Getting ready for the sale process
What do you need to consider?
The key to moving forward efficiently to the completion of a sale or private equity investment is having your house in order. Below are some key issues to consider.
Your management team and professional advisers
The quality of the management team is crucial, and the buyer will see the transaction as an investment in the team staying on, so you will need to choose your team carefully from the start. You’ll need to ensure that, in addition to all-round strength, the individual members of the team have the different capabilities and attributes required in the key business areas and that each justifies their inclusion on merit.
The typical positions that need addressing, depending on the specific business, include:
- Chief Executive Officer - a leader with strategic vision, ambition, drive, and clarity is important in uniting the team and driving the business forward.
- Chief Financial Officer – will need to demonstrate intimate knowledge of all accounting information, be competent in forecasting and budgeting, and understand how company milestones operate together with changes in the business environment impacting results and budgets.
- Chief Scientific Officer – will require the vision and business acumen to align the science-related decisions with the company’s strategic objectives.
- Chief Operating Officer – needs a clear and practical understanding of the business, people, and operations, including legal matters, as well as being able to control unit economics, production costs, and capital expenditure.
- Business Development Director – a key driver of revenue and potential new business who is results-driven and capable of motivating others.
Getting the right management team on board is crucial, but so is making sure they are rewarded, motivated, and retained. Their remuneration and incentive structure, whether options, equity, or bonuses, should be carefully considered.
Equally important is making sure the business is protected with appropriate service contracts for key management, including provisions around IP protection and to prevent management from competing or from soliciting customers, suppliers or employees if they leave the business.
Choosing the right professional advisers (including accountants, corporate finance advisers, W&I brokers, etc) is also key to the success of a transaction, and the management team might also need their own advisers. We can help you get the right ones in place.
Preparing the business
During the sale process, the buyer will want to learn as much as possible about you, your team, the company, its products and the scientific basis behind them, its patents and other IP rights, and your business or development plan (and perhaps the wider market). As part of this due diligence, a buyer will require those in the know, usually the management team, to disclose information so that they can make an informed assessment of the value and potential of the company. Legal due diligence will form only one part of this exercise, with both financial and tax due diligence also being key.
The exact areas of legal due diligence will depend on your business and where you sit within the life sciences ecosystem. Most companies in the sector will receive particular attention from buyers on areas like intellectual property, regulatory compliance matters (particularly to ensure that business performance complies with regulatory standards and/or the businesses's regulatory product pathway) and data protection policies to ensure that they meet necessary requirements, particularly to the extent that the company holds sensitive patient data or personal data.
Other areas of interest to buyers may include:
- material contracts
- employment matters
- product liability matters
- real property insurance
- technology
- ESG matters.
Problems, or even potential problems, could lead to a reduction in the value of your business or even the transaction going off the rails completely.
The due diligence process can be a difficult, stressful, and time-consuming exercise, but you can avoid a lot of headaches if you and your team are prepared for it and problems are dealt with in advance. One of the best ways to prepare is for your own lawyers to undertake due diligence, particularly in key areas, before the buyer (a process called ‘vendor due diligence’) so that issues can be identified and ironed out where possible and otherwise presented in the most favourable light to the buyer.
Even if the sale does not proceed, this can be helpful to the business going forward to identify areas of improvement or rectification.
At the same time, you also need to dedicate sufficient time to running the business. It’s important that performance continues to be in line with expectations during the sale process to ensure you receive the best possible valuation.
Areas to focus on to smooth the process of the transaction include:
Regulatory compliance
When determining a company's or a business's regulatory compliance, the nature of the business's products and activities will be key to determine which licences, authorisations or permits are required. These are likely to be key to the ongoing success of the company or business and so ensuring such licences, authorisations or permits have been obtained based on valid and accurate information and have been properly maintained in accordance with applicable laws and regulations is of critical importance to a buyer.
If there has been any failure by the company or business in complying with such laws and regulations, this may result in sanctions, fines or, in extreme cases, criminal convictions and will be red flagged in any due diligence reporting. Ensuring that all of your compliance is up to date at the start of a sale process, and that you have a clear overview of the regulatory framework as it overlays onto the business and its value proposition, is critical.
Intellectual property
The materiality of intellectual property (IP) rights to the business will be a commercial point to consider for any buyer. As well as other forms of IP, the strength of a life sciences company's patent portfolio will often be key to its valuation. Where this is the case, the extent of patent due diligence can range from a basic verification of ownership rights in the relevant registers, to freedom to operate opinions in the material product arena.
Where key IP has been in-licensed to the company, buyers will want to understand the scope of those licences and any commercial terms attached. In the case of IP developed in-house or with third parties, you should consider in advance who was involved in that development and what contracts or grant funding applied to that development, so you can make sure they are all in order ahead of any due diligence exercise.
As well as intellectual property rights relating to technology, branding-related IP can also be key to valuation. Where this is the case, the buyer will typically ask detailed questions about the company's brand protection activities and strategy. The buyer will want to ensure the right steps have been taken to protect the company's brands, whether through the registration of rights or taking enforcement action against an infringing third party and will want to be comfortable that the company's brands do not infringe third-party rights.
Considering in advance who was involved in developing your IP and checking that their relevant contracts include appropriate IP provisions relating to that development to ensure such rights belong to the company ahead of any due diligence exercise being carried out on the company will be key to a smooth sale process.
Competition
Regulators are active, particularly in drug development, pharma manufacturing and other areas, in order to avoid anti-competitive pricing arrangements and any buyer is likely to want to carry out sufficient due diligence to satisfy itself in this regard.
