1. Introduction
Since the end of 2023, the mergers and acquisitions (M&A) trend in China’s life sciences industry has garnered substantial interest. This trend was, notably, initiated by AstraZeneca’s announcement of its intention to acquire Gracell Biotechnologies, a Chinese innovative biopharmaceutical company, for up to US$1.2 billion. This acquisition marks the first instance of a Chinese innovative biopharmaceutical company being acquired by a multinational pharmaceutical company. A month after AstraZeneca’s acquisition of Gracell Biotechnologies, Nuvation Bio announced its acquisition of AnHeart Therapeutics through an all-stock transaction, one of the few all-stock deals initiated and completed by a NASDAQ-listed company for a domestic biotech company in recent years. Fangda advised AnHeart Therapeutics as external legal counsel from the start to finish of this major transaction.
The macroenvironmental trends that have precipitated this recent spate of M&A transactions in the pharmaceutical industry warrant serious consideration. As our readers will recall, there was a surge of activity in the years immediately following the epidemic’s onset, followed by a swift return to rationality and stability. At present, China’s innovative pharmaceutical industry and related markets are still mired in this first wave of an historic adjustment cycle. Effectively, we are at the bottom of the cycle and we can expect an upturn.
The downturn in China’s financing markets significantly impacted the cash flow of research and development-focused pharmaceuticals companies. Among the projects that we have represented over the past two years, many biotech companies have sought to enhance their financial resources through licensing partnerships and asset sales, forming alliances with larger pharmaceutical companies.
However, it remains to be seen whether this wave of M&A will become a sustained trend. The potential for Chinese R&D-oriented biotech companies to be “seen” as quality acquisition targets depends on various factors, including the level and landscape of competition in relevant fields, the progress and quality of their R&D, the choice of R&D direction and strategy, the pricing environment of China’s life sciences industry, the compatibility of their corporate structures with proposed deals, and their or their founders’ market activity. From a legal perspective, as a highly regulated industry, numerous challenges inherent in such transactions are capable of being addressed but are certain to require guidance from lawyers who are well versed in the sector and with deep experience of such transactions. Fangda can provide just such a service.
2. Key Aspects of M&A of Biotech Companies in China from a Legal and Regulatory Perspective
M&A transactions of biotech companies are often complex, involving multiple legal concerns and commercial arrangements. This section focuses on four key aspects affecting mergers and acquisitions of biotech companies from a legal perspective: equity structure; intellectual property rights; pipeline product review; and compliance requirements.
I. Equity Structure Considerations
In general, if the parent companies of both parties are located in offshore jurisdictions (e.g., many biotech companies with their main business operations in China would opt for the Cayman Islands and the BVI as their holding company registration locations), the legal system is generally more flexible, enabling a shorter transaction timetable with fewer regulatory processes. However, transactions involving parties from different jurisdictions may face more constraints. For example, if the acquisition target is a domestic company and the acquirer is an overseas entity, regulatory or filing issues may arise with various authorities such as the Commission of Commerce and the Administration of Foreign Exchange.
Moreover, an existing shareholders’ agreement may include restrictive provisions on takeover transactions, such as the commonly seen “change of control” clauses which require consents from key shareholders for events that constitute a “change of control”. Such events may also trigger the liquidation distribution mechanism under preferential liquidation clauses.
What this means is that prior to the implementation of an M&A transaction, it is necessary for each party to bring in its legal counsel to review and assess the respective shareholding structure of the parties, the legislation applicable in the relevant jurisdiction and the existing shareholders’ agreement and the articles of association, and to formulate a complete transaction structure and a detailed transaction plan. All of these will help clear the way for the subsequent advancement and smooth execution of the transaction.
II. Intellectual Property Rights
The healthcare industry is highly dependent on knowledge and technology. As the key competitiveness differentiator and major assets of biotech companies, intellectual property (IP) becomes the core focus for M&A transactions of such companies. The legitimacy and stability of the target company’s IP rights, potential IP infringement risks and other related concerns will significantly impact the success of an M&A transaction, and is certainly the area that a potential acquirer will pay most attention to during the due diligence investigation.
