Companies in the life sciences sector and its sub-sectors, including pharmaceuticals, medical devices, diagnostics and services, are involved in a high number of mergers and acquisitions (“M&A”) transactions. This M&A activity is driven by a range of factors, as discussed in our first article. 

M&A is a complex process that requires extensive due diligence to be completed by the buyer on the target, as well as careful structuring of the transaction to ensure that any legal, regulatory, commercial and/or financial issues are identified and appropriately dealt with before the transaction is completed and the buyer acquires control of the target. 

We’ll examine the key legal issues that may be encountered in M&A transactions involving life sciences companies, focusing on due diligence (including regulatory, intellectual property and other key issues), deal structuring, employment issues, and tax considerations. By understanding these issues, buyers and sellers should be better placed to successfully navigate the M&A process.

What are the key areas of diligence that a buyer needs to undertake?

Due diligence is the cornerstone of any M&A transaction. Comprehensive due diligence goes beyond financial and operational reviews and includes an in-depth examination of all legal and regulatory matters relating to the business. This can include intellectual property, data privacy, employment, regulatory compliance, amongst other areas.

The key legal areas that a buyer should focus on include the following:

1. Marketing Authorisations and Pricing & Reimbursement Approvals 

The buyer will want to ensure the existence and validity of any marketing authorisations the target has, as well as any pricing and reimbursements approvals for any existing products. Similarly, for products which have not yet been granted approval, the buyer will want to assess the likely timelines for obtaining such approvals. 

The buyer will also want to determine whether there are any factors which might suggest that approval will not be granted or may be granted subject to conditions, which in turn may make selling the products more difficult or less profitable. For example, the requirement to carry out expensive post-approval clinical studies. A competitive assessment of the market should be carried out in relation to products which have not yet been granted approval – is the product genuinely innovative, or will it join an already well serviced sector?

Notwithstanding the EU’s objective of creating a level playing field in the pricing and availability of medicines (as demonstrated by some of the proposed changes to the pharmaceutical regulatory regime), there are national variations in pricing and reimbursement policies.  In key jurisdictions a review of how these policies will affect the targets’ sales prospects should be undertaken.

The buyer will also want to check the target complies with Good Practice (GxP) guidelines, including good clinical, distribution, manufacturing, and vigilance practices.  GxP is crucial to ensure the safety, quality, and efficacy of pharmaceutical products as well as adherence to the highest ethical standards, and consequently any lapses in compliance may have significant consequences, such as the suspension of marketing authorisations, regulatory sanctions, fines or even the suspension of operations.  It’s important to check that all processes throughout the development, manufacture and distribution of any pharmaceutical products which are governed by GxP are assessed in detail.

2. Intellectual Property 

Intellectual property underpins the value of many biopharma companies and is generally the target’s most important asset. It’s critical for a buyer to conduct a detailed audit to assess the target’s technology and how that  technology is protected. This involves determining the ownership, scope, and enforceability of the target’s IP rights, which will include examining patents, trademarks, trade secrets, and proprietary technologies. 

Patents are critical, providing market exclusivity and competitive advantage, whilst not actually creating a right to sell or develop a product. “Patent thickets” (i.e. overlapping sets of patent rights) are common, and often licences from others need to be obtained from third parties.

It’s important that the buyer assesses the strength and breadth of the target's patent portfolio, including the scope of claims, remaining patent life, and geographic coverage. They should also ensure that all administrative steps have been taken and fees paid to the relevant patent offices. 

A buyer should also consider the potential for patent challenges by other companies and litigation risk, which can have a significant negative impact on the value of the intellectual property. A “freedom to operate” report is often undertaken, where patent experts assess the strength of the patents (and applications), review the competitive landscape and check that all necessary licences have been obtained or granted.

Another key area is know-how, trade secrets and confidential information, which often reside in the minds of key employees. Buyers should ensure that the target has implemented adequate measures to protect these assets, including confidentiality agreements, employee training and robust security protocols. Where appropriate, it’s important to ensure that such know-how is captured as part of the acquisition process, particularly where any key employees may be leaving the business post-acquisition. It's essential that the value of know-how, trade secrets and confidential information is protected by prohibiting the seller and its employees from using or disclosing the same post-sale.

