Earnouts, milestones, contingent value rights. Call them what you will but the use of these potential future payment clauses is rising across M&A to bridge the valuation gap, particularly in the biotech space. One problem: almost all of these triggers never hit. Here’s why.
The use of earnouts, generally, is booming as dealmakers are grappling with a stubborn stalemate over valuations and uncertainty over future performance. SRS Acquiom, a Denver-based deal advisor, found earnouts in 21 percent of all its 2022 deals, the highest rate since 2017.
A new American Bar Association survey of public companies involved in private company deals found a 30 percent increase in earnouts from 2020-2021 to 2022-2023, says Tatjana Paterno, a partner at Nashville’s Bass, Berry & Sims. Paterno is a member of the ABA subcommittee that managed the survey. The survey found that 26 percent of 2022-2023 deals examined contained at least one earnout provision.
“The use of earnouts traditionally goes up during economic uncertainty,” Paterno says.
One industry particularly noted for these types of structures is the biopharma space. Nine out of 10 biopharma transactions these days include one. Now, with older deals maturing, one study shows that the majority of commercial milestones are missing their mark.
One big reason, says SRS Acquiom senior director Kip Wallen, is that many biopharma milestones can be more about marketing than achievable.
“Commercial milestones can be a major component of the big numbers seen in press releases,” Wallen says.
Some recent examples:
- In October, United Therapeutics announced it would pay about $91 million in cash for Miromatrix Medical, a Research Triangle, N.C. company attempting to genetically engineer pig organs for transplants in people. The deal included an additional $49 million if a genetically engineered pig kidney is implanted in a human by Dec. 31, 2025.
- North Chicago, Ill.-based AbbVie’s deal announced last month to buy San Francisco biotech Mitokinin for $110 million includes $545 million worth of milestones.
- This past summer, Swiss drug giant Novartis announced it would buy San Diego-based DTx Pharma for $500 million in cash, plus an additional $500 million in future payments if certain milestones were achieved.
“These commercial milestones often have very astronomical goals and when they hit, they hit big,” Wallen says. “But most don’t.”
A significant number of biopharma milestones are paid only after a drug hits $1 billion in annual sales. A lofty goal, considering the rarity of hitting that revenue figure. Many biopharma deals are for companies without any products on the market, which require FDA approval after costly and time-consuming clinical trials.
SRS recently released a study of 383 deals it advised on since 2008 in medical devices, diagnostics and biopharma. Some 272 of them, or over 70 percent, included an earnout. The aggregate upfront cash was $70.6 billion while earnouts promised a combined $74.1 billion.
Some 40 percent of the deals’ aggregate value, or about $25 billion, had milestones pegged to $1 billion in annual sales.
While all three categories reported achievement rates under 50 percent, the 128 biopharma deals performed the worst in terms of achieving milestones. Milestone payments were included in 91 percent of the biopharma deals. Only 22 percent have paid. Many of those are tied to research advances such as launching clinical trials to test drug candidates in patients before applying to the FDA for marketing approval.
Wallen says those types of earnouts have a better chance of hitting than the ones tied to commercial goals.
Earnouts tied to revenue targets only hit three percent of the time, underscoring the experimental nature of the sector. Many deals, for instance, include earnouts for a product that exceeds $1 billion in annual sales, a lofty and longshot goal.
Wallen says he expects the failure rate to continue, especially as deals increase the number and complexity of earnouts.
Robert Masella, a partner at Goodwin Procter who represents life science companies, says the industry is more complex than other industries. The regulatory environment is more challenging and the fickle nature of science makes valuations difficult. Nonetheless, disputes between buyers and sellers are stalling life science deals, similar to other sectors. Including earnouts helps break that impasse.
“Milestones will always be something that can help bridge the valuation gap,” Masella says. “More are being discussed every day.”