IP due diligence includes regular due diligence steps such as verification of the origin, ownership and status of IP rights to ensure clear and undisputed ownership, while an in-depth analysis of patentability, stability, and freedom to operate (FTO) assesses the progressiveness and stability of the IP. Specifically, the patentability analysis goes to the possibility of patent grant of the unauthorized patents while the stability analysis evaluates the likelihood of an authorized patent being invalidated. In recent years, the proportion of patents being invalidated has been relatively high, and cases of core patents for blockbuster drugs being declared invalid by the China National Intellectual Property Administration (CNIPA) are not uncommon. FTO analysis focuses on investigating whether the technology implemented by a company infringes the patent rights of the others, guarding against unexpected “shocks” at the post-closing stage.
III. Pipeline Product Review
A comprehensive review and arrangement of pipeline assets is also a key step in M&A transactions. If a certain pipeline product is subject to an upstream licensing arrangement, it is vital to assess the stability of the upstream license (e.g., whether there are any existing defaults or other circumstances that may lead to the revocation of the upstream license). In addition, the non-compete arrangements, firewalls, and change of control clauses commonly seen in the upstream license agreement could have a significant impact on the M&A transaction.
Taking the non-compete obligation as an example, in addition to the customary non-competition obligations under upstream license agreements which restrict the development, manufacturing or sale of competing products, there may be additional restrictions on acquisitions. For example, the upstream license agreement may specify that if a party is acquired by a third party engaging in competing business, the third party may be required to divest the relevant competing business or set up “firewalls” to maintain the independence of licensed products and technologies. Therefore, if the pipeline products of the target company involve licensing arrangements, it is crucial to scrutinize any non-competition clauses that may impact the business layout and planning of the acquirer and the post-acquisition target company.
In addition, as the M&A transaction will result in a change of control of the target company, if there are change of control clauses under the upstream license agreement, corresponding requirements, such as notification to, or obtaining written consent or waiver from the relevant parties in accordance with the license agreement, should be completed prior to the M&A, so as to avoid the breach of contractual obligations under the upstream license agreement.
IV. Compliance Requirements
Given the robust regulatory framework governing the healthcare industry, it is crucial to ascertain the target company’s compliance status and identify potential compliance concerns arising from the M&A transaction. Evaluation of M&A risks and formulation of an optimal transaction structure requires attention to three key compliance areas: anti-corruption compliance; human genetic resources compliance; and anti-monopoly compliance.
A. Anti-Corruption Compliance
In the recent past, China has intensified its efforts to crack down on corruption in the biopharmaceutical industry. In the context of an M&A of a biotech company, the failure of the acquirer to effectively identify the corruption or bribery risks involved in the target company may result in subsequent liabilities and losses which the acquirer has to bear. Accordingly, the acquirer should meticulously assess the compliance risk of the target company, conduct comprehensive anti-corruption compliance due diligence, and make adequate arrangements in the transaction documents that dictate the consequences and damages should there be a breach of compliance obligations by the seller(s)/target company.
b. Human Genetic Resources Compliance
When it comes to human genetic resources, China’s legal and regulatory framework imposes rigorous constraints on foreign organizations or institutions formed or controlled by foreign organizations or individuals (each referred to as a “Foreign Entity”) with regard to their activities relating to these resources. Such constraints include: (1) in the event that a Foreign Entity needs to use China’s human genetic resources to conduct scientific research, it must cooperate with Chinese entities and obtain approval for international cooperative scientific research or complete prior filing for international cooperative clinical trials; (2) where information on human genetic resources is provided to a Foreign Entity, prior filing is required and backup information shall be submitted, and a further security review is mandatory in the event that such information sharing may affect China’s public health, national security and public interest. Consequently, if the target company is designated as a Foreign Entity under the human genetic resources regulatory system following the closing of an M&A transaction, the reporting and approval obligations relating to its human genetic resources-related activities will diverge from those that were in place prior to the M&A. It is therefore essential to give due consideration to the potential implications on the specific business model arising from the changed route, and make timely adjustment of the arrangements for the relevant research activities and to fulfil the corresponding reporting and approval obligations.