Trade marks, whether registered or not, and associated goodwill can have a significant value so an assessment of the trademark portfolio should be undertaken to determine whether the marks have been maintained properly and whether they are subject to any threats or challenges.

Copyright, whether in manuals or labels/instructions, or in software should also be reviewed to ensure it’s protected and to determine the target’s freedom to use the copyrighted material – licences may be required.  It’s also good practice to check for the use of open source software in developing any valuable software, as such material may “contaminate” a programme so that it is all open source and not able to be protected.

3. Material Contracts 

The buyer should closely examine the target’s key commercial agreements. In life sciences companies, many of these contractual arrangements involve intellectual property rights, such as licensing, collaboration and research agreements. We consider licensing and collaboration transactions in more detail in our fourth article.

It’s important to ensure that the terms of the target’s material agreements are robust and that the target owns or has the exclusive rights to use all the intellectual property required to operate the business. Research undertaken in collaboration with third parties may impose contractual limitations on the target’s ability to exploit, license or assign intellectual property. Such limitations should be carefully considered as they may impact value or the way in which the products can be exploited in the future by the buyer. 

A common issue is where intellectual property is “jointly owned” but where the implications of joint ownership are not clearly defined. Joint ownership of intellectual property is treated differently in different jurisdictions, so a failure to clarify the rights of each owner can be catastrophic. In some jurisdictions (in the absence of express provisions to the contrary), joint owners can each do what they wish with the jointly owned intellectual property, meaning all exclusivity and control has been lost.  In other jurisdictions, such as the UK, joint owners of a patent can exercise the patent themselves but cannot license, assign or mortgage the patent, meaning further exploitation and commercialisation is not possible.

Similarly, issues regularly arise where research has been conducted by the target together with third parties. A buyer will want to ensure that the intellectual property rights have properly vested in the target. So, for example, reviewing founder contracts, especially where they consult for the target but also have other roles, for example with a university or hospital, is very important. 

If issues are identified, a range of options will need to be considered.  Sometimes deals can fall through if there are material issues, e.g. where key IP is not in fact owned or there are material restrictions on how IP can be exploited. More commonly, the terms of such agreements may need to be amended or IP assignments entered into as part of the wider deal process. 

4. Data Protection/Privacy 

Life sciences companies often process substantial amounts of personal data, related to members of the public, patients, study subjects, healthcare professionals and employees. Where this involves the processing of health data, buyers should conduct a thorough assessment of how data protection compliance has been addressed. Buyers should investigate the extent of any restrictions on the sharing of personal data as part of the purchase, and on any proposed uses of the target’s data following completion. Ensuring ongoing compliance with cross-cutting patient confidentiality obligations must also be ensured. 

Most of a life science company’s day-to-day interaction is with healthcare professionals rather than patients, so it’s important to check that the target has collected data about and interacted with this group in a compliant manner, especially as healthcare professionals are particularly known to exercise their data protection rights. 

Restrictions on the ability to carry out marketing to healthcare professionals can arise under e-privacy and data protection laws but also regulatory restrictions under the EFPIA code on promotion of medicines, and the ability to keep on contacting a company’s primary audience must be assessed. Where consent has been obtained and is the legal basis for marketing, reviewing the wording of consents and notices will be vital, especially if the acquisition is structured as an asset transfer where the buyer will not step into the shoes of the target that obtained an initial consent. 

While assessing information security compliance is often an area of overlap with the IT workstream, buyers should take particular care to assess the sufficiency of measures that have been put in place. They should also assess the extent of any security breaches to date, particularly affecting patient data, to understand any residual risks that might need to be addressed by way of warranties or indemnities. 

5. Litigation 

The buyer will also want to assess the status and risks involved with any litigation already in progress and whether there is any risk of potential litigation, especially regarding the target’s intellectual property and key contracts such as licensing and collaboration agreements. 

