Another question that must be addressed is who will lead SpinCo and whether the management and scientific team who are familiar with the pipeline assets placed into SpinCo will go with the business that is acquired by the buyer. If the thesis of the deal is that the buyer wants the leadership team to stay with the acquired company, SpinCo may find itself without the right people to guide it to success. Finally, it may be questionable whether SpinCo, on its own, will attract sufficient investor float and will meet the eligibility criteria to be listed on a national stock exchange—the inability to list may be fatal to the ability to execute a spin-off merger.
Finally, spin-off mergers do not lend themselves to a clean break between the buyer and SpinCo. In addition to buyer financing arrangements, the parties often need to enter into transition services agreements, contract manufacturing or facilities sharing arrangements, IP licenses, and data sharing protocols. As such, they create several interdependencies between the buyer and SpinCo, which can add to the negotiation timetable at the front end and can take years to untangle post-closing.
Contingent Value Rights (CVRs)
A potential alternative to a spin-off merger in situations where the two parties have differing views as to value are CVRs. CVRs represent the right of the target company shareholders to receive payments when specified milestones are achieved. They are not typically transferable (a feature necessary so that they are not treated as securities and do not require SEC registration) and are issued to the target shareholders at the time of closing as a component of the acquisition consideration.
While contingent payments in the form of milestones and earn-outs are commonly utilized in private company M&A, contingent value rights—their counterparts in public M&A—have historically been used less frequently. However, in the current environment, CVRs can be an attractive tool in deal structuring. In 2022, there were more CVR public deals than in 2020 and 2021 combined, and in January 2023, all three public pharma acquisitions announced at the JP Morgan (JPM) Healthcare Conference—AstraZeneca’s acquisition of CinCor Pharma, Ipsen’s acquisition of Albireo, and Chiesi’s acquisition of Amryt Pharma—included CVRs.
Some buyers disfavor CVRs due to the potential for litigation with a large number of CVR holders over whether the buyer has complied with its contractual undertakings to achieve the applicable CVR triggers. CVR agreements often contain commitments by the buyer to use a specified level of efforts (usually commercially reasonable efforts or variations thereof) to achieve the payment triggers, with the exact standard of efforts being one of the most heavily negotiated points in the CVR agreement. While buyers often push back on the inclusion of an efforts clause or push to narrowly define it, public deals without efforts clauses are rare. All three of the public pharma acquisitions announced at the JPM Healthcare Conference contained efforts undertakings to achieve the applicable milestones.
Buyers who wish to have contractual certainty as to what their obligations are, but who are not able to get a “no efforts” standard, may seek in the alternative provisions which state that the buyer is not required to do certain enumerated things (e.g., additional clinical studies not previously contemplated) or “safe harbor” provisions which specify that if the buyer has devoted specific resources to achieving the trigger (e.g., minimum dollar spend), it will be deemed to have complied with the efforts undertaking.
Other mechanisms buyers have used to try to limit litigation exposure is to provide that the CVR holders can enforce their rights only through the rights agent under the CVR agreement (and not individually) and that only a minimum percentage of CVR holders (commonly ranging between 30% and majority) can direct the rights agent to bring claims for breach of the efforts covenant. While this type of mechanic does not eliminate the risk of litigation, at least it has the benefit of consolidating any claims over the CVR through one channel and proceeding.
Applications Beyond Life Sciences
Pharma, biotech, and other life sciences deals provide a natural context for the inclusion of CVRs, as the value of a particular drug may change dramatically based on the achievement or failure to achieve a major development or other milestone. They are also a natural forum for the consideration of spin-off mergers, as companies often have early-stage pipeline products they may see significant potential in, but for which buyers may not be willing to pay. Nevertheless, buyers outside these industries may soon begin to tap into these deal structures as dislocations between stock price and intrinsic value, heightened volatility, and economic uncertainly may force more parties to think about how to bridge valuation gaps in order to execute on deals that may have strong strategic sense but where it may be difficult to reach a meeting of the minds on deal price.