c. Anti-monopoly Compliance
The anti-monopoly enforcement authorities always keep a close eye on the healthcare industry, and M&A transactions, which fall into the category of “acquiring control over other undertakings by acquiring their equities or assets”, might need to file a declaration of “operator concentration”. It is of paramount importance to ascertain during the legal due diligence whether the target company has engaged in any actions that may be construed as monopolistic practices, such as fixing or restricting resale prices; if so, contractual arrangements aiming at providing adequate remedies in the event of any breaches should be put in place under the transaction documents.
3. Brief Analysis of Pros and Cons of the Alternatives to Equity Acquisitions
Biotech companies looking to expand their business usually rely on equity acquisition as a pivotal strategy. The acquirer secures the core assets of a target company by purchasing its equity or shares. Except for a target company which is a single-asset entity, the normal equity acquisition model entails inheriting all assets (including some inferior assets) and liabilities of the target company, unless it is otherwise agreed in the transaction documents or specific carve-out arrangements are tailored for certain assets or liabilities. In some cases, therefore, a 100% equity acquisition may not be the optimal choice for the acquirer to achieve highly strategic synergy.
Considering the above, the ���NewCo” route model has re-emerged as an attractive alternative for biotech companies and their investors. A case in point is Hengrui Pharmaceuticals’ strategy in May 2024, where it licensed the ex-China rights of its GLP-1 innovative drugs to a newly established American entity, Hercules, in which it holds a non-controlling stake. Under the “NewCo” model, a company licenses the overseas rights of its core products to a newly established overseas company (NewCo) and receives equity in the NewCo as part of the licensing consideration. This model allows for asset appreciation and monetization through NewCo’s potential overseas listing or equity sale, offering a streamlined equity structure and clear asset ownership, thereby providing greater flexibility, as well as convenience and imagination as compared to traditional equity acquisition and licensing transactions.
Licensing and cooperation agreements serve as a vital conduit for biotech companies to swiftly bolster their cash flow, and continue to account for a significant portion in a tightening external financing environment. Specifically, the licensor licenses the product pipeline and related IP and commercialization rights to the licensee through a license agreement, which allows the licensee to carry out subsequent development and commercialization within designated territories. Such a transaction serves the purpose of cooperation on a specific product pipeline within a limited scope. For biotech companies, out-license of key products or technology-related rights and interests provides immediate cash flow to fuel ongoing R&D efforts in critical areas. However, such a transaction may not be appropriate for investors aiming for a complete exit from their biotech investments.
IV. Conclusion
The landscape of pharmaceutical M&A in China is intricate and multifaceted, especially in the context of globalization, where different acquirers bring distinct perspectives and strategies to M&A transactions. Multinational companies often opt for all-cash transactions (or with the major portion of consideration being cash) to rapidly expand their product portfolios, as demonstrated by AstraZeneca’s acquisition of Gracell Biotechnologies to expand its cell therapy pipeline with a total transaction value of about US$1.2 billion. In contrast, biotech companies with relatively abundant cash flow seeking acquisitions for strategic expansion may prefer transaction models other than all-cash transactions for a variety of reasons. Nuvation Bio’s stock-for-stock acquisition of AnHeart Therapeutics, as mentioned above, exemplifies this trend.
M&As of biotech companies are full of challenges. Navigating the complexities of pharmaceutical M&A requires not only effective strategic objectives but also the collaboration of internal and external professional consultants to carry out meticulous due diligence, transaction structuring and deal execution.
If you would like to know more or to make contact with one or more of our experts, please contact any of those listed below:
Josh SHIN
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Chen LU
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Henry HE
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