If there is any litigation, then a detailed assessment of the target’s position and likely outcome of success will be necessary.  

If there is no litigation, then understanding the risk and likely quantum of potential litigation will also be important. 

6. Tax 

Conducting thorough tax due diligence to identify potential tax risks and liabilities is essential. This includes reviewing the target's tax filings, assessing compliance with tax regulations, and identifying any outstanding tax disputes. 

Ensuring that potential tax risks are identified and addressed early in the transaction process is essential for mitigating future liabilities and ensuring adequate warranty and indemnity coverage is incorporated into the transaction documents. Key areas include assessing transfer pricing issues on cross-border transactions and assessing the use by the target of tax credits and other incentives available in different jurisdictions. 

Another key area is ensuring any options and growth shares have been correctly awarded while complying with the requisite rules.  Similarly, the ability of the target to claim R&D tax credits will be significant because they can trigger tax savings/losses or cash refunds. As part of due diligence, the buyer will want to satisfy itself that any tax savings/losses or cash refunds have been properly claimed and that any amounts recovered from a tax authority cannot be clawed back.

The above isn’t an exhaustive list of the areas that need to be focused on during legal due diligence. Other topics, such as any finance arrangements, employment, real estate and anti-bribery and corruption laws, also need to be carefully reviewed. 

What are the common transaction structures?

Transactions will generally be made by either a share acquisition or an asset acquisition. 

The most common and straightforward approach will be to structure the transaction as a share sale. The buyer acquires all the shares in the target company and as a result, the whole business of the target, including all assets and liabilities and all of the target’s contracts and regulatory consents.  

However, there are circumstances where an asset acquisition will be more appropriate. For example, if the target has significant liabilities which the buyer does not wish to acquire, e.g. litigation or clinical trial liabilities.  An asset acquisition may also be more appropriate where the buyer only wishes to acquire the assets relating to one or more products and no other products being developed by the target.

Why are milestone payments so common in life sciences deals and what typical milestones are used?

Most M&A deals are structured as share sale and purchases, so the acquisition involves the transfer of the shares in the target in exchange for the payment of consideration. Contractual protection relating to the transaction is then provided to the buyer by way of warranties and potentially indemnities from the seller, in respect of any specific issues identified during the due diligence process. 

Unlike other industries, it’s generally very difficult to determine with certainty the value of a biopharmaceutical company with drugs in the course of development. The seller(s) will generally value pipeline products on the assumption that they will ultimately be successfully developed, approved and commercialised. Conversely, a buyer will be mindful of further development costs and the very real risk that product candidates might not be approved or, even if they are approved, that they will not be commercially successful (perhaps because a competitor develops an even more effective product). Assumptions around outcomes in the course of a products development are very binary and have a significant impact on a target’s valuation.

As a result of this “valuation gap”, contingent consideration structures based on the satisfaction of milestones in the lifecycle of a target’s product(s) are used in the vast majority of deals. This enables the sellers to share in the upside if milestones are satisfied following completion while a buyer can reduce the upfront cost of a deal and ensure that a higher price is only paid if the milestones are subsequently achieved. 

What are examples of typical milestones used in life sciences deals?

It is common in life sciences M&A deals for a defined amount of consideration to be paid to the seller(s) upfront to reflect the value of the target and its product pipeline at such time, with additional milestone payments becoming due if, and only if, the relevant milestones are satisfied. 

Milestones which trigger these additional payments include a mix of both regulatory and commercial matters.  

Typical regulatory milestones include: 

• filing a Clinical Trial Application (CTA) in the UK/EU or a New Drug Application (NDA) in the US (or an equivalent of any of the above in another relevant jurisdiction);
• first dosing of a patient in Phase I, Phase II or Phase III clinical trials;
• receipt of regulatory approval in Europe, the US or other relevant markets; and
• receipt of pricing and reimbursement approval in Europe, the US or other relevant markets. 

