer tightening disclosed information. Quiet buyers that provide no insight on how things are progressing, especially buyers that “go silent” or minimize disclosures, can cause suspicious sellers and, in turn, more litigation.

Casey McTigue: With increasing M&A deal growth in this sector, it is reasonable to anticipate a corresponding increase in litigation. With that caveat, we haven’t seen significant change outside of pandemic-related disputes, which are hopefully temporary. Ann is right, though. Buyers have tended to be more circumspect in their regular reporting recently.

Q: Are established life sciences companies getting more aggressive with “bolt-on” M&A strategy?

Casey McTigue: While not specific to life sciences, M&A advisors tend to pursue market investments more aggressively in a downturn, which can certainly be an important strategy in the life sciences sector. These tend to be large deals, and if one “hits,” it can be lucrative. The advisors understand that contingent payments are the key to smart investment decisions.

Ann Byers: We see this occur when an investor may want to keep one division of a life sciences acquisition but not another. For example, if the division fits an acquisition or growth strategy, they will keep it in the portfolio or divest it.

Not much seems to affect the upward trajectory of life sciences M&A deals except government interactions (such as FDA delays), more expense in clinical trials, and longer earnout terms. The stock market and associated life sciences M&A deals just keep moving forward.

Q: How can buyers and sellers best protect their interests in the current life sciences M&A environment?

Casey McTigue: Robust observation rights help both sides by creating trust. Everyone should ensure that the deal terms most important to you are reflected in the purchase agreement—and clearly defined.

Ann Byers: Remember that ongoing communication between buyers and sellers on the status of milestone achievements is the key to minimizing post-closing litigation. Ultimately, buyers are only obligated to provide the information required by the terms of the purchase agreement. Therefore, these considerations should be made when negotiating that language. When sellers do not have good visibility during the post-closing period, it can lead to the increased suspicions I previously mentioned and perhaps increased information requests or questions put to the buyer, which, in turn, can cause buyers to take a more cautious approach with disclosures.

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