The uptick in deals involving medical device companies raises unique issues for both buyers and sellers. Minding those issues on the front end of a deal can help dealmakers and their advisers avoid delays and negotiate transaction agreements that provide a road map for resolving post-closing problems.
1. Stage of Development
Two milestones particularly affect valuation and viability in medical device deals: regulatory clearance or approval, and the launch of commercial sales. Deals involving targets that have not achieved one or both of these milestones are more common in the medical device world than in many other industries. For these deals, the parties often structure the purchase price to share risks and bridge valuation gaps, using variable earn-outs based on post-closing sales, fixed payments contingent on achieving regulatory or commercialization targets, and minority investments coupled with acquisition options. These two milestones also affect due diligence. For example, pre-approval companies typically do not have many vendor, distributor or customer relationships, or other operational arrangements to review and assimilate into the deal. Also, intellectual property risks can be harder to evaluate, because third-party infringement and validity claims often arise only after commercialization. (Pictured: Derek Devgun, Medtronic, Inc.)
2. Intellectual property
Intellectual property is another key value driver and a primary focus of due diligence and deal negotiations. In addition to the normal review of patents, copyrights, trademarks, applications and procedures for protecting unpatented know-how, buyers will want to scrutinize any research, collaboration, and intellectual property licensing arrangements to understand their scope and economic impact on planned activities.
3. Regulatory environment
Obtaining U.S. Food and Drug Administration and foreign regulatory approvals and clearances can require significant time and effort. And any clinical trials, applications and regulator interaction will be reviewed in detail by buyers and their advisors. Due to differences in foreign regulatory regimes, medical device companies often commence commercialization outside the U.S., while simultaneously conducting studies and progressing along the FDA regulatory path. Although obtaining foreign regulatory approvals can be quicker, transferring them to an acquirer can be more complicated and time-consuming than transferring FDA approvals and clearances in the U.S.
4. Physician involvement
Medical device companies frequently purchase or license technology from the physicians who invented it and pay them to assist as consultants in device development. Because government reimbursement programs pay for medical devices prescribed by physicians, regulators require visibility into these payments so they can evaluate whether physician device prescription decisions are improperly influenced by payments from the device manufacturers. A buyer's due diligence review should cover the target's contracts with physicians and its compliance with state and federal physician payment disclosure requirements, as well as whether physician inventors on staff at universities and other institutions actually have the right to transfer or license their inventions to target companies. (Pictured: Jamie Snelson, Fredrikson & Byron)
5. Sales channel
If a target company's products are approved and available on the market, buyers will be interested in the strength and structure of the target's network of distributors, sales agents and sales employees. Strategic buyers usually dedicate significant time and effort to reconciling the target's sales organization with their own existing force. Third-party distributors and agents sometimes also hold foreign product registrations and inventory, which can complicate deal negotiations if the distribution or sales agent contract does not adequately address return of these assets.
6. Software and mobile applications
If the seller's medical devices run software, buyers will look to confirm adequate testing, access to source code and documentation, rights to use the software in the desired manner, and the ability to access and provide support and updates. Regulatory questions might also arise, because the FDA's regulatory authority extends to certain software applications for both separately regulated medical devices and for otherwise unregulated electronic devices, such as mobile device applications. This is an area of increasing activity by innovative companies, and the regulators' approach to it is still evolving.
7. Privacy and cyber security
Privacy laws such as the Health Insurance Portability and Accountability Act (HIPAA) in the United States and the European Union Privacy Directive impose obligations on device companies about the personal health information they obtained through clinical studies, product servicing or patient monitoring. The FDA has also issued many recent warnings about the cybersecurity vulnerabilities of medical devices, many of which are linked to hospital networks and remotely accessible from other points. A buyer's due diligence should include a review of the scope of personal health information processed by the target, along with the company's related compliance policies and procedures. If the acquisition target's devices monitor or use patient data, buyers are well advised to expand their information technology security diligence review to cover any potential and past breaches. (Pictured: Daniel Weintraub, Audax Group)
8. Anti-bribery enforcement
Over the past decade, U.S. regulators have stepped up their enforcement of the Foreign Corrupt Practices Act, and the U.S. Department of Justice has targeted the medical device industry for enforcement efforts. Similar anti-bribery laws have been enacted and expanded in other jurisdictions. Depending on the extent of the target's interactions in foreign countries, extensive anti-bribery compliance due diligence can be part of the acquisition process.
9. Supply chain
Many medical devices involve novel components manufactured using specialized processes and materials, and buyers typically require a detailed understanding of the supply sources. If any critical vendors are not easily replaced, their contracts should be reviewed to evaluate remedies in the event of a supply interruption. Suppliers and service providers sometimes also own intellectual property rights for a device or its components, and these rights should also be addressed in the relevant contracts.
10. Post-closing product liability
Even with federal pre-emption, product liability and warranty claims are common in the medical device industry, and resolving these claims can consume significant time and resources. A widespread device problem might require costly and complicated recall efforts. Acquisition agreements typically allocate responsibilities between buyer and seller for handling these problems.
Derek Devgun is a senior legal specialist focusing on mergers and acquisitions at medical device company Medtronic, Inc. Jamie Snelson is co-chair of law firm Fredrikson & Byron's life sciences and M&A practice groups. Daniel Weintraub is a managing director and general counsel at private equity firm Audax Group.