For Biotech VCs, Anticipation And Adjustments In The Age Of Earn-Outs

Article preview from Start-Up - March, 2012

For biotech companies and their backers, the structured acquisition -- with contingent payments that stretch well beyond the close of the sale -- is practically the only exit available and, everyone agrees, a permanent part of the landscape. While it's certainly a buyer's market, the sellers have begun to adopt strategies and rules to help boost returns. Are they working?

For Biotech VCs, Anticipation And Adjustments In The Age Of Earn-Outs

Article preview from Start-Up - March, 2012

When a venture-backed biotech company is sold these days, the list of conditions is long and a lot of the cash is contingent. In this buyer's market, biotech executives and their VC backers have adopted strategies and rules to help boost returns. Are they working?

• Up fronts plus earn-outs have become the standard components of a biotech acquisition structure, and that structure is probably here to stay. In a few deals, post-acquisition payments are starting to trickle in, but it's still too early to say for sure how many in the past five years have come to fruition.
• Clever deal terms and sophisticated math are nice, but biotech executives would do well to choose the best buyer based on trust that it will carry the project forward as diligently as possible, say those who have sold companies, which can make selling a biotech these days a lot like choosing an alliance partner.
• Watchdogs and lawyers say the age of earn-outs is ripe for litigation and other post-acquisition disputes as penny-pinching pharmas and the representatives of disbanded biotechs haggle over milestones.

Drip, drip, drip. That's the sound of biotech VCs getting paid when their portfolio companies are acquired. Instead of cashing out in one lump sum, they usually have to take a slice up front – and how much can vary wildly – then wait patiently while the buyer advances the program in question and hits the milestones that trigger a payout. Biotech VCs are adjusting to the new reality of exit-by-earn-out in many ways.

"The vast majority of our portfolio companies will exit through structured M&A," says Abingworth Partner Jonathan MacQuitty, whose firm has had a stake in at least five biopharma companies sold in structured transactions since 2006, most recently Avila Therapeutics Inc. [See Deal] "We think about this relentlessly," he says.

The trend started in earnest in the middle of the previous decade. Big drug companies and other acquisitive shoppers wanted sellers to share the risk inherent in the drug development process, and as the public market appetite for new biotech issues shrank, the shoppers had the leverage to negotiate deals that paid part or most of the cash after the acquisition. And why not? The odds of success for any given biotech asset are not good, so risk-sharing has become, at times, the only way to get a deal done – which arguably is best for all sides.

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