The International Who’s Who of Life Sciences Lawyers brings together three of the leading practitioners in the world to discuss key issues facing lawyers today.
Saul Ewing LLP
Who’s Who Legal: The global financial crisis and the long time it takes investors to see a return on investments in many life sciences sectors, such as pharmaceuticals and biotechs, have led many transactional lawyers to describe the market as “tough” or “slow” over the past 18 months. Is this the case in your jurisdiction? Do clients and lawyers have to be much more creative given the current climate and what are the results of this?
Cheryl Reicin: Definitely. I work in both the US and Canada. In the US, the biotech indices are up but it is based on the results of a few of the more well-established companies. Most early stage companies, which are not included in the indices, are struggling and many of the venture capitals (VCs) are unable to raise new funds. In Canada, the situation is even worse than in the US. Canadian investors are entitled to large tax incentives for investing in the resource industry, so investors who like the high-risk, high return stocks, tend to prefer to invest in that sector. Moreover, there are only a handful of Canadian health-care venture capital funds, so most of my Canadian clients are receiving money from angels (there are robust angel networks in Canada) and US VCs.
Mark Gruhin: The DC metro area life science industry is alive and well, notwithstanding rumours to the contrary. Yes, there have been consolidations occurring and fund raising efforts continue, but these corporate activities occurred prior to the global financial crisis and will continue long after it. Valuations may be lower and raising capital may take longer, but these efforts continue and my practice thrives through it all. So long as there is a disease to cure or a need to improve the health of our population, young entrepreneurial companies will keep thriving and more mature companies will morph into larger ones. There is a strong infrastructure here, beginning with the NIH, the multiple university complexes which support the life science industry, the incubators and the government agencies providing capital and streamlining regulations. There are also experienced professional like myself willing and able to support the life science industry. Clients always need to be creative to be successful but they also have to be smarter and more efficient because of the expenses involved to bring products to market.
Yuval Horn: Yes. The Israeli funding market has been slower over the past 12 months. We have been witnessing a decline in trade and pricings in the Tel Aviv Stock Exchange and in the pace of funding by Israeli venture capital funds. The need for more creative funding requires not only stamina from the companies, but also more creative drafting and modelling of funding structures. Recent examples of various such models that our firm was involved with include:
the purchase of controlling interest by a strategic partner, over negotiated milestones and in consideration for predetermined amounts;
options to license non-core intellectual property; funding at distressed terms in lieu of straightforward equity issuance (convertible loan bearing substantial discount and conversion rates; high multiple liquidation preferences);
the purchase of controlling interests of public companies at favourable terms; and
“down rounds” in private companies with carve out mechanisms to protect management.
Who’s Who Legal: Lawyers have particularly noted a decline in venture capital and IPO financing for emerging companies resulting in them looking for alternative methods of financing. What methods of financing are available to small and/or emerging companies in your jurisdiction? How have these changed over the past few years? How has this impacted on the type of work you are seeing?
Cheryl Reicin: We are seeing more investment by large pharma in the form of licensing deals and strategic partnerships and acquisitions, as well as more angel investment, venture debt and royalty monetisation deals. In Canada, there are a number of very rich government incentive programmes for conducting research and development, which are also available to non-Canadian entities under certain circumstances. If structured correctly, these programmes can return up to 70 per cent in refundable tax credits for any R&D work done in Canada and serve as a great source of non-dilutive financing.
I have also focused efforts on devising other alternative financing structures, including tax incentivised structures for US and foreign companies that have been successful in helping companies attract investment. I think it’s during the tough times like these that give lawyers the opportunity to earn their stripes by proactively bringing new ideas to their clients, rather than just trying to implement deals that many other lawyers could do.
The US Jumpstart Our Business Startups (JOBS) Act, which was passed in 2012, was intended to facilitate financings for smaller companies, but the impact on life science companies is still at the margins. The part of the JOBS Act most helpful to life science companies is the ability of issuers to “test the waters” and generally meet with institutional investors during the public offering process to “determine interest,” thus allowing for real-time feedback and less guessing as to the viability and success of a proposed deal. In addition, the JOBS Act allows those filing for an IPO to do so on a confidential basis (in the past this was only permitted by non-US companies that were public on a non-US exchange). This permits US and non-US companies to get through the SEC process, resolve complicated disclosure issues and wait until the market timing is ripe before an issuer is required to disclose and create market expectations. Lastly, the SEC is in the process of setting forth rules for crowdfunding for US companies for up to $1 million. Canada tends to follow US trends and Canadian regulators are proposing “testing the waters” with a more limited group of institutional investors and in connection with an IPO only. Also, the Ontario Securities Commission is currently consulting with market leaders on crowdfunding.