Regulatory approval i.e. a marketing authorisation in the UK or EU, is often the key milestone because a product cannot normally be sold without such approval. Similarly,  pricing and reimbursement approval is another key milestone because a product may not generate substantial sales unless it has received reimbursement approval.

Commercial milestones include the commencement of commercial sales in specific markets (such as the US, EU, UK or Japan) or the achievement of a specified level of net sales (e.g. US$100 million) of a particular product in specific markets (such as the US, EU, UK or Japan).

It’s critical that milestone language is clearly defined to avoid the risk of subsequent disputes about whether a milestone has been achieved. Key terms include the following:

• what milestone events will trigger payments to the seller?
• how much will each milestone payment be? 
• where applicable, can milestones only be achieved once or multiple times (e.g., approval and/or sales for a second use of the product)?
• will the buyer be required to undertake any specific actions in order to achieve the milestones?
• will there be any restrictions on what the buyer can and cannot do?
• will there be any events which trigger accelerated payment of any or all of the milestones?

A buyer will want to take advantage of other ancillary rights that dovetail with the inclusion of milestone payments in a transaction. For example, a contractual right of set-off is often required by a buyer so that any liabilities (i.e., warranty or indemnity claims) can be set-off against any milestone payments that fall due.

What obligations will the buyer be under to achieve the milestones?

Given the potentially significant value of milestone payments, the seller(s) will want to ensure that the buyer is under an obligation to carry on the development process with a view to satisfying the milestones.  Equally, the buyer will want to ensure that any such obligations are reasonable and not onerous. They will also want the ability to make decisions as they see fit.

The most common approach is to require the buyer to use “commercially reasonable endeavours” to satisfy the milestones. This phrase has no set legal definition in English law and so it is commonplace to define the phrase in the acquisition agreement.  There are multiple variations of this phrase, but generally they require the buyer “to carry out its obligations in a diligent and sustained manner using efforts substantially similar to the efforts a biopharma company of comparable size and resources would typically devote to a product of similar market potential, profit potential, similar stage in development or commercialisation, or strategic value, and taking into account all relevant factors, such as technical, medical, efficacy, safety, manufacturing, and delivery considerations, product labelling, the patent and other proprietary position of the product, the regulatory environment and the competitiveness of the marketplace”. Alternative approaches include express buyer discretion, “good faith” efforts, and “no bad faith”. All of these formulations have potential issues to be aware off.

A seller may require the buyer to carry out specific activities to achieve the milestones. A buyer will generally resist being subject to specific requirements to avoid being stuck with commitments which may subsequently make less commercial sense if a product’s development path differs from that originally expected at the time of the deal.

Examples of specific actions include making a minimum financial investment in seeking to achieve milestones or performing certain agreed actions as part of a broader agreed development plan. In these cases, sellers will want so-called audit rights in order to monitor progress made by the buyer.  Similarly, failure to satisfy the agreed requirements may also result in sanctions, such as reversion of rights and assets, and even liquidated damages payments. As with the drafting of any milestones, these provisions require care and the approach will not eliminate the possibility of a dispute between the parties even if it does provide a contractual framework.  

What tax structuring issues need to be considered?

Tax is another key area that needs to be considered at the outset of any M&A transaction.  In particular, cross-border deals require careful planning to navigate different tax regimes and optimise the transaction structure for the respective parties. 

One of the key areas is considering the tax treatment of any milestone payments, the capital gains treatment for selling shareholder(s) and the potential for double taxation. As a result, it’s important to engage tax advisors early on in the process so a tax-efficient structure can be identified and any potential liabilities mitigated to the maximum extent possible.

For example, assessing whether the seller(s) may be able to claim capital gains relief on the disposal of the shares in the target as many jurisdictions have a capital gains participation exemption enabling the disposal of subsidiaries without triggering a tax charge provided certain criteria are satisfied.  

