Avoiding the Train Wreck

When biotechnology CEOs get together, the conversation quickly turns to "working with Big Pharma." Few topics are discussed as passionately as surviving the due diligence process. Due diligence occurs when a large firm seeks to license a biotech company's compound. The process allows the licensor to verify the biotech's claims, assess the technology's value, understand third-party rights, and gain an accurate understanding of key issues that affect Big Pharma's ability to commercialize the compound. The biotech must conduct due diligence of its own to assess the commercialization resources of the large firm and choose the best possible partner.

If the process goes poorly, it can be a train wreck. Teams of large pharma managers collect irrelevant information, failing to ask important questions. Small firms send managers to potential partners and only hear what they already know. The longer the process drags on, the worse things get. The goal of both sides is to conduct due diligence in the most efficient way possible while collecting the information needed to make a "go or no-go" decision.

This article describes the "due diligence framework," a rigorous, structured approach for planning and implementing a successful due diligence process. The framework includes tools, metrics, and management techniques that help focus both companies' attention on technology development, competitive risks, and commercialization potential.

Building a long-term relationship between a pharmaceutical company and a biotech firm is an explicit part of the framework. A limited number of "best-in-class" biotech companies engage in innovative programs directly related to a large pharma's areas of therapeutic interest. These programs will produce a continuing flow of innovation, not just one compound. Big Pharma needs preferential access to this flow of compounds, not just the immediate target molecule.

With this in mind, the due diligence framework has four goals:

• Prepare both firms for the process by accurately communicating events, timelines, resource requirements, and outcomes.

• Accurately evaluate the immediate opportunity.

• Make the process as valuable to the licensor as it is to the licensee.

• Allow the pharma company to gain preferential access to the biotech's portfolio of compounds by allowing it to build a strong relationship with the target company.

The due diligence framework is an efficient process, but efficient does not mean quick and easy. There are no shortcuts. Efficiency takes the form of minimizing resource commitments and disruptions to ongoing programs while learning what each side needs to know. In other words, the framework converts normal due diligence root canal into a painless filling. The process has six steps:

1. determining what you need to know

2. assembling the due diligence team

3. preparing the partner for the due diligence process

4. managing interactions between firms

5. conducting due diligence on intellectual assets

6. using the collected information to create value for both firms.

Determining What You "Need" to Know

Everything begins with an accurate understanding of what you need to know. Before starting the formal due diligence process, managers at Roche, for example, evaluate the opportunity along the entire commercialization pathway, from research to sales and marketing. In particular, they assess four dimensions:

• scientific merit—the compound's technical merit and the appropriateness of the small firm's scientific approach to technical challenges

• strategic fit—the compound's fit with Roche's strategy and its R&D and commercial portfolios

• risk—including technical, manufacturing, regulatory, data package, and other elements
• value—the opportunity's net present value and strategies for sharing the risks and rewards between firms.

The bulk of this work is done before starting the formal due diligence process using the biotech's confidential information. Open questions are collected into a questionnaire and sent to the biotech firm in preparation for the due diligence team's visit.

Assembling The Due Diligence Team

The due diligence questionnaire informs the team selection process. Subject matter experts are drawn from internal and external sources. Although resource constraints affect large pharma's ability to field a team, these same constraints can quickly overwhelm the biotech firm. The challenge for both firms is to balance team members' due diligence responsibilities with their normal job demands. Senior management's role is to ensure that the due diligence team is staffed with highly qualified members who understand their roles and responsibilities and have adequate authority to carry out the task. Utilizing outside experts can help solve the resource problem.

The team selection process is directly related to building strong relationships between firms. Successful companies utilize as many firm managers as possible who will have ongoing alliance responsibilities if the agreement is signed. The due diligence process is a time of close interaction, giving team members from both sides the opportunity to build the interpersonal relationships that are so important to ongoing alliance success.

Once the team is in place, each side is informed of the focus and expectations of the due diligence process, the rules of engagement, and each member's legal responsibilities as a participant.

Preparing the Partner for the Process

An early responsibility of the large pharma team leader is to prepare the other side to participate in the process. This includes providing details such as defining data requirements and agreeing on how data will be collected and handled, where it will be kept, who will have access, and other related issues. Early preparation minimizes confusion and prevents misunderstandings.

This stage is another opportunity for relationship building. In recent years, companies such as Eli Lilly, Roche, and GlaxoSmithKline created specialized groups to facilitate alliance implementation when agreements were signed. Depending on the opportunity, large pharma management may introduce these implementation experts during the due diligence process to assess cultural fit, decision making style, and communication preferences. By actively participating in the due diligence process, these managers prepare key groups inside the large company to work with the smaller partner.

Managing Interactions Between Firms

The most sensitive stage in the due diligence process is assessing each company's proprietary intellectual assets. These exchanges are carried out under carefully crafted nondisclosure agreements and material transfer agreements. Although the content of these documents is outside the scope of this article, at a minimum they must describe each company's responsibilities to protect the other's proprietary information as well as each one's rights to use disclosed information.

