Reed Smith’s Iqbal Hussain looks at the challenges and key considerations that need to be navigated during medical device M&A deals in Europe
Deal making in the medical devices sector involves a number of challenges and key considerations that dealmakers need to navigate carefully in order to achieve success. If not entirely unique, such challenges and key considerations are more pronounced in medical device transactions than in transacting in other industries, so an examination of these factors may prove useful for dealmakers across the life sciences sector.
Preliminary buyer considerations
At the outset, it is critical to ensure that the buyer has a robust understanding of the relevant market and the technology and be confident there is a clear business case for doing the deal.
Some of the key factors buyers need to focus on include developing an in-depth understanding of the device (including intellectual property, regulatory pathway and route to market), understanding how it fits within the buyer’s business and whether an existing platform/ sale force can be leveraged, and what, if any, further investment (including in complementary technologies) will be required to develop and commercialise the technology.
Having considered these business considerations, in the event a decision is made to proceed, there are a number of diligence, transactional and transition key considerations and challenges to consider.
Broadly, these can be divided into: defining the scope of the transaction; aligning on the optimal deal structure; agreeing a valuation/ deal financials; due diligence; deal terms, regulatory challenges and post-closing business integration.
Scope of transaction
The scope of the transaction can be very complex, particularly in carve-out situations, even if the relevant assets have been managed as a self-standing cost-centre/ business, as often there are significant amounts of shared services.
One of the most complex scenarios is a business carve-out comprising multiple product lines, often each with multiple stock-keeping units (SKUs). Identifying every relevant SKU and all associated tools, records, contracts (supply, manufacturing, commercialisation and regulatory) and intellectual property is often a labour-intensive and time-consuming exercise for both the seller and also the buyer in its verification of assets.
It is advisable for this process to be undertaken very early on in the planning stages of a carve-out and a robust wrong pockets clause with a reasonable timeline to rectify errors is agreed.
The buyer has to be confident that all other assets that the buyer anticipates to be in the scope of the transaction are in fact in scope.
Key assets in medical devices include intellectual property, regulatory authorisations and licenses, commercial contracts and employees critical to the successful development of acquired development-stage technologies, and sales employees critical to operate the commercial activities of the acquired business immediately post-closing.
Equally, there may be assets and liabilities the buyer wishes to leave behind with the seller and it will be critically important to identify such assets and liabilities.
Aligning on optimal deal structure
There are several factors critical to determining the optimal deal structure, including tax; the stage of assets/ technology and the regulatory pathway; conditionality and timing; and the level of liability exposure the buyer is willing to accept.
When it comes to the stage of assets and the regulatory pathway, for instance, for products in R&D, it may be appropriate to consider a structure involving R&D and sales-based milestone payments and for newly launched products, a sales-based earn-out, as a way to bridge valuation gaps.
Some of the other factors to consider when structuring transactions include conditionality and timing, regulatory approvals and transition (including transition of marketing authorisations), works council processes and, increasingly in many European countries, navigating foreign investment restrictions.
Lastly, the level of liability exposure the buyer is willing to accept will depend on the scale of acquisition.
On a full company acquisition, generally, all historical liabilities will transition; however, on an asset deal, there is scope for the buyer to determine liabilities it is prepared to assume and those that are to remain with the seller.
In an industry in which product liability claims can escalate quickly into millions and even billions of dollars of exposure, this is a critical consideration.
Due diligence is a key part of every deal process. With respect to medical device transactions, some of the key areas of focus are regulatory, compliance, investigations, litigation (including claims history), intellectual property and commercial contracts. The buyer is advised to consider carefully the right scope of due diligence.
Understanding the target business/ technology and exposures are critical. The Covid-19 pandemic has resulted in the key focus of due diligence being placed on a number of areas including business performance, financial forecasts, force majeure clauses, employment relations and governmental funding.
Medical device deals often involve products at various stages of development and commercialisation. This directly impacts the structuring of deal financials with consideration often being linked to the achievement of pre-agreed development and sales milestones.
As discussed above, structuring deals in this way can be a pragmatic way to bridge valuation gaps between buyer and seller. In addition, when consideration is linked to future success, it is typical for the seller to expect some level of efforts on the part of the buyer to ensure the relevant milestones are achieved. This point is often heavily negotiated.
With respect to patented and novel technology, a key concern of the buyer should be to ensure the intellectual property has been appropriately protected and sits in the right entity, all relevant formalities have been completed and the intellectual property will transition.
In a number of European jurisdictions, for instance, Germany, inventorship laws mandate certain inventor compensation, and in some jurisdictions, inventions reside in the inventor and not the employer without additional actions being undertaken.
Due diligence exercise should reveal any gaps and it is then for the buyer to negotiate appropriate actions which may have an impact on deal timing.
There are many other deal terms that need careful attention and have specific significance/ flavour in the context of a medical device deal including regulatory approvals, employee retention and incentivisation, conditionality, representations and warranties, interim covenants and so on.
For commercialised medical devices, transition can often be a long, time consuming and resource-intensive process as compared to the transition periods typically seen in less regulated industries.
This is generally driven by regulatory transition timelines, including the transition of marketing authorisations and product-related licenses such as CE marks, along with the practicalities of transitioning manufacturing (if applicable to the deal) and sales/ distribution channels.
The negotiation of transitional arrangements is often a lengthy and detailed process and will often require parties to not only agree a transitional services agreement but also transitional supply, manufacturing, distribution, quality and regulatory agreements.
Preparing for post-acquisition integration, harmonisation, and remediation
Another key challenge that will have a material bearing on whether a buyer can make a success of an acquisition is integration. Often integration planning is left late, which can add further disruption to the business and negatively impact transitioning employee morale and experience. A key factor in successful transition is robust and early planning, effective workforce communication and efficient implementation of an integration plan.
Some other areas buyers are advised to consider early are any remediation actions; harmonisation of internal standards and policies; and additional compliance audits that could not be carried out in the context of an M&A transaction.
In short, there are certainly many challenges and key considerations for potential medical devices M&A. While this article has attempted to address only at a very high level some of the factors critical to implementing a successful deal, life sciences companies should consider whether their planning addresses these make-or-break crux points.