Royalty Monetization in an Era of Drug Pricing Pressure: How the IRA is Affecting Royalty Monetizations

The Inflation Reduction Act, signed into law in August 2022, enacted significant changes in the way the government treats certain prescription drugs under the Medicare program. Prior to the IRA, Congress left Medicare drug pricing to the drug manufacturers, pharmacies, and insurance plan sponsors to negotiate and expressly prohibited the government from “interfering” in those private price negotiations under the so-called “Non-Interference Clause” of the Medicare Modernization Act of 2003. 

With the IRA, Congress changed the pricing model for certain “high-priced” Medicare-covered drugs without generic or biosimilar competition (“qualifying single-source drugs”). Specifically, Congress directed HHS to establish the Medicare Drug Price Negotiation Program, whereby CMS selects top-spend drugs under Medicare for “price negotiations” to determine a Maximum Fair Price, or MFP, for the drugs. Unlike prior pricing reforms that operated at the rebate or formulary level, IRA negotiation sets a hard price ceiling that flows directly into product net sales. The MFP is intended to represent an “all-in” price net of rebates and discounts, potentially affecting how net sales are calculated under existing royalty agreements. Highly punitive excise tax penalties make non-participation in the IRA practically impossible, while legal challenges to the IRA’s drug price negotiation program have been unsuccessful to date. 

At the same time, continued capital market volatility, coupled with a costly, tightening, and oftentimes burdensome debt landscape, has driven royalty monetization transactions into the mainstream as life sciences companies increasingly seek non-dilutive financing alternatives to support drug development and related operations. Royalty monetization transactions, where a company sells or finances against some or all of an existing royalty stream (a “traditional” royalty monetization) or future revenues (a “synthetic” royalty monetization) to an investor in exchange for upfront cash, are priced on long-term cash flow projections – sometimes ten or even twenty years. 

Why are royalty monetizations different in this landscape?

Unlike equity investors, who can revalue their investment continuously as new information emerges, royalty investors have pricing fixed as of closing with limited ongoing mark-to-market ability. As a result, any subsequent negative development is fully absorbed without the ability to dynamically reposition. 

While certain negative developments, like generic or competitive entry, can be foreseen as part of the expansive patent and competitive diligence performed by royalty investors, the IRA’s Drug Price Negotiation Program is extremely difficult to model: only an early and limited dataset of negotiated outcomes exists at this point to anchor discount assumptions, and MFP determinations are made in an opaque, unpredictable, and highly subjective and fact-specific government process. 

Further, while the royalty monetization landscape has broadened over time to encompass early-stage products and products being developed by smaller biotechs, traditionally the royalty financing industry focused on royalties on “blockbuster” drugs. As a result, these deals are uniquely sensitive to structural changes, like the IRA, that cut to the heart of long-term revenue assumptions. 

Royalty investors have publicly noted that while they face portfolio-level exposure as a result of the IRA, they are protected by diversification as a mitigant; as portfolio scale becomes an increasingly important competitive advantage, we may see even more consolidation in the royalty investment space.

How will the IRA affect deal valuations?

Investors evaluating assets that may become subject to price negotiation should model multiple IRA scenarios alongside base case projections rather than, or in addition to, embedding IRA risk solely in the discount rate. Modeling MFP outcomes for a given drug is challenging given both the limited precedent data available and the unpredictability of price negotiations: HHS considers a number of factors, including R&D costs, production cost, federal financial support for the drug’s development, patent landscape, existing and pending exclusivities, comparative effectiveness against therapeutic alternatives and the extent to which the drug addresses unmet medical need. The rebate profile of an already-approved drug is also crucial in modeling: the royalty base of a drug that is lightly rebated and becomes subject to an MFP discount will be more impacted than that of a drug that is already heavily rebated. 

The distinction between small molecules and biologics in the IRA is also important. Small molecules become eligible for selection into the Drug Price Negotiation Program nine years after FDA approval, whereas biologics become eligible thirteen years after approval. The asymmetry between small molecule and biologic timelines is a critical deal valuation variable, as it significantly affects when IRA risk attaches to a given asset. The shorter period of immunity granted to small molecules has the effect of reducing valuations disproportionately for small molecules, as price negotiations for selected small molecules will often begin before the given asset has hit its peak sales timeline, significantly undercutting the period in which royalty cash flows should be highest. However, active legislative efforts are underway to eliminate the small molecule/biologic asymmetry by moving small molecules from nine to thirteen years (the so-called “pill penalty”), including pressure from the Trump administration in the form of an executive order directing HHS to work with Congress to resolve this discrepancy.