Mark Gruhin: While there has been a shrinkage in life science venture funds investing in life science companies in our region, we are extremely lucky to have strong, healthy and experienced venture funds which invest in life sciences companies in the DC metro area like NEA and HIG Ventures. Also, yes the IPO market has been soft during the economic crisis for all industries including life science companies but it is also not impossible to find public financing. One of our young life science companies was able to successfully conclude an IPO and a follow up public financing as well as a venture debt deal all in the span of approximately one year.
Yuval Horn: In addition to the various financing structures that have been referred to in my response to the first question, Israeli small and emerging companies have the benefit of an impressive variety of government support and funding, besides venture capital funds and angle investors. Two significant examples include:
An ongoing technological incubator programme led by the Office of the Chief Scientist in the Israeli Ministry of Industry Trade and Labour (OCS) provides companies with funding in the amount of $600,000 for a two-year term and against additional funding of $150,000 or so. The OCS also supports research and development activities of larger companies, in amounts that vary according to the size of the programme, and in consideration for the payment of single digit royalties.
The OCS has recently announced a competitive process for selecting a concessionaire that will establish and operate a new biotechnology incubator. The contemplated funding of companies which will be supported by the new incubator will be approximately $1.5 million per company for a two year period.
Biotech companies whose securities are traded on the Tel Aviv Stock Exchange are having a more difficult time in raising funds. Two to three years ago, many biomed companies raised funds in the public market. This appetite has now diminished and has led companies to either seek additional non-dilutive funding from the OCS, or enter into PIPE transactions. In several cases, investors took advantage of the current prices and purchased control of the company.
Who’s Who Legal: According to our sources there has been a rise in restructuring work as companies seek greater efficiency. Does this type of work now make up a significant part of your practice? Is this trend here to stay?
Cheryl Reicin: Many of the companies need to rearrange their finances, but the biotech industry is not really fertile ground for restructuring per se. Until a life science company has substantial revenue, most of its value is in its IP and other intangible assets and therefore it is difficult to obtain debt financing. Since credit is generally the impetus for restructuring and because intangible assets are difficult to monetise, life science companies are more often liquidated rather than restructured.
Mark Gruhin: While my firm has a significant bankruptcy and restructuring department which has been extremely active during the economic downturn, this type of work does not make up a significant part of my practice. I have had to renegotiate a few bank loans and other debt structures but for me these kind of deals are the exception rather than the rule. As the economy improves so will the capital markets.
Yuval Horn: This work did take place during 2012 as efficiency was highly regarded. We assume the same to continue in 2013. Our firm advised with respect to a restructuring which included a consolidation of classes of shares of a company and significant waivers of liquidation preferences; a merger of parent company and its subsidiary in order to save costs of operation of the two companies; a merger of an Israeli private company with a US publicly traded company, both of which are from the life sciences field.
Who’s Who Legal: What impact has the “patent cliff” had on the life sciences transactional market? Are clients looking for strategic mergers or acquisitions that could boast their revenues and consolidate costs and expenses?
Cheryl Reicin: This is huge. All of our pharm clients are looking for additional revenues and good products. In the last five years, we have been actively getting calls from pharmas looking even for non-innovative drugs that will boost top line revenues. The pressure to compensate for the lost revenues arising from the patent cliffs is tremendous.
Mark Gruhin: The “patent cliff” is definitely having an impact on the life sciences transactional market. The “patent cliff” is encouraging big pharma and others to “think out of the box” to buy biotech companies to facilitate quick and efficient ways to develop products while helping mitigate risk and expense. There is great value in buying a young biotech company with a phase two trial compound with promising results than simply increasing internal budgets of research and development departments. These departments are often less nimble or financially efficient than a biotech start up.
