By: Oded Ben-Joseph, Ph.D., MBA & Thomas Busby, MBA
As a high-risk, capital- and knowledge-intensive sector, the life science industry is mostly a feeder industry where innovative companies feed technologies to larger players through Merger & Acquisition transactions. Given the pivotal role M&A transactions serve in moving innovation from the laboratory to the patient, it is imperative that management teams understand that the process of selling a company is arduous, time-consuming and laden with risk. As members of a specialized life sciences investment banking group focused on private equity financing and M&A, we have the unique experience of witnessing first-hand the various and recurring missteps life science management teams are susceptible to when engaging in corporate transactions. Below is a list of avoidable missteps in M&A transactions and their respective remedies:
Management teams often make the inaccurate assumption that corporate business development teams rigorously analyze each potential deal that comes to them. This belief, however, can cause otherwise value enhancing transactions to never leave the runway. A clear and differentiated value proposition must be communicated to buyers from the initial point of contact. Sellers should take the time to formulate and articulate a strategic fit, tailor-made to each potential buyer. The strongest Letters of Intent (LOI) are products of thoughtful strategic discussions centered on how an asset is better leveraged in the hands of buyer.
Lesson: Identify your company’s true value to its market and how its value is differentiated (and defensible) from competitors. Then, review each potential buyer separately and identify unique value enhancing synergies.
Given the high stakes nature of M&A, maintaining an objective mindset can be challenging. The result of failing to do so, however, is succumbing to heavily biased judgement. When deciding to pursue an M&A route, Boards and management must consider external market forces. A private company might never be concerned with public market movements until a public buyer is interested in acquiring them. Changes in a buyer’s corporate leadership or strategy, buyer M&A activity, public market sentiment, and macroeconomic forces constantly alter deal dynamics.
Lesson: Expand your view to include external forces that need to align for your transaction to close; be prepared to refine and recalibrate your strategy in light of developing market dynamics.
With respect to M&A transactions, executives seldom adopt objective and statistical mindsets. Instead, they rely on “rules of thumb” (heuristics) that may seem reasonable but lead to severe errors. They plan an M&A strategy haphazardly and make predictions about acquisition price and various other terms. Their point of view is heavily dependent upon the information available to them as well as their personal judgement based on individual experience. These executives are likely to commit a planning fallacy because they relay on unrealistic, best-case scenarios. However, if appropriate benchmarks are chosen and an unbiased advisor consulted, a more accurate indication on where the “ballpark” is will emerge.
Lesson: Do not allow biases to impact decision-making. Accept that human error is rampant. Adopt a statistical mindset and substitute human judgment and intuition with formal thinking.
An adequate understanding of the competitive landscape and comparable transactions is key. The life science industry consists of an array of smaller segments whose particular dynamics are ever-changing. Life science executives thus should prepare for a significant effort to grasp the particular dynamics of their segment. It is devastatingly common for executives to benchmark their technology against companies who play in different markets and expect the same valuation. Insofar as comparable transactions are concerned, market identification is crucial.
Lesson: Avoid futile discussions about valuation by disregarding transactions that are not relevant to your value proposition. If they are not a key competitor, do not benchmark yourself against them.
Significant psychological and behavioral drivers are often at play in M&A transactions. Left unchecked, these drivers propagate unfounded over-confidence about the chances of success. However, when a major multi-national company offers a term sheet, they are seldom inclined to engage in exhaustive discussions about specific valuation metrics. As the buyer’s business development team is likely strapped for resources, they will lose patience negotiating superfluities. It is imperative that management focus their time on closing instead of engaging in never-ending discussions. The longer negotiations draw on, the increasing probability of a missed sales projection or production deadline, or macro-economic shift.
Lesson: Time is the enemy of transactions, move with haste and focus on what is truly important.
A detailed LOI oftentimes results in more favorable terms for the seller and reduces the time needed to execute a definitive agreement. However, once an LOI is executed, leverage migrates from the seller to the buyer because of exclusivity provisions that prohibit the seller from negotiating with other bidders. Some of the terms to be included in an LOI are price, structure (upfront cash, milestone, royalties), the calculation for price adjustments (working capital, cash free, debt free), amount and duration of escrow holdbacks, treatment of employees, representations and warranties, and conditions to closing. A seller must be clear, early on in M&A negotiations, about what the expectations are, and what “third rails” to avoid.
Lesson: Early on in the process, identify key terms to be met for a deal to be consummated; communicate those terms to buyers and do not waste valuable time negotiating less important issues.
M&A transactions, for most executives that successfully undergo the process, are the most career-defining events of their lives. Not only a source of personal transformation, these transactions signal an executive’s “crown jewel” achievements. Typically lost in these success stories is the team of experts executives depend on for strategic, legal and financial advisement. These advisors add significant value at multiple levels including M&A strategy, positioning, buyer identification, negotiating and structuring the transaction to enable management to focus on running the company. The latter is of particular importance as a deteriorating financial situation, resultant from management’s underestimation of the time and focus needed to close a transaction, allows the buyer the opportunity to reprice the deal when the company is most vulnerable.
Lesson: M&A transactions are complex and require considerable expertise; seek expert assistance and choose your team wisely.
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