The dynamic life sciences venture capital scene presents investors with a high-risk, high-return proposition. While often faced with a number of challenges, such as limited sources of revenue and capital, to early-stage companies often without products on the market yet, there can also be significant opportunities, including expanding into new markets and jurisdictions, and expanding the scope for innovation and value creation in the life sciences sector. As investors are becoming increasingly global, the following are some key considerations for Asian investors.
In the life sciences startup scene, entire business models can be built around a product. It is therefore critical to consider protecting intellectual property (IP) at the outset before significant resources are invested. Amid a litigious landscape in the United States, businesses require robust patents to use as offensive and defensive tools with competitors.
Due Diligence and Patent Portfolios
IP due diligence often revolves around a freedom to operate (FTO) review to evaluate risk and other companies’ patents to determine if the target company overlaps with existing patents, including the United States and those from outside the United States. There should be diligence around each claim within a patent, of which there can be several, which determine its scope of each claim’s rights. However, it is worth noting that less can be more, as it is the quality of the claim and the claim construction that are important, rather than volume. There is a risk that if a patent is too broad, or even too narrow, others could supersede it.
Owned vs Licensed IP
Inventions, ideas, and formulations will likely have been transferred and assigned between a scientist and the company. It is important to document the ownership of IP through invention assignment agreements, employment agreements, and employee contracts. An FTO search could be even more paramount if former employees have not signed an invention agreement, as they may hold the patent. In the case of licensed IP, it could be exclusive or non-exclusive. An exclusive license can be tantamount to an IP transfer.
US venture investors often maintain close contact with private companies in a portfolio. There could be a combination of a regular cadence of board meetings, visits to physical onsite locations, and frequent communication with executive management.
Investors in Asia may experience some challenges in maintaining close contact given time zones and geographic distance. Often, Asian investors have a local team wherever the target company is in the United States. Language and cultural differences are also a consideration, particularly in technical conversations with scientists, where it is key to have an interpreter that is a field specialist. “Deemed exports” in export controls regulations may also prevent investors from access to certain information.
Life sciences is a heavily regulated industry, making it important to understand regulations and impact they will have.
Partnerships and collaborations are an integral part of the life sciences industry, from partnering with a larger company to develop a drug or medical device or private companies leveraging resources of a large pharmaceutical or medical devices company with leverage for distribution.
Government funding for early work is common, particularly for research. It can be non-dilutive and often does not need to be paid back. However, some capital—such as from academic institutions and other government grants—come with obligations attached, including march-in rights.
CFIUS is an interagency government committee that reviews foreign acquisitions of US businesses, as well as minority investments in US businesses and other transactions in the interest of protecting US national security. Scrutiny of non-US matters has intensified in recent years based in part on new statutory authorities. Participation by a non-US investor may cause a transaction to fall within the jurisdiction of CFIUS, and if so, the transaction could be restricted, blocked, or significantly delayed if CFIUS believes that a transaction raises US national security concerns.
Non-controlling investments by a foreign investor may also implicate CFIUS if the US company is engaged in a business involving “critical technology” that raises concerns from a US national security perspective. CFIUS can even unwind a transaction after it has closed if it identifies national security concerns that were unaddressed because CFIUS did not review the deal before closing. This authority, that has been in effect since 1975, could stifle future opportunities to invest in US life sciences companies in addition to creating reputational risks.
The Foreign Risk Review Modernization Act of 2018 (FIRRMA) is the latest comprehensive update to cross-border national security reviews and the statute expanded CFIUS jurisdiction to include certain non-controlling and nonpassive investments, as well as certain real estate investments. FIRRMA changed the filings from voluntary to both mandatory and voluntary, thereby creating a new class of cross-border investments that would be subject to required CFIUS filings. This new authority reflects a departure from the previous system in which all notices were voluntary.
It is key for companies to determine if they have “critical technology,” “critical infrastructure,” or “sensitive personal data” for CFIUS purposes. “Critical technology” analysis is heavily dependent on export controls classifications of a product, technology, software, material, or equipment. Without a sustainable export classification, parties to a cross-border investment are unable to determine whether mandatory filing requirements exist, thereby emphasizing the need for robust diligence in this area to limit any faults related to decisions on whether to file a CFIUS notice.
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