Recent Developments in Biotech Reverse Mergers

Transcript

Tony Chan:
Hi, I'm Tony Chan. I'm a partner in the Life Sciences Group here at Orrick.

Dave Schulman:
And I'm Dave Schulman. I'm a Life Sciences partner and we're both based in Washington, DC.

Tony:
And we're going to be talking about a new transaction structure that Dave has done a couple of transactions in over the last couple of months. So, Dave, would you like to tell us a little bit more about what you've seen in these deals?

Dave:
Since the end of 2023, valuations have come from historically low pricing valuations for public biotechs and sort of as a reaction as the public company markets have started opening up, there have been a number of publicly traded biotechs that have been looking to, as you know, Tony, to combine with privately held biotechs. And as part of this transaction, one of the structures has been to negotiate mergers and to effectively accelerate the process so that you sign and close these transactions. And maybe we can run through some of the reasons why people do it and also some of the features.

Tony:
Yeah, so why are people looking at this, both from the public company side as well as the private company side?

Dave:
So, the public company biotechs, so maybe, because I know you and I were in a meeting last week, there are roughly a hundred or so publicly traded biotechs that are trading below cash. That was probably closer to 400 back in December. Those biotechs, many of them either have discontinued programs or in what people referred to as the data desert. They have programs, they're still ongoing, but they don't have anything exciting to offer. And it makes it ever more difficult to try and tap the markets for those companies. They're looking to combine both management teams and their pipeline expertise with the privately held biotechs. And the idea is, among other things, that at least for those privately held biotechs, they're going to have more opportunities to do releases of data, showing progress, and being able to tap the capital markets.

Tony:
Interesting. So, it's like the public companies have maybe come to a place where they're maybe not as dynamic or exciting, and they're looking for a way to revitalize themselves in some respects.

Dave:
Yeah, I think that's exactly how people are looking at it. And so, there are a number of bankers and lawyers who are trying to help the investors of those privately held biotechs. Many of them are very well-known private equity and venture capital firms that are recognizing that, for example, if you have a privately held biotech, it's going to make it ever more easier to be able to attract capital if you consolidate the management, take the same base of, if you will, overhead and spread it across a much larger base of pipeline opportunities. And like everything in life, science isn't linear, but you're increasing the chance that something good is going to happen. And there are a bunch of public investors who are just not prepared to put money behind privately held biotechs.

Tony:
Interesting. So, you end up with a combined company that has a larger portfolio of products, maybe of differing timeframes. And part of this I understand is also that they maybe add in some financing as well. So, maybe let's talk a little bit about what the transaction structure looks like. So, if a company is thinking about doing this, what actually happens in this transaction structure?

Dave:
So, the first dating item is, in order to do sign the merger, announce the merger, and close the merger, same day, for that public company.

Tony:
The public company buying the private company.

Tony:
That's exactly it. And for a deal lawyer and banker looking at it, that public company is still going to be the holding company. It may rename itself. In fact, on a number of these deals in the last several years, they have renamed themselves to give themselves sort of to recognize they have a different pipeline focus. But what you have to do in order to continue to be able to be listed for trading on NASDAQ, you need to deal with Rule 5635, which among other things sort of says, you cannot issue privately held unregistered shares more than 19.9% of the outstanding common. And so, what that immediately forces you into when you're trying to accelerate and sign and announce the closing of the deal is the rump, the remaining portion above and beyond that 19.9% ends up being in a non-voting convertible preferred.

Tony:
Okay. Interesting, so you've got the public company as the acquirer, and they basically tell the target company that's the private company, "We're going to buy you in exchange for shares of preferred stock and common stock. We end up owning 100% of your company, and you get some percentage of our public company."

Dave:
Yeah, that's exactly it. And the legacy shareholders have to vote to approve the deal. And so, there typically will be a special meeting, or you can roll it into the next annual meeting. The way you win your way through the process in order, once you have the, typically for a large enough deal, two years of prior audited financials for that private biotech together with a pro forma, you'd typically have that shareholder meeting of the legacy shareholders of the public company within about four or five months. And once that approval comes through, the shareholders of the private biotech will be able to convert subject to certain blocker caps from the preferred, the non-voting preferred down into the underlying common.

Tony:
Okay. Interesting. And so, there's that component, but then my understanding is that there's frequently additional investment that's done alongside that?