It’s important to ensure that any milestone payments receive a similarly favourable tax treatment. An individual seller who remains as an employee or officer of the target post-completion may be at risk of taxation on cash consideration received in satisfaction of an earn-out will be taxed as employment income. If any part of the cash consideration is, in reality, remuneration for employment, the target may be required to withhold income tax and employee social security contributions from such consideration.

When choosing between an asset purchase or a share purchase, the route that secures the most advantageous tax treatment for the parties (or the party in the strongest bargaining position) often prevails. Sellers often find share purchases more advantageous, whereas an asset purchase is favoured by buyers. This asymmetry arises as a result of the interaction between the availability of a participation exemption for the seller on a share purchase (or, in the case of individual sellers, the availability of lower rates of capital gains tax) and the buyer's ability to claim amortisation relief on the price paid for intangible fixed assets on an asset purchase.

What competition law issues need to be considered in life sciences M&A deals?

As noted in our second article, antitrust authorities in different jurisdictions, including the UK Competition and Markets Authority (“CMA”) and the European Commission, scrutinise M&A transactions to prevent anti-competitive practices. 

The buyer will need to undertake a detailed assessment of whether any merger control filings are required.  This needs an examination of the products being developed and acquired as well as the buyer’s existing product portfolio in similar therapeutic areas.  Transactions will need to be assessed both on certain turnover thresholds and the relevant definitions of the relevant products and geographic markets in which they are sold.  An assessment will need to be made of market shares, competitive dynamics, and potential barriers to entry. 

It’s important to remember that the competitive potential of the target may also be a relevant consideration for competition authorities to determine whether they have jurisdiction to review a merger. Consequently, assessing the target for both current and future (post-acquisition) factors, including its potential to innovate with regards to valuable new drugs or therapies, will be a critical consideration when deciding whether to make a merger notification. In such circumstances, the fact that the target has not reached certain turnover thresholds may not prevent scrutiny. With the introduction of the UK’s Digital Markets Competition and Consumers Act 2024, new merger thresholds are being brought into play that significantly expand the CMA’s jurisdictional remit. If only one party to a merger transaction has a share of supply of at least 33% and turnover of more than £350m in the UK, and any other enterprise concerned has a UK nexus, then the transaction falls within the CMA’s jurisdiction. This means transactions by acquirers with a large UK presence, even where there is no overlap between the acquirer and the target, will be captured. The new threshold has been introduced to deal precisely with so-called ‘killer acquisitions’ and address the issues raised above. 

Once the buyer has conducted a market analysis, it will need to assess what filings are required to obtain clearance, including any relevant FDI procedures e.g. those required by the UK’s National Security and Investment Act that need to be observed. Considering whether relevant merger thresholds have been reached can be an intensive and time-consuming process, which needs to be planned into any timetable. Advance thought should also be given to whether any potential remedies need to be proposed and the negotiation of those remedies with the relevant competition authorities.  

Typical remedies may include divesting certain assets, granting licences, or implementing behavioural remedies to preserve market competition. Developing a proactive strategy to address potential competition concerns and, where possible, engaging with regulators early in the process can help secure timely approval.

Is warranty and indemnity insurance commonly used in life sciences M&A deals?

In recent decades, there has been an increase in the use of warranty and indemnity insurance in M&A transactions. However, warranty and indemnity (“W&I”) insurance has typically been a less common feature in life sciences M&A.  

This is partly because the potential liabilities e.g.  death or serious injury resulting from clinical trials can be substantial, and insurers generally exclude or limit claims in these areas. As a result, the relative benefits of W&I insurance are seen as less advantageous than in other sectors.  Instead, companies often focus on deductibles, retentions or escrows as their primary means of recourse, as well as contractual set-off rights that allow claims to be offset against future earn-out payments.     

However, the increase in warranty and indemnity insurance in the sector may be driven by an increase in the number of non-life sciences companies entering the sector, particularly private equity and technology companies.  These players are more accustomed to using W&I insurance products on deals.  At the same time, insurers have evolved their offering by broadening the coverage they typically offer, particularly in key areas such as IP, product liability and tax. However, policy exclusions will always be a key area of negotiation when underwriting a policy and insurers will generally want to assess the due diligence carried out in a particular area before deciding.