In addition to these legal documents, each side must have a thorough understanding of key contact personnel on each side, including their roles and responsibilities. Each side must also agree to a common vision of the process, including actions for each stage and likely outputs. Gaining a complete understanding of the management process for the data room (a designated location where all due diligence input is maintained and monitored by both sides) is critical. Even when legal agreements and process understandings are in place, there are risks to sharing proprietary information, particularly as each side must disclose its proprietary assets to the other before signing the licensing agreement. This point is crucial. If the licensing agreement never occurs, each side possesses knowledge of the other's proprietary intellectual assets. Even more important, both companies are intent on commercializing this type of technology. It is easy to see how disputes can arise when a licensing agreement does not take place and one company sees the other bring a similar technology to market. With this in mind, both sides must balance the need to share proprietary information with the knowledge that the deal may not occur.

One preferred methodology is to begin with a clear understanding of what each side needs to know, then engage the other in a series of targeted discussions with very clear agendas. A goal of each meeting is to rapidly reach a go/no-go decision while minimizing the amount of proprietary information disclosed. This goal encourages each side to identify its deal breakers and share them with the other side. For example, when a large pharma company is assessing a small biotech's technology, the two companies' due diligence teams will create an agenda based on the following questions:

• What information about the biotech's technology must the pharma company learn to move to the next decision making stage?

• What complementary information about the pharma's technology must be shared with the biotech?

• Who is the responsible manager from each company?

• Which scientists and business managers from each company will attend the meeting?

• Where will the meeting take place?

• Do both sides agree on the agenda?

After the session, both companies reassess their interest. If warranted, another session is held to reveal the next level of information. This technique may not match the claim of firms that allegedly have 24-hour due diligence programs, but it is a superior way of controlling the release of proprietary information and minimizing overexposure if a deal falls through.

Conducting Due Diligence on Intellectual Assets

The framework's 550-question diligence survey covers the gamut of physical and intellectual assets. But the intellectual assets are the most difficult to assess. There are two types, those that are "hard" to assess and those that are "really hard" to assess. The hard category includes patents, trademarks, copyrights, and domain names. Their claims are captured in legal documents that are available to the public. Although reasonable men can differ on their interpretation and value, little is hidden from view. One complicating factor is the existence of agreements with third parties that grant rights to these assets. For example, many biotech compounds have their beginnings in university research labs. What rights does the university maintain to the technology and how will those rights impact large pharma's commercialization plans? When assessing these intellectual assets, due diligence team members should ask the following questions:

• Are the intellectual assets (for example, trade names and patents) registered everywhere the product will be sold?

• Are these intellectual assets encumbered or are they enabled by third-party agreements?

• Are all the third-party agreements that enable the intellectual assets being transferred?

• What additional third-party intellectual assets are needed to practice this technology?

• Are there known cases of litigation or notices of infringement?

• Have any intellectual assets been used as collateral?

• What third-party activities could lessen the value of these intellectual assets?

• What do the patent landscape and existing licensing agreements reveal about the licensors' intellectual assets and their value?

• What level of funding is the venture capital community committing to this technology? What are the results to date?

Armed with this analysis of the hard to assess intellectual assets, managers move to the really hard one: know-how.

The broadest definition of technical know-how is information that (a) is not patentable, (b) has been chosen to be protected as a trade secret, or (c) is not required in a patent disclosure. Nearly 75 percent of a patent's value is know-how. It is difficult to assess this information because it resides in people's minds. When evaluating know-how, managers need to consider the following:

• Are the key scientists going to transfer the technology and support its development?

• For how long and in accord with which agreements?

• Which third-party scientists (for example, consultants or university researchers) are needed to move the technology forward?

• How will large pharma managers protect biotech know-how during the course of the license?

• Is there any documentation of the originality of the know-how?

• Is the licensor willing to commit this know-how to paper and share it with the licensee?

Making the Process Valuable for Both Companies

Part of relationship building is openness and transparency. When the large pharma company shares its findings with biotech management, the biotech should be able to verify the accuracy of its conclusions. More important, biotech management benefits when the large company provides a candid assessment of its technical approach, data package, path forward, and other aspects of its technology and strategy. They can play an important role as inputs to the biotech's strategic planning process.

Two-for-One

The due diligence framework applies common sense to a sensitive business problem.

The most valuable due diligence efforts occur when both companies commit to the twin goals of assessing the opportunity and building a long-term relationship. When both parties clearly understand how the process works and to what ends, they conduct as much due diligence as possible using confidential information before an actual meeting takes place. They also undertake to build something of more lasting value through their efforts: a strong relationship not limited to a single opportunity.

Gene Slowinski, PhD, is director, Strategic Alliance Research, Rutgers University, and Dan Watson is senior partner, M&A and Alliances, Alliance Management Group, Gladstone, NJ.

Acknowledgment: The authors wish to thank Rutgers University and the Federal EDA University Center Program for their support of licensing research. The “due diligence framework” is a service mark of Alliance Management Group.