Dave:
Yeah. And so, at the same time, so for example, we just finished working on Onconova, did this exact structure, and announced it last week, and two private equity VC shops, OrbiMed and Torrey Pines, they were the largest shareholders of the private biotech Trawsfynydd. And they ended up, when the dust settled on a fully diluted basis, having roughly 80% of the underlying common stock, they put in 14 million in an immediate pipe. All of these deals typically contemplate having much larger pipes assemble after you make the announcement. And this is just, as you know, Tony, because dealing with all these companies, the problem is, as you're developing drugs, you have a mismatch. The drug will take eight to 10 years if you're lucky, if it's safe, it's effective, it keeps going. Eight to ten years if you're fortunate enough to be approved. But unfortunately, the mismatch durationally is, these biotechs rarely have more than one and a half to two years of financing. And so, this is just a means to usher in more capital to continue these preclinical and clinical development programs.

Tony:
It sounds like this is, I mean, there's upside for both parties, right? The public company gets more shots on goal, they get new products in the pipeline, they get additional financing, the private companies get access to public markets, they get additional financing as well. What are some of the challenges? Like, why would companies not do this?

Dave:
So. And again, the challenges for the middle and lower end of the publicly traded market with some of these biotechs, the shareholder base is always going to be concerned about dilution. So typically, a lot of these companies will have sort of three pathways. They can continue as is, and continue to do at the market, public offerings. And so, it's, if you will, death by a thousand cuts as they do one 10 to 20 million series of injections that dilute the existing shareholders. The second is to do an M&A exit, unless you have really exciting proof of concept data, that door is usually not open in a way that provides value. And the third way is this way, which is you sort of, rather than having to exit immediately, rather than doing death by a thousand cuts with the year to year dilution to try and keep enough cash on the balance sheet to keep operating. This is, you're combining portfolios. You're typically reducing the overhead with management. You're certainly spreading it over a larger base. And you're inviting just a whole new cadre of investors to come in. And it's like everything in the biotech space. Science isn't linear. Your lead program that you think is exciting next year, certain data tells you you've hit a dead end. And by widening this approach, you're giving the biotech more leeway to try and fund its existence.

Tony:
And you've done two of these, and it sounds like there have been a number of these in the market. Would you say this is a trend?

Dave:
Yeah, there are a number of deals. I mean, it's getting to the point now where NASDAQ is... So we're only going to speak about the public biotechs that have existing programs, so not shell companies. Let's skip those. For those biotechs which have existing programs, this is getting to the point where the SEC recognizes that this is just part of the business combination process. It's not a backdoor way of going public. And equally, NASDAQ, again, for these biotechs which have existing programs, has effectively given a green light into how you can approach this, right down even to the point of using the NASDAQ rules where the new shareholders, they'll have a proportionate right to have representatives on the board without taking control of the board.

Tony:
Let's say that either a public biotech or a private biotech is thinking about this. Is there something you tell them as they're thinking about, "Okay, is this the right kind of transaction for me?" As you're thinking about, "Okay."

Dave:
Yeah, so and you know this, Tony, from the work that we're doing for pharmas and biotechs. You have to constantly take hard looks as a board. What are your strategic alternatives rather than just continuing the same playbook? And it's part of that ongoing review that good governance requires boards to be thinking about in terms of strategic imperative. It's just another newer opportunity for thinking about if you can't be able to tap the markets for 60 or 80 million of equity, if you can't do an M&A exit immediately because you don't have the proof of concept data that's exciting enough to get some of the pharmas we work with to step in. If you can't get a licensed deal, which once again requires really exciting positive data or some other scientific insight, this is another way to sort of continue the development. And just to be very clear about it, a lot of these deals, people do hive down their personnel. They hive down personnel, but this isn't anything. There have been a bunch of VCs have been making some very difficult decisions, which you can speak to about how you have to figure out how far down the list do we continue to fund and below that we need to think about other things.

Tony:
So it sounds like it's just another option that companies can consider, especially since it sits in kind of an interesting place in the life cycle of a company where other alternatives may not be as attractive as a way of creating value and continue to develop their programs.

Dave:
Yeah, that's exactly it. And then what we've been doing for a number of biotechs is sitting down, and as you say, there's some biotech boards who conclude, "You know what? That's interesting. It's just not right for us yet." We can continue to tap the equity markets as a public biotech. There's some private biotechs that equally are saying, rather than do the combination, because in share-only mergers, at some level, you have to put a valuation on the public company and the private company. You and I are both way too familiar with dealing with CVRs. You can speak to that right now. Maybe just to explain how that sometimes takes a little bit of the pressure off of allocating hard numbers to two biotechs.

Tony:
I think that's a very good summary. So it seems like, it may not be for everybody, but it could be a compelling option for parties that are in the right space at the right point in their life cycles as well.

Dave:
Yeah, I agree with that.

Tony:
Okay. Well, this has been a really interesting conversation. Thanks for taking the time to speak with us about this.

Dave:
Enjoyed it.