Medical Device Earn-Outs More Common As Buyers Hedge Bets
This article was originally published in Start Up
Executive Summary
A review of mergers-and-acquisitions data in our Elsevier Strategic Transactions database suggests that strategic buyers are more interested than ever in hedging their bets by structuring acquisitions around earn-out payments, which come due once the acquired company delivers on its promises.
No one particularly enjoys taking risks these days. A fair number of venture capitalists, for example, are increasingly basing their investment decisions upon how a company has mitigated and managed every conceivable risk facing start-ups today – technology, regulatory approval, and reimbursement. In exchange for safety, venture capitalists might be willing to invest a little more capital and accept slightly less frothy rates of returns on investment. Safety, like everything, comes with a price.
Corporate acquirers, not surprisingly, are equally if not more risk adverse. Clearly, large medical device corporations still find a rich source of innovation outside their own corporate walls. And they're willing to pay the price to secure what they see as the best opportunities for growth. But they're being cautious. A review of merger-and-acquisition data in Elsevier's Strategic Transactions suggests that strategic buyers are more interested than ever in hedging their bets by structuring acquisitions around earn-out payments, which come due once the acquired company delivers on its promises.
Clearly, sellers would prefer to avoid the structured earn-out, choosing to receive their full payment up front. And until 2008, when the wheels popped off the economy's wagon, sellers – venture capitalists or corporate owners looking for a spin-out – sat in the driver's seat at the negotiating table. In 2008, only 9% of the medical device acquisitions recorded in our database reported an earn-out clause, a considerable drop from the 20% in 2007. But the good times were short-lived. That percentage climbed to 13% in 2009 – although it's a bit of a surprise that it wasn't higher – and so far it's 31% year-to-date in 2010. ( See Exhibit 1.)
Strategic acquirers want to pay for performance. But the positive news for sellers is that while the number of deals with earn-out elements is rising, the percentage of the up-front payment also remains higher than in more recent years. ( See Exhibit 2.) The sample size is small, but buyers in 2010 are paying roughly 70% of the purchase price up front. Medtronic PLC, for example, agreed to pay $350 million for interventional cardio device developer Invatec SRL, with an additional $150 million set aside in earn-outs if certain milestones are reached. [See Deal] Unfortunately, although more than 40 companies were used in these figures, we didn't include deals where terms weren't available. Medtronic's acquisitions of CoreValve Inc. (now Medtronic CoreValve LLC) and Ablation Frontiers (now Medtronic Ablation Frontiers LLC) are among the few notable omissions. [See Deal] [See Deal]
With that caveat, we present a listing of the therapeutic categories with the highest number of acquisitions. It's here we see that companies in the cancer and cardiovascular fields, on average, draw the largest percentage of up-front payments, 81% and 84%, respectively. ( See Exhibit 3.) Companies focused on musculoskeletal areas tend to draw much less, only 56%, with the exception of Baxter International Inc., which paid 70% of its potential $330 million price tag up front to ApaTech Ltd., looking to snag exclusive rights to its artificial bone graft bone graft material. [See Deal] ( See "Baxter Spends Big on Apatech to Join Orthobiologics Fray," IN VIVO, March 2010 (Also see "Baxter Spends Big on ApaTech to Join Orthobiologics Fray" - In Vivo, 1 Mar, 2010.).)
– Tom Salemi