Key Decisions for Life Science Companies: Stay the Course or Exit via M&A?

By Andrew Levitch, Mark Murray, Patrick Nugent, Linda Rubinstein

This article is the fourth in a 4-part series reviewing financing solutions for the Life Science sector.

Many life science companies are fortunate to reach a critical inflection point where leadership must face a decision: continue to fund growth to reach clinical milestones independently or exit via merger and acquisition.

This article explores the complexities of this decision through personal CFO experience and best practices.

Valuation and Pricing are a Key Question

Stay the course or exit via M&A? Either way, valuation is a key component of the decision. What is your company worth?

Staying the course means the company will continue to operate independently. This decision may make sense if the company has strong growth potential or other prospects and can marshall the resources and execute to achieve its goals independently.

Exiting via M&A involves merging with or being acquired by another company. In this article, we mainly contemplate the sale of a smaller, earlier-stage life science company to a larger, more mature enterprise.

FLG Partner and life science CFO Linda Rubinstein summarizes the issue with this question: Does the anticipated higher pay-off down the road more than offset the additional dilution and risk from continuing to run the company, compared to the pay-off from selling now or at any given time?

At the decision’s most basic level, a life science company may elect to exit via M&A if the value on offer is greater than the company can achieve on its own. Beyond comparing the valuation currently on offer in a potential sale versus the risk-adjusted potential valuation down the road, additional considerations may include whether the company can create more value by combining with a complementary partner or by availing itself of a larger company’s resources, expertise, and market access.

Should I Stay or Should I Go – Now?

Most life science companies will exit at some point. And most will evaluate whether to exit or continue independently at multiple points in their trajectory. The calculus may be different at different times. For example, as valuation increases with a product approval and a major derisking event, the trade-offs will change. Similarly, as a company progresses or has setbacks, the opportunities from joining forces with another organization that isn’t available to it independently will change.

How do you decide at any given point in time? Evaluate the execution and other risks. Identify the projected valuation increase from remaining independent against the valuation achievable in an earlier exit via M&A that eliminates those risks.

Common execution risks include:

• Building a commercial sales-marketing-distribution team and operations
• Obtaining full reimbursement from payers
• Successfully landing practice guideline inclusion
• Navigating competitive threats
• Developing a realistic model of potential market penetration and executing to achieve target revenues

Staying independent may require raising additional funds, which can dilute investors. Or it may involve licensing to a development or commercial partner, which can dilute the value of assets. Assess the company’s potential valuation, risk, and return to stockholders in each scenario. FLG Partner and life science CFO Andrew Levitch noted that “A bird in the hand could be worth two in the bush.”

Some structures, such as contingent value rights, are used to bridge valuation gaps and buyers’ and sellers’ different perceptions of risk. These rights allow a selling company’s stockholders to continue to hold upside and, therefore, retain some risk related to the outcomes in question.

A common aphorism in life sciences is that companies are bought, not sold. This means that companies whose strategy, team, and execution propel them to succeed independently are attractive acquisition targets.

The Decision to Fundraise or to Sell 

Key Inflection Points for Biotech Companies

Major derisking events are important milestones for biotech companies, such as achieving clinical proof-of-concept, completing registrational clinical trials to generate Phase 3 data, submitting an NDA or BLA, and launching a commercial product. Potential buyers may prefer to wait and pay more for a de-risked asset.

Biotechs might consider partnering with or selling to a larger company for help with development or commercialization. For example, a drug targeting a small market may be manageable for a smaller biotech company, while a drug targeting a larger market may require a major commercial presence.

The same considerations apply in reverse. A larger acquiring company will consider cash outlay, earnings impact, and probability for success, as well as the nature of the business opportunity, such as pricing, potential margins, competitive profile, and patent or regulatory exclusivity.

Key Inflection Points for MedTech Companies

FLG Partner and MedTech CFO Patrick Nugent has reviewed M&A Transactions for MedTech companies over the past decade and has found distinct trends. The data compared M&A transactions for MedTech companies at different stages of development, such as post-clinical trials and post-FDA approval. It also looked at companies with different revenue levels, such as less than $5 million, $5 million to $25 million, and over $25 million.

Key Findings: Surprisingly, for the 10 years of historical data reviewed, there was no incremental M&A value for companies in the middle range of $5 million to $25 million in revenue over the value achieved before revenue reached $5 million.

This data suggests two inflection points for M&A decisions at MedTechs. The first is to sell upon FDA approval or shortly after launch before top-line revenues have had a chance to grow (up to $5M in revenue). The second is to exit after investing to grow top-line revenues to $25M or beyond. Of course, these don’t hold true in all cases, but they provide a helpful rule of thumb.

Tactical Advice on Life Science M&A

FLG Partner and Life Science CFO Mark Murray suggests focusing on these three key items:

• Investors: What do they want?
  Investors are important when a company is considering merging with or acquiring another company. Understanding what they want and how much money they will invest is crucial.
  
  
• Management: What do they want?
  It’s also important to consider what the company’s management wants. Are there any big changes in leadership coming up? Can they effectively execute the business strategy with their current capital and competitive environment?
  
  
• Competition: Potential acquirers?
  It’s essential to consider whether the competition would be interested in buying the company. What are competitors’ strengths and weaknesses? What if your company loses out to a competitor?

After understanding the investors, management, and competition, it’s helpful to compare what would happen if the company sold today versus not selling. This analysis can show how much more money would be needed and how much the company would need to grow in value to break even.

For example, investors might make $100 million if they sell the company today. But if they wait for a future sale and have a 30% dilution from fundraising, they might need a 30% increase in value just to make the same amount of money – and this is before factoring in the time value of money.  Is it worth the risk and investment?

The Right Timing is Essential

Finally, Life Science companies considering potential M&A opportunities will be engaged with different medical technologies, addressable market sizes and composition, and commercial risks. The right decision for a company also depends on the universe of potential acquirers and their actual interest and business needs at a given time.

For example, an acquisition may need to be accretive to the bottom line of the acquiring company within a certain time horizon. Less tangibly, it may be easier to extract a high value based on expectations whereas a commercial-stage enterprise may be valued within narrow conventional metrics, such as a multiple of revenues, bookings, or EBITDA.

Additional Considerations

Federal Trade Commission considerations have become more important in recent years. Anti-trust should be considered in both M&A transactions and potential partnering/licensing transactions.

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For additional FLG Partner commentary about trends in financing for Life Sciences companies, please watch our recent roundtable, Creative Solutions in Life Science Company Financing.

Part I. Trends in Financing in Life Sciences: 2024 Updates

Part II. How to Successfully Extend Cash Runways to Growth in Early Commercial Stage Life Science Companies

Part III. Creative Financing Approaches in Life Science