Today’s Due Diligence Norms and What’s Next
The different spaces within life sciences, including pharmaceuticals, medical technology, and artificial intelligence, have their own unique due diligence standards and considerations. These are influenced in part by the regulatory structures in place to monitor these spaces, as well as the deal landscape in which companies operate. Pharmaceutical companies tend to take a deeper dive into due diligence than medical device companies in considering reimbursement issues as part of due diligence efforts, since they face extra requirements for drug pricing transparency and accountability. At the other end of the spectrum, due diligence for artificial intelligence and other digital health applications—which are currently garnering record-high valuations—is largely unstructured. The AI space will only continue to evolve, however, and as it does, diligence standards will firm up.
Overall, due diligence for medical devices falls in the middle of this spectrum and has evolved in recent years, driven in part by consolidation among larger medtech companies, a lackluster IPO market, and a dwindling number of buyers. Today, due diligence for new medtech focuses first and foremost on the technology’s promise for improving patient outcomes, quality of life, or other metrics. Only once that criteria is satisfied does the focus shift to the competitive landscape or reimbursement.
Across all these life sciences spaces, however, due diligence demands are growing. Buyers and investors are well advised to consider end-game issues such as reimbursement and commercialization earlier in their planning process. Market players are often highly focused on the science itself and, as a result, might pay less attention to issues such as supply chain, intellectual property components, and reimbursement. Addressing these topics at the due diligence stage is critical, because left unexamined, they can cause a deal to unravel, regardless of the strength of the science. By evaluating the competitive landscape and commercialization pathways early on, buyers can identify potential problems and work to mitigate risk.
Key Topics to Address: Reimbursement, IP, and Leadership
In today’s competitive market, buyers are often unable to spend as much time on due diligence as they might like. To focus their efforts strategically, buyers may wish to frame their areas of focus around the value drivers of their target deal model and key contract elements requiring verification. A buyer’s strategic plan should drive the diligence efforts, in turn allowing the due diligence findings to effectively inform the action plan moving forward.
When evaluating a potential life sciences transaction, it is never too early to start thinking about reimbursement. While it is not essential to have a firm plan for reimbursement in place, having given it advance thought is half the battle. Due diligence should take into account the commercialization channel for the product and include engagement with data sources on alternative therapies and their reimbursement.
If the product in view is entering an existing market, conversations with reimbursement specialists can help a buyer determine the best path to reimbursement. A product that is opening a new market, however, is more challenging and requires larger amounts of data. Questions that can help guide the process include the following:
- What is required for a new reimbursement code to be created?
- Are there case studies available on similarly complex products for which reimbursement codes were created? What kind of trials had to be conducted, with how many patients and what length of follow-up? Can you draw conclusions from these case studies to guide your financial plan?
- Do you have the right experts (e.g., payers) to advise you?
- Do you understand the scale of data that you need?
Intellectual property (IP) is another key element of life sciences diligence. The IP portfolio—and how secure it is—will affect the ultimate M&A discussion and, in some cases, will influence the deal outcome and valuation itself. A deep dive into IP-related matters—including contracts and consulting agreements—is an excellent option for reducing risk, but it is an expensive one. Companies, therefore, should plan their IP diligence strategy around their specific business needs.
Careful attention to contracts—whether with development partners, manufacturers, or parts suppliers—is a critical element of IP due diligence, because it prevents surprise IP ownership claims from arising just as a transaction is about to conclude.
Another area of potential risk worthy of focus is the target’s management team. In an early-stage life sciences company, management is often fresh out of academia. The founding CEO may be a scientist or an engineer, for example, with little experience building or leading a company. Due diligence efforts should consider whether the company has the right people with the right skillsets to successfully manage the company through every stage—preclinical, clinical, and commercial.
First-time life sciences entrepreneurs and company founders may be surprised to receive these types of end-game questions so early on in the process—and, perhaps, may be frustrated by the extra time required to answer such questions. In today’s market, however, a realistic picture of the final result is vital for both the company’s strategic plan and a successful transaction.
Early-stage and emerging companies should be proactive in contemplating diligence issues so they are prepared to answer questions from investors and buyers. Even if an early-stage company has limited resources or cannot possibly evaluate every potential issue, it is still important to conduct some advance preparation so the company can either provide answers or identify a path to developing them when due diligence issues arise at the deal table. Such planning should take into account the ultimate buyer and how the specific product or company will fit into the broader life sciences landscape in the future. Potential questions to consider include:
- Is there a marketplace for this innovation?
- Who will be the likely acquirer?
- What does that acquirer’s current portfolio look like?
- What is that entity working on in-house?
- What other possible acquisition targets might the buyer be considering?
- What are the options for reimbursement?
- Are the IP licenses set up with a view to the eventual commercialization partner?
Strategic, thoughtfully executed due diligence is a critical factor for deal success. It is never too early to start considering key issues such as reimbursement options, protection for valuable IP, and pathways to commercialization. Getting a head start on diligence will help companies come to the deal table well prepared for buyer and investor questions, and will alleviate potential difficulties down the road.
Robert H. Underwood, Ph.D., helps clients achieve business objectives by drawing on his extensive experience establishing U.S. and international intellectual property (IP) rights and identifying and evaluating third-party IP risks. He focuses his practice on the life sciences and chemical industries, including biologic and small-molecule pharmaceuticals and diagnostics, vaccines, medical devices, food science and nutritional supplements, agricultural technology, renewable and clean chemical technology, organic chemistry, polymers, and catalysts.