Yuval Horn: The Israeli market is relatively young, and has not yet been affected by its patent cliff, but rather by the patent cliff of the strategic players who are seeking for new pipelines. Several companies and universities have benefited from licensing transactions which allow the companies to purchase technologies which have already reached a more mature stage of development. Public companies have sought both internal consolidation, which would decrease costs, but also the purchase of companies who own technologies which either complement or hedge their current business.
Who’s Who Legal: Several lawyers have commented on the increasingly important role biotech companies are playing in the life sciences M&A market, with more pharmaceutical companies trying to buy into the biologics sphere over the past year or so. Have you seen this trend? What impact is it having on the market?
Cheryl Reicin: This goes hand in hand with the patent cliffs. We are seeing some large deals between very early-stage companies and big pharma. Big pharmas historically had a bias for their internally developed drugs – this bias has largely disappeared. The increased appetite by big pharma for new products coinciding with less available capital for life science companies to grow internally has resulted in motivated buyers and sellers, creating a ripe environment for M&A deals. However, the M&A deals happening at the early stage generally look a lot like licensing deals in that much of the consideration will come in the form of an earnout on the backend that is substantively very similar to a royalty. Acquisitions of companies that are public, however, are generally full cash or stock-for-stock deals.
Mark Gruhin: I am seeing the trend of large pharma companies buying up well known successful biotech startups in our market. Examples include MedImmune, purchased by AstraZeneca, and Human Genome Sciences, purchased by GlaxoSmithKlein. Whether or not this trend will have a negative effect on new entrepreneurs sprouting out from these companies to start and grow new biotech companies is as yet unclear. In the past, many scientists would join the cutting-edge work of companies like HGS and MedImmune, stay a few years and leave to grow new businesses. This, of course was healthy to the biotech market as a whole. I have a “wait and see” view to determine whether these trends will continue. At the moment, it is hard to tell given that the capital markets remain soft as well.
Yuval Horn: Israeli biotech companies and technologies, which are relatively young, have been a target for well-established international pharmaceutical companies with substantial R&D budgets. Our firm has assisted companies that have sought to merge with publicly traded companies in order to facilitate funding opportunities in the public market. In addition, we have advised public companies and investors with respect to their interest to increase the IP portfolio of the public companies by way of transactions with academic institutions, licenses from companies and purchase of companies and technologies.
Who’s Who Legal: What do you foresee for the year ahead in the life sciences transactional market?
Cheryl Reicin: The fourth quarter of 2012 was very active in the US. There is still tremendous pent-up demand from companies that have been waiting to go to the markets for the past two or more years and we expect to see many deals in the first half of 2013. The deal prices and terms however will tend to be conservative and many deals will not get done on the terms desired or at all. Investors will buy but they are much more selective than when the markets were stronger. I consider this a necessary levelling of the market. In the past, we had too many “ideas” that were sold at high valuations and actual results didn’t match expectations.
Mark Gruhin: I have been working with life science companies for the last 20-plus years and have seen significant growth in this industry in our Metropolitan area during that time. I have no reason to believe that said growth will not continue in the future, notwithstanding the ups and downs and the economic cycles the industry faces. As said earlier, the DC metro area has all the important and necessary infrastructure components to make the life science industry prosper going forward. As the economy grows, so too will our life science industry.
Yuval Horn: We hope that the biotechnology incubator referred to earlier will be established after the concessionaire will be selected based on the terms of the OCS tender. We expect that the two Israeli leading life sciences venture capital funds will continue to invest in Israeli companies. Also, several existing technological incubators are expected to change ownership or to cease their operations during 2013, an event which may bring about a consolidation of technologies and more opportunities for such consolidated companies.
In addition, the Israeli parliament (the Knesset) approved the Medical Equipment Law, which sets the legal framework for regulation of the medical equipment field in Israel, a field which is now only partially regulated. The provisions of such law are expected to enter into effect following the promulgation of certain regulations to be set by Israeli Minister of Health.
We foresee that the trends that have affected our market in 2012 will continue to affect it in 2013. The year, which begins with elections and change of government, is expected to be a year of budget cuts. We hope that the research and development budgets will remain intact, if not grow, due to the proven correlation between such funding and the prospering of a well educated work force developing new ideas into medical treatments and devices.