Mastering The Fundamentals Of Life Sciences Due Diligence

Conducting effective regulatory diligence is foundational to life sciences transactions. At their core, life sciences companies and products are subject to a maze of laws and regulations.

Compliance with such laws and regulations is the cornerstone of a life sciences transaction and plays a vital role in the success of a transaction. However, conducting regulatory diligence often is a multifaceted exercise and involves immense amounts of information. It requires strategic considerations and sound judgments before, during, and after the transaction.

Broadly speaking, the life sciences industry is a complex industry that consists of companies developing pharmaceuticals, biotechnology products, medical devices, diagnostics, cosmetics, food and other consumer products that enhance the life of human beings.

These products are governed by different regulatory frameworks and the applicable
frameworks also differ in different jurisdictions. Below, we focus on pharmaceutical and
biotechnology aspects of the life sciences industry in the U.S., including life sciences
companies and products, biological products, and emerging biotechnologies.

This article provides an overview of conducting effective and strategic life sciences
regulatory due diligence, discusses key regulatory diligence issues, and analyses using
diligence findings strategically to achieve and improve transactional strategies and ensure smooth post-transaction integration.

In addition, this article discusses due diligence in four categories of life sciences
transactions: mergers and acquisitions capital markets transactions, (2) collaborations
and licensing transactions, venture capital investments, and (4) other commercial
transactions.

These transactions have continued to gain tremendous momentum in recent years.
According to J.P. Morgan, 2024 saw a strong growth in life sciences transactions, surpassing 2023 with $3.8 billion raised across 19 initial public offerings, $26 billion in venture capital investments across 416 rounds, $49.1 billion across 91 biopharma M&As, and $171.2 billion in partnership and licensing transactions.

These call for effective diligence to help identify significant risks, prevent potential liabilities, devise appropriate transaction structure and contractual protections, inform post transactional integration strategies, and maximize the transactional value.

Life Sciences Regulatory Due Diligence and Why It Is Important for Life Sciences
Transactions

Term Sheet Negotiation

Many life sciences transactions start with term sheet negotiation. It is an initial yet
important step of the transaction.

The key terms often revolve around the target or lead products, including the product
indications, nonclinical and clinical development, regulatory filing plans, and marketing and sales, especially in licensing and collaboration agreements.

In many cases, the major economic terms — e.g., up-front, milestone or royalty payment terms — are linked to, or contingent upon, achievement of certain regulatory, development and marketing objectives of the products.

For example, these may include milestone regulatory events such as the submission of an investigational new drug application; enrolment of, or dosing, a certain number of
participants in a clinical trial; progression of the development program to the next phase; key meetings with the U.S. Food and Drug Administration; acceptance of a new drug application or biologic license application for filing; receipt of FDA approval; and obtaining certain sales revenues, among others.

If these regulatory milestones are part of a transaction, it is critical to ensure that such
terms represent an objective and reasonable timeline and are as measurable and feasible from a regulatory perspective as possible.

For example, a transactional party often wishes to seek assurance regarding the adequacy of clinical trial data to support approval; however, the FDA will not make that decision until it completes the review of the application.

Therefore, parties should be cautious about milestone payment terms that are linked to the certainty of obtaining FDA approval during the clinical development and application review process, and ensure that such terms, if included, are truly objective and measurable.

At this stage, it is important to conduct preliminary diligence on the counterparty and the key assets, identify and craft clear and feasible regulatory related terms, and specify the scope and steps of due diligence. While the term sheet generally is nonbinding, negotiating and drafting feasible and thoughtful provisions in the term sheet can lay a solid foundation for the transaction and avoid potential disputes down the road.

Conducting Effective Life Sciences Regulatory Due Diligence

Why Conduct Life Sciences Regulatory Due Diligence?
Once a term sheet is signed, the parties would move to conduct full diligence, although in some transactions, the diligence might be phased.

Regulatory due diligence aims to verify and assess the regulatory and compliance status of the target company and target assets, confirm a transactional party’s assumptions regarding the transaction, identify significant liabilities and risks, and help achieve the party’s transactional and regulatory strategy.

Conducting thorough and effective diligence is a crucial and prudent step before entering a transaction. It enables a party to make informed business decisions, evaluate the proper value of the transaction, help prevent significant risks and liabilities, inform the transaction structure and provisions, and help serve as an effective defence against potential negligence lawsuits.

For instance, effective diligence may help demonstrate fulfilment of the company’s
directors’ and officers’ fiduciary duties and defend against potential shareholder lawsuits. In securities offerings, issuers may be held liable for material omissions or misrepresentations in the security offering documents. And nonissue parties, e.g., underwriters, have the burden of proof to show that they had reasonable grounds, after a reasonable investigation, to believe that the disclosures made in the registration statements are true and do not contain omissions of material facts or misleading statements.

This typically requires conducting effective, thorough, and fact- and context-specific due diligence. In addition, from a corporate criminal liability perspective, the U.S. Department of Justice incentivizes acquirers in M&A transactions to perform robust pre-M&A and post-M&A due diligence, and voluntarily disclose misconducts uncovered during diligence, to avoid successor criminal liability.