The IRA also contains several exceptions to eligibility criteria that have caused certain IRA-insulated assets to see spikes in valuation. Orphan drugs, for example, are exempted from IRA eligibility if they do not have any non-rare-disease approved indications, creating meaningful valuation differentiation for rare disease assets. Further, because drugs must exceed a Medicare expenditure threshold to be selected, we are increasingly seeing higher valuation premiums for drugs with predominantly commercial payer profiles.

Last, assets with strong projected ex-US sales are increasingly commanding valuation premiums over Medicare-heavy assets, coinciding with a sharp increase in the past several years in global cross-border royalty transactions. On the other hand, IRA negotiation could accelerate international price erosion if IRA-driven US price reductions trigger renegotiation of ex-U.S. pricing arrangements.

How should the IRA be addressed by investors in due diligence?

For drugs that are already approved, investors should ascertain the percentage of sales attributable to Medicare. If an investor is evaluating an asset approaching IRA eligibility, it may consider either reviewing existing Medicare utilization data through private data vendors or, if transacting directly with the party commercializing the product, requiring company data room disclosure as to Medicare utilization. 

While royalty investors always conduct due diligence assessments on the anticipated timing of genuine generic or biosimilar competition, that factor cuts both ways for assets facing IRA risk. While generic or biosimilar competition eats into sales, it can also mitigate IRA impact since a drug ceases to be a “qualifying single source drug” (and the MFP is removed) once such competition is actually marketed. Investors should be cautious: a manufacturer’s own authorized generic is not a permissible exit route from negotiation. CMS applies a “bona fide marketing” standard and has indicated it will deselect a drug only where there is evidence of meaningful competition. In other words, a generic or biosimilar is not “marketed” within the meaning of the statute where its availability is somehow limited or controlled by the primary manufacturer. 

For their part, companies should be prepared to thoroughly answer investor questions as to their pricing strategy in light of the IRA.

What protections can an investor seek in light of the IRA?

If an investor is transacting on an asset approaching IRA eligibility, it may consider risk-sharing via economic terms: for example, a contingent payment that is reduced or eliminated if the drug is selected for IRA negotiation within a defined period post-closing.

What protections can a company undertaking a royalty monetization seek in light of the IRA?

In synthetic royalty transactions, where companies will typically have diligence obligations, companies should take the IRA into account in negotiating those obligations, including in the definition of “Commercially Reasonable Efforts.” While profitability is generally included as a factor in the definition of CRE, companies will want to expressly call out the MFP and the effects of the IRA as factors that are able to be considered. 

Conclusion

The IRA’s drug price negotiation program represents a structural shift in the long-term revenue assumptions that underpin royalty monetization transactions, demanding more rigorous scenario modeling, targeted diligence on Medicare utilization and rebate profiles, and thoughtful contractual risk allocation between companies and investors. As the regulatory and legislative landscape continues to evolve (including potential resolution of the small molecule/biologic asymmetry and ongoing implementation of negotiation mechanics), market participants that build IRA exposure into deal architecture from the outset, rather than treating it as a residual discount rate assumption, will be best positioned to transact efficiently and price risk accurately.

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Contact Yasin Akbari (yakbari@goodwinlaw.com) and Matt Wetzel (mwetzel@goodwinlaw.com) to discuss. Learn more about Goodwin’s market-leading Royalty Financing Practice.

References:

Inflation Reduction Act of 2022, Pub. L. No. 117-169, 136 Stat. 1818.
Medicare Drug Price Negotiation Program and Medicare Prescription Drug Benefit Program, 91 Fed. Reg. 36,236 (proposed June 16, 2026) (to be codified at 42 C.F.R. pts. 423, 429).
Initial Price Applicability Year 2026 Guidance
Initial Price Applicability Year 2027 Guidance
Initial Price Applicability Year 2028 Guidance