What employment issues need to be addressed?

A key part of any acquisition involves retaining key employees. In biotech companies, this usually involves the executive team and scientists who have led the development of the business.  Their knowledge about the business and the target’s products are key to further developing the business, especially for those products still being developed.   

As a result, a buyer will want to ensure that the deal structure includes appropriate incentivisation arrangements for key employees.  In some cases, appropriate arrangements may already be in place. At other times, a buyer may want to enhance or tailor these arrangements to better reflect the position the target is in at the time of acquisition. 

Examples of typical incentives include:

• Performance related pay;
• Bonuses following satisfaction of key milestones;
• Discretionary bonuses;
• Enhanced salaries and benefits; and
• Grants of options under the buyer group option scheme.

A buyer will also want to impose restrictive covenants on the sellers post-completion as a way of protecting the value of the acquisition and avoiding the sellers subsequently setting up or participating in a competing business.  In the UK, including robust non-compete and non-solicitation restrictive covenants in the main transaction documentation can be imposed for a period up to three years. Where the relevant sellers are also employees, it is also commonplace to include restrictive covenants in their contracts of employment. However, such restrictions can only be enforceable if they go no further than is necessary to protect a business’ legitimate interests e.g. its confidential information, trade connections or the stability of its workforce, including as to their duration. Therefore, they may only be imposed for shorter periods of between three and twelve months, depending on the seniority of the employee in question. Careful legal advice is required to ensure the restrictive covenants are crafted in a manner that is likely to be enforceable. 

Care also needs to be taken when negotiating restrictive covenants with key employees who are also scientists working with universities, hospitals or charities.  Typically, scientists are specialists in a particular therapeutic field and particular attention needs to be paid to ensure that the buyer and target are sufficiently protected while enabling the relevant individuals to carry out research and other similar activities. 

Another issue that regularly arises is that a buyer may wish to rationalise the target’s operations post-acquisition, often by reducing the target’s headcount. This is especially the case where the buyer has group wide functions that can carry out key roles and where duplication in the target can be eliminated. 

In the UK, employees with more than two years’ service are protected from unfair dismissal (although at the time of writing the recently elected Labour government is considering making this protection a ‘day one’ right for all employees). In short, this means that an employer needs to have a potentially fair reason for dismissal and follow a fair procedure. In the case of eliminating duplication, the reason is typically redundancy and a redundancy consultation generally lasts 2-3 weeks, although longer periods apply in cases of collective redundancies where 20 or more employees are proposed to be dismissed. Other risks include allegations of discrimination or that the dismissal is due to whistleblowing; in both cases there is no qualifying period of service. 

In practice, it is fairly common for consultation processes to be bypassed and the legal risks to be mitigated by arranging for departing employees to enter into a settlement agreement, under which they receive an enhanced payment in return for waiving any possible claims. It’s important to ensure that any departing employees remain subject to comprehensive obligations around any confidential information they acquired and intellectual property they developed, as well as restrictive covenants as detailed above.

The timing and communications around dismissals should be carefully considered. Senior or high-profile individuals leaving the organisation, or large numbers of dismissals, can have an impact on morale and employee relations, especially where a buyer wants to make a positive impression on the acquired business. Using settlement agreements can help in ensuring that departing employees keep the circumstances confidential, and are restricted from making disparaging comments, so it’s possible to agree an announcement that communicates a positive message for both parties.

What are the key takeaways?

Acquisitions are complex transactions, especially in the life sciences sector.  They require extensive due diligence on the target, as well as careful structuring to ensure that all legal, regulatory, commercial and financial issues are correctly identified and appropriately dealt with in the main transaction documentation. Therefore, it’s important to appoint advisers who are well-versed in navigating the range of issues that can arise. 

If you would like to discuss any of the issues raised in this article, please contact James Baillieu, a corporate life sciences partner based in the London office of Bird & Bird LLP.