Overview of Life Sciences Regulatory Due Diligence Process
Regulatory Due Diligence

Overall, regulatory diligence can be multiplex. It often involves extensive information and varies by manifold factors.

For example, diligence varies by deal types and structures — be it a merger and acquisition(e.g., asset purchase, equity purchase, joint venture, divestiture), licensing and collaboration, capital markets transaction, commercial deal, venture capital, or private equity investment — where the diligence process and focus may differ.

Diligence may also vary by the party’s nature, i.e., whether the counterparty or target
company is a public or a private company. Typically, diligence on public companies can
benefit from publicly available information, e.g., U.S. Securities and Exchange
Commission filings, whereas diligence on private companies may rely more on information from the target.

While diligence in certain cases is a straightforward exercise, it can become very
complicated when involving multiple product lines, corporate entities and geographies.

Further, different products are subject to different regulatory frameworks, and the focal
points of diligence should also differ.

For example, small molecule drugs and biologics are regulated differently from over-the counter products and other consumer products, and different categories of products, e.g., oncology, cardiovascular, neurologic drugs, may be also subject to different regulatory requirements and expectations to attain approval.

Moreover, diligence also varies by the product development stages and approval statuses.

Commercial products and pipeline products are often associated with different types of
risks. Early-stage products, especially novel therapies, are prone to more regulatory risks and uncertainties.

Finally, diligence also varies by the party’s position, e.g., the seller or buyer. Buyers often
wish to conduct in-depth diligence as extensive as possible, yet sellers in certain cases may conduct reverse diligence to determine the product’s compliance status and fair market value in order to prepare for the sale.

Overall, as diligence varies case by case and can involve massive amounts of information, it is imperative to have a clear understanding of the transactional objective and set forth the diligence scope at the outset.

General Regulatory Due Diligence Process

Although varying by transactions, most diligence, especially buy-side diligence, primarily consists of data room document reviews, management interviews and calls, and on-site reviews and inspections, among others, as appropriate. Establishing clear procedures, and specifying the roles and responsibilities of the parties, is a must for conducting effective diligence.

Usually, the primary due diligence exercise is to request, collect, and review information of the target and target assets via a virtual data room or the like on a confidential basis.
Information subject to diligence may vary, but generally includes organizational, financial, legal, regulatory, clinical, nonclinical, employment, tax, privacy, intellectual property, and other information pertaining to the target and target assets.

As the first step, the transactional party and its counsel should perform an initial review of the information provided and request key documents and files that may be missing.

The parties should establish protocols on requesting documents and answering diligence questions. Confidentiality or nondisclosure agreements may also need to be in place to protect the confidentiality of the information provided.

Typically, regulatory diligence review covers extensive information relating to (1) the target company; (2) the target products; (3) third parties such as collaborators, laboratories, contract manufacturers or clinical research organizations; (4) regulatory correspondence with the FDA, including key meeting minutes; (5) FDA advisory, enforcement actions and related litigations; and (6) foreign regulatory matters.

A transactional party should require the counterparty to provide all pertinent regulatory
documents and records, including but not limited to regulatory applications such as
investigational drug, new drug and biologic license applications, including amendments and supplements; nonclinical and clinical data and files, including raw data and notes; study plans and protocols; investigator brochures; study reports; institutional review board reviews and approval records; safety data; informed consent forms; financial disclosures; and scientific publications, among others.

Such information needs to be tailored to specific transactions, yet is often dauntingly
extensive, especially for commercial and late-stage assets. Being able to review such
extensive information on an accelerated timeline and identify key regulatory issues is the chief challenge of conducting effective life sciences regulatory diligence.

Another component of due diligence is to hold interviews and calls with the target’s
management team, core employees, and third-party services providers, if possible. This
may be a good opportunity to confirm diligence findings, ask key questions arising from the diligence review, go beyond the written information, and address significant gaps and questions.

Effective diligence interviews and calls can enhance the understanding of the target and
target assets, resolve critical issues, create synergies, and facilitate the transaction
objective. Moreover, diligence may involve on-site reviews or inspections, especially by
nonlawyer technical experts.

This may be conducted typically when collecting electronic documents is impossible, when the transaction involves sales of manufacturing or clinical facilities, or when certain entities raise significant compliance issues, among others. In some of these cases, especially when they involve technical issues, lawyers may play a limited role and rely on the views of nonlegal technical experts.

Finally, diligence should leverage publicly available information, such as the FDA website, SEC filings, company and product websites, industry publications, and other information available in the public domain, which can provide valuable insight to supplement the diligence exercise, confirm the party’s understanding and facilitate an independent assessment of the key issues.

Overall, the diligence process varies case by case and requires a party to review dauntingly enormous amounts of information and assess the key issues. It is critical to conduct the review based on the appropriate diligence scope and concentrate on key issues that are most crucial to the transaction.

Parties should engage best practices and use various tools such as diligence checklists,
document requests, trackers, review logs or the like to facilitate the review and be both
pragmatic and relentless in the diligence review process.

This article was originally written for Law360, and can be found here.