May 7, 2020

Chinese Cross Border Life Sciences Strategic Transactions in the Age of COVID-19

Increasingly in China over the past decade, corporations in the pharmaceutical, biotechnology and medical device sectors have supplemented their own internal research and development and business development efforts by participating in the equity funding of start-up and early stage Chinese as well as other Asian, U.S. and European companies which have over time been able to provide the corporation’s business with potential strategic and sometimes even financial gain.  In recent years, regulations in both China and abroad relating to currency controls, foreign investments into sensitive industries and other factors have complicated this strategy, but it has continued to be an important means by which innovation in the sector is advanced in China and more broadly throughout Asia and the world.

With the onset of the COVID-19 pandemic, there is an increasing urgency to finding solutions to the crisis, including through vaccine development and manufacturing innovations, medical device advancements, and technologies to better protect the populations such as diagnostic testing tools and tracing applications and software systems. Chinese and other companies in the sector are seeking innovative means to address the enormous challenges the world is facing. As a result, many have increased budgets to fund both investments into and partnerships with third parties developing or refocusing existing innovative programs to help bring an end to the pandemic. 

In order to effectively and efficiently deliver practical legal and business advice to the investment professionals within a corporate strategic investor now faced with overseeing these critical efforts, in-house counsel of larger Chinese domestic and multinational life sciences companies advising on these matters must be sure to consider a variety of important issues unique to these types of complex transactions.

In contrast to the limited involvement an in-house lawyer may have when working with a traditional investor involved in what generally is a one-off purely finance-driven venture capital investment decision, in-house counsel and their investment professional colleagues within corporate strategic investors often must provide ongoing legal and business guidance and support throughout the life cycle of a strategic portfolio company. In-house counsel advising a strategic investor must be prepared to provide legal services at all stages of the relationship, from assisting in the seed funding of small start-ups to advising on strategic collaborations or partnerships, to overseeing exit strategies as portfolio companies are acquired or undertake initial public offerings.

In addition, strategic portfolio companies often require advising on expansion capital rounds and structuring complex business arrangements and milestone-dependent future equity or debt infusions that may accompany strategic relationships, often with affiliates of the strategic investor itself. First-hand knowledge of today’s challenging life sciences business and legal market is crucial at each of these steps, as can be working relationships with traditional venture capital firms and third-party financing sources worldwide, such as venture lenders and royalty monetization funds, focused on the industry who also may be involved in these transactions.

The strategic nature of many corporate equity investments often also require increased scrutiny and analysis by in-house lawyers of ancillary legal issues that can accompany the strategic relationship, including intellectual property review, tax structuring, review of licensing arrangements, structuring employment and equity compensation matters, navigating complex FDA or EMA or multi-jurisdictional reimbursement-related regulatory environments, overseeing and understanding potential litigation, and sometimes even structuring around or advising on bankruptcy-related issues when a portfolio company finds itself in distress.

In addition, Chinese corporate investors placing money outside of the country into non-domestic investments must consider complex domestic currency control regulations, and rules in the jurisdictions of their target portfolio companies, such as the Committee on Foreign Investment in the United States (CFIUS) review process that can sometimes surface as an issue when investing into areas considered sensitive, such as convergence transactions involving life sciences and technology blended businesses; or involving complex artificial intelligence, or companion diagnostic software that may gather private information on patients in violation of European Union’s General Data Protection Regulation (GDPR) rules.

Corporate equity investors face a number of investment considerations unique from those of more traditional financial investors, such as venture capital or private equity firms. For example, the decision of whether or not a corporate investor should have a board seat on a private company it has invested in but may also have a strategic interest in is a question that needs to be carefully considered. In such cases, in-house lawyers may be asked to help implement internal structures that will shield their investment professional colleagues who could be assuming certain fiduciary roles at their portfolio companies, from their separate business colleagues who may potentially be engaging in ancillary activities as part of the corporation’s overall strategy that are competitive to the portfolio company. In-house lawyers working on these types of transactions must also be aware of the ability for their investment professional colleagues to opt for a non-voting board observer seat type role and to consider how such a position might impact the corporate strategic investor’s ability to monitor its portfolio company relationship, from each of a financial and strategic perspective. In addition, information received from portfolio companies, while useful in analyzing the value of the investment, can also result in unforeseen consequences on the strategic investor, including non-competition, securities law restrictions and CFIUS considerations.

Similarly, large corporate investors must structure their investments to be sure that certain standard provisions in investment documents are properly tailored to protect the corporation from reputational and financial liability. For example, it is critical to focus carefully on publicity and confidentiality provisions, to insure that a portfolio company does not use the corporate investor’s involvement to improperly promote its business or financing prospects in a manner that might lead to a shareholder suit or similar litigation if the business does not perform as promised. While the corporate investor is unlikely to be directly drawn into any such litigation, it presumably will not want its own reputation tarnished through its affiliation with a portfolio company.

In addition, it is critical to carefully review technical investment provisions, such as so-called “drag-along” provisions to make clear that the strategic investor will not have to represent to any subsequent buyer of the business anything about the business’ operations, or have an indemnity obligation that is uncapped or joint and several with other stockholders who may not have the same financial means as the strategic investor.

For corporate strategic investors, it often will be necessary for in-house counsel to implement unique investment provisions. Consider, for example, covenants that might need to be added to permit the strategic investor which is itself a corporation, unlike the partnership form generally used by more traditional investment funds, from having to consolidate its financial statements from an accounting perspective with those of its new portfolio company.

In-house counsel to corporate strategic investors often are asked to assist in preparing and putting in place investment approval processes, forms of confidentiality agreements that do not “taint” investment professionals or other business personnel who may be working within the investor’s greater business in areas competitive to a possible portfolio company, forms of equity investment and bridge loan documents, and guidelines for how to handle a distressed portfolio company that may be facing bankruptcy or litigation. These and other issues mentioned above take on additional importance as portfolio companies themselves grow and go public.  Working to standardize these processes and agreements facilitates and simplifies additional investments and the monitoring of existing portfolio companies.

Equity investments by Chinese and other corporate investors are increasing in the life sciences sector as companies in China look outside of their own organizations domestically, in Asia more broadly, Europe and the U.S. for innovative technologies and approaches to address the COVID-19 pandemic.  The increased investment activity means in-house lawyers and their business counterparts are increasingly needing to consider the unique issues for both the corporation and its portfolio companies that such investments raise.  In-house lawyers working, and advising their business counterparts, on these unique types of transactions must be well prepared to navigate and address such issues in order to achieve the legal and strategic objectives of their company’s business.

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Kristopher Brown, Wendy Pan and Yash Rana are partners in the Life Sciences and Technology Practice Groups of global law firm Goodwin Procter LLP, where they focus on venture capital, private equity, initial public offerings, M&A and complex licensing, collaboration and joint venture transactions, often involving the pharmaceutical, biotechnology and medical device industries.