Issues of fraud have always been part of mergers and acquisitions. It was largely because of such issues that the concept of due diligence came into being. However, such issues have a renewed importance in today’s global economy, where deals are increasingly conducted across borders and cultures. This is especially true in the life sciences industry where, thanks to the time and expense involved in developing drugs and devices, more and more growth is accomplished through acquisitions rather than devoting resources to pipeline development.
While due diligence is usually approached from the transactional side, it can be very useful to involve someone with litigation experience in the process—someone who has seen how deals can go wrong and can identify red flags from a risk-management perspective.
As we all know, the life sciences industry has seen remarkable growth in M&A activity over the past several years, especially internationally. Even last year, when activity slowed from the blockbuster prior year, international M&A grew in certain sectors. With Big Pharma, Big Biotech, and medical device companies eager to obtain products or intellectual property to fill or even create pipelines quickly, acquisition is a preferred model over the much longer process of organic growth. Much of what is available to be acquired is found internationally and in emerging markets, particularly in Asia. In fact, several economic surveys claim that deal activity in 2013 is projected to grow significantly in China, Vietnam, South Korea, and Thailand.
But with increased activity comes increased risk.
For the acquiring company, it is obviously fundamental that the entity being purchased is what it is represented to be; that is, the target has the assets, products, and/or proprietary technology that the acquirer intends to buy.
It sounds simple enough to make sure that what one is buying is as represented, but undercapitalization, transferred assets, misrepresented or overvalued assets, and the ownership and true value of IP are significant concerns for acquirers with respect to life sciences deals generally, and with international deals in particular. Indeed, depending upon where the target and its asserted assets are located, it can be very difficult to get accurate information about the true state of assets or ownership.
In our experience, because of the way that business is done in some countries and the lack of readily available means to confirm the accuracy of information, there have been a number of instances where companies have “purchased” assets or rights that did not actually belong to the seller at the time the deal was finalized, were not of the character that they were purported to be, or were subject to a lien or claim by another entity or government authority.
Beyond the usual accounting issues, some other red flags are entities owned by individuals or families, entities that are part of a web of companies (many of which turn out to be shell corporations or other vehicles to shield assets or liabilities), or entities that are simply located in unsophisticated markets—not necessarily high-risk or politically unstable countries, just those in which deal-making is relatively new and participants are not attuned to the expectations of an experienced purchaser.
Does this mean that deals in emerging countries should be avoided at all costs? That you should pass on a promising drug company owned by an individual? Of course not. But it does pay to be especially careful with these kinds of transactions. We have seen companies end up with nothing but large legal bills after learning that what they thought they had purchased did not actually belong to the entity they now owned or that what they bought did not really ever exist.
We would recommend that any acquirer, but especially those that are interested in doing international deals in the life sciences industry, involve consultants with both transactional and litigation/dispute resolution experience at the beginning of the deal-making process to make sure that any potential red flags are identified, and that financials, product inventory, and intellectual property are fully vetted and confirmed.
If any potential issues cannot be completely eliminated and the desire is for the deal to go through any way, contract language should be implemented to provide maximum protection, including a dispute-resolution clause and a prevailing party provision. Acquirers might also look into risk-mitigation vehicles, such as specialty insurance, to provide protection against unfulfilled promises.
On the other side, the acquiree must eliminate any of these red flags it can in order to make the purchaser comfortable that it is an attractive candidate for a deal. Knowing what purchasers are looking for and what the candidate can do to not only make the transaction run more smoothly, but to position itself to be a deal candidate in the first place, can be very valuable.
Using universally accepted accounting practices and obtaining intellectual property protections in major markets are good first steps toward creating credentials as a good target—using sophisticated deal terms and reputable counsel will help the deal process go as smoothly and quickly as possible. Here, too, it can help to have counsel from litigators or dispute resolution experts, as it is as valuable to know what a red flag is from the acquiree’s side as it is from the acquirers’.
Being able to identify and complete productive mergers and acquisitions anywhere in the world will be crucial to the life sciences industry in 2013 and beyond. Fraud will always be a problem to watch out for and, for the unwary or the unprepared, a source of potential ruin. Involving skilled and experienced transactional and litigation counsel at the inception of any deal activity will provide a significant advantage to both acquirers that want to end up with what they are expecting and targets that want to be acquired. While it can be painful to walk away from a deal, that is often the best result if there are serious questions about the target. However, if the deal can be accomplished, and both sides get exactly what they are expecting, then the sky is the limit for international life sciences M&A.