EXCERPT

Chapter 5: Biotech-Pharma Alliances

The basic concept underlying these transactions is that the biotech company has developed a technology or potential product that the pharmaceutical company would like to acquire, essentially on a pay-as-you-go installment plan. These agreements – which are often referred to by the parties as “corporate partnerships” or “strategic alliances” – come in all shapes and sizes, from fairly minor transactions involving bits of technology peripheral to the biotech company’s primary focus, to major deals that can transform both parties: The small biotech company may, for the first time, have enough resources to develop the product, and the large pharmaceutical licensee could be adding a commercial blockbuster to its therapeutic pipeline.

In addition to the payment terms specified above, such as upfront payment, research funding, milestones, and royalties, the agreement would typically allocate specific control rights. That is, it would specify whether the biotech or the pharma company has the right to make certain kinds of key decisions in the future. For example, Lerner and Merges have analyzed a random sample of 200 alliances and have identified as many as 25 control rights that, depending on the companies relative bargaining positions, may be allocated either to the pharmaceutical company or the biotech company. These control rights can determine anything from the management of the clinical trials (for example, termination decisions) to intellectual property (for instance, ownership of core or derivative technologies) to the alliance governance structure, including whether the pharmaceutical firm is assigned a tie-breaking vote, equity stake, and corresponding voting rights. The allocation of such control rights is particularly important in environments that entail significant uncertainty because in those environments not all future contingencies can be anticipated and therefore accounted for in the initial contract.

 Most of the preceding discussion has been focused on the financial terms, as they are typically the primary motivation for the biotech company to transfer all or part of the rights of one of its few product opportunities to another company. But a considerable amount of time, effort, and bargaining – and much of the lengthy final agreement – is devoted to the issue of control rights. The theoretical models of incomplete contracts and control rights predict that the value created by the alliance would be greater if the biotech firm retains more control rights, especially for the earlier stages of research, because its knowledge about the product or the technology is likely to have a greater marginal impact on the success than that of the pharmaceutical company’s. Yet, a study of biotech/pharma alliances has shown that, in practice, the pharmaceutical company normally retains the vast majority of control rights, especially when the biotech is in a weaker funding position.

Does this mismatch between theory and practice matter? The answer appears in a subsequent study, which shows that, with respect to alliances formed during periods when there is a limited availability of external financing for biotech companies, the alliances not only assign more control rights to the pharmaceutical firm, but they are also less likely to lead to an FDA-approved drug than alliances signed in periods with a greater availability of funding in the public and private equity markets. It is not clear, however, that the pharmaceutical companies’ commitment to centralized internal decision making (as discussed at greater length in Chapter 7) will allow them to agree to assign critical control rights to small biotech companies.

Read More Great Content from The Business of Biotechnology

This is an article that has been published by Oxford University Press in the book From Breakthrough to Blockbuster: The Business of Biotechnology by Donald Drakeman, Lisa Drakeman, and Nektarios Oraiopoulos, published February 14, 2022.