R&D and patent box regimes
The benefits flowing from R&D tax credits and IP regimes can be substantial, and many life sciences/biotech companies are sustained in the early years by payable R&D tax credits. Correctly identifying which tax credits and patent box regimes your company is eligible for and confirming that records and documentation supporting any historical claims are complete and accurate should maximise the company's valuation and may inform how certain elements of the consideration payments are structured.
HMRC has increased its scrutiny of R&D tax credit claims in recent years and introduced a range of new checks on claims from 1 August 2023 onwards. Any uncertainties regarding the legitimacy of historical R&D claims, clawbacks of tax credits/reliefs or concerns about the eligibility of the company in respect of current/future R&D claims may result in specific indemnities in respect of any such credits being requested by the seller in the sale agreement or payments of consideration being deferred/delayed.
Commercial relationships
Formally documenting the terms of key commercial relationships, such as those with suppliers (including CROs and CDMOs), customers, agents, and distributors, will give potential buyers clarity and confidence in what they are investing in and underpin the business plan. Having complete and signed copies of those terms is important, and ideally, these would have been prepared or reviewed by the company’s lawyers.
Key contracts
You should review and appraise the contractual basis of strategically important financial commitments, supplier arrangements, and revenue-generating relationships (eg property and equipment leases, licensing agreements and customer contracts) so as to understand the degree of flexibility available to change strategy or manage costs, the reliability of revenue streams, and the effect the transaction may have on them.
In particular, you should check if these contracts can be terminated or amended, require notification, or permit your counterparty a right of first offer or refusal if a buyer takes control of the company (a ‘change of control’ clause). If there is a change of control clause, this may require careful handling depending on the counterparty and importance of the contract. Understanding what’s out there and considering how best to deal with it (before the buyer unearths it) can help to avoid delay and disruption to business continuity.
Disputes and product liability
More generally, actual and potential disputes and investigations (whether litigation, arbitration, or regulatory investigation or intervention) should be monitored, assessed, and managed to minimise their impact on the value of the business. While you might not be able to avoid or resolve a dispute before the sale process begins, it’s important to conduct a proper assessment of relevant risks and to maintain clear records of decision-making processes.
Showing that the risks have been properly considered and addressed and being able to explain and evidence the current position, and that advice has been sought where appropriate (including the ability to claim under any standard business insurance policy), will be important to getting a buyer comfortable.
If you have a medical device or medicinal product you should consider any product liability claims or disputes that may have arisen in the above context.
You should also consider key compliance-related risks in relation to the ‘failure to prevent’ offences (ie in relation to bribery, tax evasion, and economic crime) and ensure that adequate and reasonable procedures are in place.
Employment and immigration
You should maintain good employee records, such as by formally documenting employment and service contracts and regularly updating the company’s policies and employee handbook. In particular, disciplinary and grievance policies should be implemented and employee relations issues dealt with in accordance with these, with detailed records of any claims kept to enable a buyer to assess potential liabilities.
An area of particular focus in a buyer’s due diligence will be around the classification of independent contractors and self-employed workers. Misclassification presents a number of risks, including the individual having employment status for tax or employment purposes, so it’s important that documentation and working practices are put in place to reflect the correct status of such individuals and appropriate records are retained to evidence these working practices and the status determination of such individuals.
You should also ensure compliance with the off-payroll working rules and that equivalent documentation and records are maintained where independent contractors are engaged through personal service companies.
Regular overtime, commission and bonus pay calculations should be factored into holiday pay (both during employment and payment of accrued but unused holiday on termination). Failure to do so can create an exposure to claims for backpay dating back for two years, which can be a concern for buyers. Holiday pay liabilities are also often excluded from cover under W&I insurance policies.
From an immigration perspective, employers are required to check that UK-based employees have the right to work in the UK in advance of the commencement of their employment. Buyers will want to see that you’ve carried out these checks, so make sure your records are complete.
Options
Where tax-favoured (eg EMI or CSOP) options have been granted and will be exercised in connection with the sale, buyers will want comfort that the company has followed HMRC rules and guidance in granting such options and operating the scheme. Any failures in this respect can affect, or result in the loss of, capital gains tax treatment and/or other tax-favourable treatment for optionholders, with their option exercises instead being subject to income tax and national insurance contributions on the full gain.
Buyers pay particular attention to this because it will likely give rise to a requirement for the company to withhold those amounts (with a risk of penalties or interest for failing to do so) and a corresponding national insurance liability for the company.
Issues to consider include:
- A review of historical grants – do you have copies of appropriate HMRC valuations, fully executed option agreements, and, where required, screenshots evidencing timely and complete HMRC notifications and filings?
- An assessment of previous option exercises – has the company used a general discretion to allow the early exercise of options (eg to facilitate a secondary sale on a funding round)? Was the exercise in line with the rules, and were Section 431 elections signed by UK tax-resident employees no later than 14 days from the acquisition of the shares?
- An analysis of the scheme rules and option terms – can unvested options be accelerated in connection with the sale without jeopardising their tax-favoured treatment? Would existing shareholders be supportive of that? Consider whether that presents any issues with what has been promised to optionholders.
Horizon scanning
As well as identifying issues in the business, it’s also important to identify any potential hurdles or blockers to closing a deal (for example, from shareholders, lenders, regulators or possible government intervention) at an early stage to avoid losing momentum or running into issues at a late stage that can be difficult to resolve. A few key areas to consider include:
Understanding expected returns and required consents
Larger cap tables
Warrantors and warranty and indemnity (W&I) insurance
Debt repayment and release of security
Warrant holders
Regulatory approvals are common in life sciences deals
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