Catalyst - Winter 2011 - Legally Speaking, M&A Due Diligence is Worth its Weight in Gold

While “Location, Location, Location” are three of the most important things in real estate, “cooperation, fairness and credibility” may be three of the most important aspects to consider in any merger or acquisition negotiation.

When it comes to the legal side of mergers and acquisitions, experts say that buyers and sellers each have their own “needs and wants.” But, transactions that are reasonable, fairly valued and well-researched are the most likely to make both sides feel like they’ve gotten a good deal.

It’s no secret that the M&A market, especially in the life sciences sector, hasn’t been robust – to say the least -- for a while. However, a company that has invested in a venture – but can’t afford to continue the costly process of getting a drug or medical device to market -- will likely look to selling IP and product rights instead of going out of business.

And that’s the upside for sellers. After years of nurturing your “baby,” you still may be able to walk away with something for your investment.

However, the glass is considerably fuller for buyers. Indeed, like in real estate, this is a buyer’s market. In fact, a buyer can find a deal, cherry pick assets (leaving the seller with liabilities and less worthy parts of the business) and refuse to assume property or all of the employees.

Jeffrey S. Marcus, a partner with SorinRoyerCooper LLP’s Life Science Practice, advises that there are plenty of questions to be asked before buyers should start celebrating. It’s critical to consider the most important legal aspects of deal negotiation – whether it’s a merger, acquisition, strategic alliance or partnership.

As obvious as it may seem, there are two key points that buyers must not lose sight of:

  • Make sure you get what you think you are getting. Most M&As happen because the company with the IP needs funding to proceed. If you are the buyer, you want to get the IP rights and freedom to operate. (And, if you are buying something in development, you want protected proprietary rights going forward.)
  • Understand the liabilities (or potential forthcoming liabilities). As the buyer, you must know if there are liability claims against the selling company or product. Keep in mind that lawsuit may not come to light until after the deal is done. (You can protect yourself by doing due diligence and having adequate property liability insurance.)

“Think about it this way, if there is a liability and you don’t plan adequately for it, you will be dealing with an injured reputation,” Marcus warns. “Much worse is the fact that the FDA could pull the product off the market and now you have bought a company that has no product and no market.”

Marcus suggests the following pieces of advice to ensure that the deal is fair and that both sides walk away happy. These tips are part of the process known as “due diligence,” and experienced team consisting of an M&A attorney and financial consultant, is a critical component of a successful negotiation. Again, these tips are aimed at the buyer.

  • Make sure the company owns the IP they think they own (you don’t want to think you are getting rights to something that you aren’t getting because the seller doesn’t own it)
  • Be sure that none of the activities the selling company is engaging in might infringe upon your company’s assets or dealings
  • Read the material contracts – know the contractual obligations of the selling company. What consents will be required to complete acquisition?
  • Evaluate potential undisclosed liabilities. (Check to see if there has been any correspondence with the FDA. Are there potential employment liabilities? Sexual harassment cases? With regard to clinical trials, are there any know complaints with regard to adverse effects?)

“By the way, problems in these areas that arise during the due diligence process don’t necessarily mean you have to walk away from the deal,” Marcus says. “But these things may very well impact valuation. Or, you may want certain dealings (such as litigation) to be finished before the deal is done so any liability stemming from it will be known.”

A Few Other Points… 

When it comes to signing an exclusivity agreement, Marcus says this is a must for both buyers and seller.

“When you reach an understanding on the terms between buyer and seller, it’s important to have a period of time where there is exclusivity and confidentiality – usually about 60 days,” Marcus says, noting that the buyer will be spending a lot of money on due diligence and doesn’t want the seller to go off and consider another deal. Similarly, the seller is “off the market” during that time and possibly not considering other opportunities and would not want the buyer to still be searching for a better deal in the market.

The attorney also suggests that the buyer escrow a portion of the purchase price.

Escrow a Portion of the Purchase Price

“An important step buyers can take to protect themselves is to escrow a portion of the purchase price (say, for example, 15 percent) for a period of time post-closing (maybe 18 months) in the event that some of the indications that the seller made turn out not to be true.”

Final words of advice? For the buyer -- “Take time to do your due diligence. Know what you are getting. Avoid a bidding frenzy.”

For the seller, “be transparent, cooperative and forthcoming,” Marcus says. “And don’t 'forget to mention' something. Your credibility will be shot and maybe the deal will be, too.”

Jeffrey S. Marcus is a partner in SorinRoyerCooper LLP’s New York office.  

EisnerAmper's Catalyst: Winter 2011

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