Question: An increasing amount of funding appears to be going to start-ups that in-license compounds from pharma companies in agreements known as reverse licensings. How are these deals structured?
Answer: In-licensing opportunities should continue to increase, as pharma company mergers force drug firms to focus on their higher-priority, higher-potential products. And the larger the companies are, the higher their threshold sales levels are for any products they spend time developing. This often means that development-stage compounds with expected sales of less than $250 million are shelved, while smaller, marketed products lose their sales support. Rather than have these assets sit unattended and unproductive, drug companies are increasingly interested in out-licensing them. And sometimes they're forced to do so by the FTC, which can require, as a condition of its approval for a merger, that the newly combined firm divest certain products.
In turn, biotech companies are eager to trade discovery and development risk for marketing risk. Success stories like Dura Pharmaceuticals Inc. (purchased by Elan Corp. PLC for $1.7 billion) and Jones Pharma Inc. (acquired by King Pharmaceuticals Inc. for $3.2 billion) provide attractive role models.
The underlying theory is value-added arbitrage: the in-licensing biotech believes that it can do development faster and cheaper than the pharma licenser, or that it can sell a niche product more effectively than its current marketer. An in-licenser can also add value by uncovering previously unknown applications for an otherwise uninteresting compound, by developing ways to make a compound more cheaply, or by marketing the compound to small, but easily reached markets. The public financial markets have resoundingly endorsed this belief by underwriting the successful IPOs of Pozen Inc. and The Medicines Co. during the past few months, and venture capitalists have enthusiastically backed virtual drug development and marketing start-ups such as DJ Pharma Inc., Pharmion Corp., Prometheus Laboratories Inc., and Reliant Pharmaceuticals Inc.
Identifying and in-licensing a compound is, however, challenging, since the licensee must still sell the pharma company on its development prowess and convince the pertinent business development person that the transaction will not turn out to be a career-ending out-license of a future blockbuster. Here are some of the key points in a deal:
- Defining the "Licensed Compound:"
- Ensuring Access to Data and People:
- Freedom to Develop the Compound in an Unencumbered Manner:
- Buyback Rights:
- Constructing Sensible Economics:
- Controlling the Intellectual Property:
The license agreement is the best (and perhaps only) opportunity for the licensee to gain access to not only the specific compound of interest, but also future analogs, derivatives, and alternative formulations which the pharma company owns or may develop and which could extend the patent life of the original compound. The license should also be accompanied by a broad non-compete commitment by the licenser, to protect against seller's remorse. The pharma company should provide access to unpatented know-how potentially useful for making the compound, as well as technologies which might improve manufacturing yield. All samples of the compound should be identified and transferred to the licensee; any outstanding material transfer or similar arrangements with academics or other third parties must be terminated and the associated samples retrieved.
All clinical records need to be transferred to the licensee, who must also be permitted to reference in future FDA filings any prior filings by the licenser. Equally important, the licensee must be permitted access to consult with key employees of the licenser on formulation, scale-up, regulatory, and other issues. While both of these points may seem obvious, many licensers would like to view these transactions as simply intellectual property licenses with little or no downstream obligations.
The licensee (typically a small company) must have complete flexibility to choose whether and when to sublicense out certain aspects of the development and marketing process, without being burdened by the need to obtain the consent of the licenser (or to extend rights of first offer or refusal to the licenser, which will seriously chill the ability to sublicense). The start-up licensee should resist obliging itself to keep the licenser aware of development plans; such an obligation will get in the way of the licensee's (and its sublicensee's) legitimate interest in confidentiality. Finally, licensers might want, quite appropriately, to require reasonable commercial diligence by the licensee. On the other hand, their equally natural desire to fix development timelines-to ensure that their compound is developed speedily-is problematic, given the uncertainties of the drug development process (especially when the failure to meet these timelines causes revocation of the license).
More in-licensing deals have fallen apart over the issue of buyback rights than any other. Drug firms fear out-licensing an unknown blockbuster-the way Aventis SA outlicensed to King Pharmaceuticals Inc. the me-too, also-ran ACE inhibitor Altace, which went on, in King's hands, to become a major drug-thanks to new data from a trial Aventis had supported. Thus they want the ability to buy back the drug. In principle, the licensee should avoid granting this right. In effect, if the licensee does too good a job with the drug, it loses rights to it. And the provision also makes it difficult to sublicense the drug, reducing the company's strategic options. Indeed, a buyback provision can dramatically hurt the licensee's valuation as investors recognize their limited upside. On the other hand, drug companies often won't out-license a drug without such a provision-the reason so many deals fall apart. Thus the price of any such provision needs to be quite high, high enough to compensate investors for the potential loss of the incremental value associated with an unexpectedly successful drug.
The principal consideration paid by the licensee should be royalties on net sales, accompanied by an up-front payment and milestone payments tied to key regulatory hurdles (preferably payable at the licensee's option in its stock, which should appreciate in value as development progresses). Royalties should be payable on a per-country, annual basis in jurisdictions where patent coverage is in effect. Generic competition should lead to a reduction in percentage royalty rates. If possible, the licensee should try to negotiate up front for the right to buy out the royalty stream at a pre-determined price. Whatever the financial terms, the licensee should also be sure to factor in the cost of product liability insurance.
Hopefully, the licensee will be able to negotiate for the assignment of the relevant patents (and their progeny) instead of an exclusive license, since this will prevent "prior art" problems under the patent law down the road. Whether the patents are assigned or licensed, the licensee should in either event control the patent prosecution process, so that patent claims can be tailored to the specifications of the commercial product. It is also critical for the licensee to have the ability to control litigation against infringers and the defense of any infringement suits; sub-licensees will want reassurance that the licensee has this authority, instead of a distant, less committed licenser.
If an in-licensing deal is structured properly, it should offer the biotech company the opportunity to leverage the generally excellent quality of pre-clinical and patient data compiled by pharma companies. Then, with minimal overhead and infrastructure, the biotech can benefit from the growing community of CROs, contract formulation and manufacturing companies, and specialty CSOs. The pharma mega-mergers have freed up management with the requisite skills to manage these external resources cost-effectively. Just as companies such as Dura, Forest, Marion, and Roberts grew themselves around other people's drugs, the new generation of biotech in-licensers should be able to do so in a similar manner.
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