The cornerstone to a successful negotiation is strong internal alignment on the objectives and structure for a deal. More often than not, companies will enter into a negotiation process in a reactionary position and gloss over, or skip entirely, the internal discussion around what they are seeking in a deal. While it is easy to get carried away and jump into negotiations or a formal transaction process once a term sheet has been received, it is critical to start the process with a clear set of strategic objectives. As discussions with parties begin to materialize and the likelihood of a transaction appears high, we encourage clients to have an engaging discussion with their investors and Board of Directors about the objectives of a deal. Key elements of these discussions typically include:
• Deal structure (stock purchase agreement, asset purchase agreement, license, etc.)
• Geography (worldwide vs. regional deal)
• Retained rights (co-promotion, co-development, manufacturing)
• Economic preferences (near-term vs. back-end economics)
• Upfront consideration expectations
Management teams can mistakenly assume that their investors and Board’s perspectives align with their own and fail to appropriately discuss the options available. Here are some illustrative examples of deal situations that we have seen at Locust Walk:
Case example 1:
Company has a promising lead asset in Phase 2 and a number of preclinical assets leveraging their technology platform.
Management: interested in licensing rights to their lead asset to provide non-dilutive capital to support development of preclinical assets.
Board/investors: interested in selling the company as a whole and maximizing near-term gains given that early assets have not been appropriately proven out to merit further investment.
Case example 2:
Company has a promising lead asset in Phase 2 and limited development prospects.
Management: seeking a global partner to take over development and move program forward to eventually commercialize.
Board/investors: seeking to retain partial ownerships in the U.S. as part of a co-promotion structure that provides validation of the compound and downstream value that can be leveraged for a public offering (IPO).
Not only can management and the investor/board’s perspective be misaligned, but investors within the syndicate often have differing perspectives as well:
Investor 1: investment in company was early in the fund’s lifecycle and is seeking to maximize total return; fund is supported by LP’s with a ‘long’ perspective; seeking to maximize return over the life of the drug, especially upon commercial success
Investor 2: investment in company was late in the fund’s lifecycle and is seeking to maximize near-term value with large upfront and development milestones in exchange for lower downstream (post-approval) consideration
Having an in-depth discussion is the only way to surface internal misalignment of deal objectives. However, how do you manage a misalignment in the circumstance one exists?
Typically, misalignment between management and investors is easier, although more painful, to get around. Inherent to nearly all management-investor conflicts is a misaligned interest of the longevity of the company. More often than not, investors are looking to close out their investment and get a near term return while management is drawn to the long-term value prospects of either their primary asset or other pipeline assets. The following should be carefully considered and evaluated when considering whether to construct a deal for long-term vs. near-term company value:
Co-promotion/co-development:
• Does the company have the know-how to continue developing and or eventually commercializing the drug?
• Does the company have sufficient capital and resources to fund development and or commercial activity?
• Is there potential value that can be extracted (e.g., IPO, future transactions) from the retained co-promotion or co-development rights?
Regional deal:
• Does consideration from a regional deal provide sufficient non-dilutive capital to move the program forward in core geographies?
• Is there investor support to make up any funding gap not covered by a regional deal?
• Is the region in question a key component of a future global partner’s focus (i.e., will this prevent a deal with that global partner down the road)?
• Is a regional deal necessary given interest from global partners?
Additional opportunities:
• What is the value of additional pipeline opportunities?
• Would such opportunities merit investment on a standalone basis?
• Do current investors support such opportunities?
• What is the resource requirement and cost of materializing such opportunities to an eventual exit?
Conflicting objectives among investors can be more difficult to manage and can jeopardize the success of a transaction. While investors often prefer near-term return on their investments, it is not uncommon for a long-term position to be taken where an investor, such as a family office, seeks to maximize return over a longer horizon. One way to avoid this from the outset is to consider investment objectives carefully when building your investor syndicate. Given that this may not always be an option, how you position a deal to investors can greatly alter their perception of a deal.
Some important considerations when positioning a deal to investors include:
• What is the stake each investor has in the returns?
• What is the timing of various investments by each investors?
• What is the expected IRR for each investor given timing?
• What are the minimum near-term and long-term return objectives for each investor?
While we typically view the weighting of a deal to be a see-saw, i.e., near-term vs. back-ended, creative deal structuring can often be used to accommodate differing investor perspectives. For instance, sacrificing some development milestones to increase upfront payment helps short-term focused investors maximize early returns and may retain ability to structure robust commercial milestones or royalties after approval to appeal to long-term investors. Ultimately, understanding investor’s preferences will guide payment structures and can be used to accommodate differing preferences.
Creating internal consensus around deal structure ultimately puts a selling company in a position to provide guidance to a potential partner or acquirer. Deal guidance is an important step that can loosely set expectations so initial offers are closer to investor and board expectations and the gap to a successfully negotiated agreement is decreased. That said, a company should be cautious when communicating deal preferences so as to not negotiate against itself; we typically like to communicate structural preferences and high-level expectations with regard to near-term or long-term economic preferences.
Not only does internal consensus allow a company to provide key guidance to potential partners, but it also mitigates the risk of a deal falling apart due to internal rejection. A prime example of this, which we recently covered in a blog post, was a lawsuit filed by venBio (a beneficial owner of Immunomedics) against a structured deal between Immunomedics and Seattle Genetics on the basis that it provided little value to Immunomedics shareholders. This suit ultimately resulted in an injunction which blocked the deal.
Locust Walk works closely with sell-side clients to carefully consider deal structures that address management and investor preferences and maximize value. If interested in learning more about various deal structures and how to creatively position a deal to successfully close, please contact Chris Baird, Associate at baird@locustwalk.com
Written by Chris Baird