Date: 2024-04-28 Page is: DBtxt003.php txt00020924
Financial Planning
PwC
What pharma and life sciences companies should know about monetizing existing products
Peter Burgess
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Original article as PDF: PwC-Monetizing-pharma-and-life-sciences-products
What pharma and life sciences companies should know about monetizing existing products
Observations from the front lines
Pharmaceutical, biotech, medical device and other life sciences companies (collectively, “PLS companies”) are increasingly looking for creative ways to raise capital and fund their core operations. With increasing frequency, PLS companies have considered monetizing revenues from existing products. Cash flows ring-fenced to support these monetization transactions may include royalties generated from prior out-licensing arrangements and sales or profits from an approved product.
Parties seeking to enter into these types of transactions span organizations across the R&D lifecycle, from large pharmaceutical companies to smaller biotechs as well as medical research programs at large universities. While these monetization transactions are not a cheap source of capital, this type of funding has the advantage of avoiding potentially more significant dilution (and potential loss of control) with equity raises and restrictive covenants with debt issuances.
The increasing frequency of these transactions is driven, in part, by a growing market of investors that specialize in this asset class, one which has portfolio diversification benefits while providing an attractive return in a yield-starved market. As product offerings and market participants in this space continue to grow, PLS companies are afforded the opportunity to explore another avenue of raising capital to fund R&D projects and other growth opportunities.
These monetization arrangements generally apply to approved products. PLS companies exploring monetization of R&D projects must consider a different set of structural matters and accounting guidance.
Common structures for royalty monetization
- Out-licensed IP ... Commercializing a drug
- Out-licensed IP ... Intellectual property
Why it matters
For PLS companies (the sellers of future royalties or sales), the accounting for a monetization transaction could take many forms, from recognition of an upfront gain to recognition of a financial liability and associated interest expense. Transactions structured as a “royalty sale” in legal form may not be recognized as a sale from an accounting perspective (“sales accounting”). In our experience, getting to sales accounting is difficult and rarely achieved, in particular when the seller of the royalty retains the IP underlying the royalties.
PLS companies may prefer to show “deferred income” rather than a financial liability for the upfront cash received if sale accounting cannot be achieved. However, these arrangements may include puts and calls which typically preclude deferred income accounting. Financial liability accounting is complicated by consideration of embedded derivatives and complex cash flow modeling required for interest expense recognition.
Changes in expected cash flows could result in immediate P&L impact depending on policy elected for subsequent measurement. To the extent that the upfront cash needs to be recorded as a financial liability (debt), companies will need to assess the impact for debt covenants and related covenant ratios.
These transactions often involve multiple elements. For example, the buyer may also purchase equity in the seller as part of the deal. The requirement to allocate value to multiple units of accounting may require PLS companies to engage third-party valuation specialists.
These transactions and their varying terms create financial reporting complexities for the funding parties (buyers in the monetization transaction) as well. The table summarizes financial reporting issues typically faced by buyers and sellers:
- Potential financial reporting impacts for a buyer Potential financial reporting impacts for a seller
- Determining whether the purchase is a financial asset or an intangible asset
- Determining whether a derivative (or embedded derivative) must be recorded for any contingent payments
- Determining how to appropriately forecast cash flows to measure the asset and recognize interest income if a financial asset
- Determining whether the asset is subject to the current expected credit loss (CECL) model (see How CECL can affect deals), and if so, how to measure expected credit loss if a financial asset
- Applying the appropriate derecognition model if the right is sold if the royalty acquired is a financial asset
- Determining whether the transaction is:
- Sale of an intangible asset (gain)
- Deferred income (liability)
- Financing/debt (liability)
- Determining the appropriate subsequent measurement model for any liability recorded based on the substance of the transaction
- Determining whether a derivative (or embedded derivative) must be recorded for any contingent payments
- Presentation of a portion of the financial liability as current
PwC has experience advising companies on both the buy and sell sides in a wide range of royalty monetization structures. We offer a dedicated cross-functional team with deep industry insights to help your organization navigate those complexities. Our support includes, but is not limited to:
- Advising on deal structures and options;
- Developing a playbook to evaluate the financial reporting impacts under US GAAP and IFRS;
- Providing commercial diligence on the drugs underlying the targeted royalties;
- Analyzing contractual terms in proposed agreements;
- Advising on valuation considerations;
- Advising around the financial reporting controls; and
- Advising around tax impacts.