In part 1, the authors discussed the relatively high professional threshold in innovative drug R&D investment compared with the investment activities of other industries, and further noted what should be kept in mind from the perspective of invested companies and the founding team. However, new drug R&D is a bumpy road, which challenges not only the R&D companies and teams. Investors must also make prudent decisions based on the characteristics of the industry during transactions.
In this article, the authors analyze the features of this area from the perspective of investors, and provide advice.
Role of counsel
For the R&D of innovative drugs, a large number of regulatory regimes and numerous parties are involved in the whole process of pre-clinical research, clinical trials, registration and approval, and production and management of post-marketing adverse drug reaction reports, which requires investors and counsel involved in transactions to have a thorough understanding of the industry and its regulatory status.
Taking the license-in contract as an example, it will involve many clauses such as licensing target, licensing scope, consideration and long-term co-operation obligations between the two parties during R&D, production and commercialization, among which the contract consideration alone includes prepayment, milestone payments, sales commissions, annual fees and so on. If counsel are not familiar with the relevant content of the contract and industry practices, it will be difficult to identify the legal risks.
Representations & warranties
Representations and warranties stating the basic situation of the invested enterprise serve as the most fundamental safeguard clause for investors’ interests.
Compared with other industries, the business model and assets of innovative drug R&D companies are obviously different, so it is necessary to adjust and supplement the content of representations and warranties according to the industrial features.
For example, in addition to commonly concerned intellectual property (IP) rights integrity, investors also need to pay attention to the exclusiveness of IP rights, and figure out whether the IP rights have been authorised to other parties (for proprietary technologies that cannot be patented, investors need to make certain of confidentiality status), in order to ensure that the IP rights and products of companies will not be used by other parties, and thus cement their market position.
Investors should also pay attention to other high-risk-related matters in this industry, such as the division and transfer of IP rights between founders and their former employers, the privacy protection of participants in clinical trials, and commercial bribery involved in drug sales.
As mentioned in part 1, most of the founders of pharmaceutical companies are professors and researchers from universities or research institutions. In the early stage of their entrepreneurship, the founders may retain their positions in their original organizations, and thus are unable to establish a full-time employment contract relationship with companies.
To a certain extent, the position retained can strengthen the co-operative relationship between companies, universities and research institutions, and provide necessary resources and opportunities for the companies in their early stages. Therefore, strictly enforcing the full-time employment requirement of founders is not appropriate for the innovative drug R&D industry.
Investors may consider allowing the founder to retain a position at an existing non-profit organization, and setting up a mechanism that requires the founder to start fulfilling full-time employment obligations when scenarios such as IPOs and mergers and acquisitions (M&A) occur in the future.
It is a long-term process to cash in on innovative drugs, involving pre-clinical research, clinical trials, drug registration, sales and marketing, and the valuation of the invested companies may double at the end of each stage. Investors who joined early and supported the completion of these stages may consider obtaining the right to subscribe for capital increase based on a preferential valuation, or pre-emption rights of oversubscription upon the company’s new equity issues, prior to third parties, so as to facilitate the investors making additional investments when the company is showing promising results, as a return for the earlier investment risks.
It may take more than 10 years for innovative drugs R&D, far beyond the residual maturity of many investment funds. Pharmaceutical companies in the R&D stage, without profits or revenue, are allowed to go public on domestic and foreign public capital markets. Therefore, investors can exit through the company’s IPO. In addition, an exit through M&A is also an important channel for investors to withdraw.
As a means for investors to initiate an M&A transaction, the drag-along right can ensure that, with the consent of majority investors, the main research projects of the invested company, or invested companies, can be smoothly liquidated by means of equity sale or asset sale at reasonable prices, so that investors can close investment prior to the liquidation and closure of the fund.
Despite the take-off and rapid development of China’s current R&D and investment in innovative drugs, the number of mature pharmaceutical companies is not large, and the risks and coping strategies in this industry remain to be tested. Only by understanding the risks in projects can investors take precautions and balance between risk control and gaining the development benefits of companies.
Jin Youyuan is a partner and Guo Xiaoxing is a senior associate at Merits & Tree Law Offices
Merits & Tree Law Offices
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