Biopharmas love to break the news of an M&A deal with a splashy number. There’s the upfront fee, then milestones and other payments tacked on down the line. A new report suggests that commercial milestones currently represent as much as 40% of the so-called earnout potential for deals in the biopharma space—adding up to about $25 billion in potential cash available for sellers. But how much of that is actually paid out in the end?
According to a new report from M&A financial services company SRS Acquiom, not very much. The majority, or $15.3 billion, of this potential is wrapped up in commercial milestones linked to product sales of $1 billion or more. So, if a drug from a purchased biotech never reaches that sales milestone and that particular caveat was included in the deal, that money may never be received by shareholders.
Biopharma is seeing lower achievement rates on these commercial milestone earnouts, according to Kip Wallen, senior director for thought leadership at SRS Acquiom. When compared to other sectors in life sciences, such as medical devices or diagnostics, the disparity in biopharma is “more dramatic,” he told Fierce Biotech in an interview.
Wallen estimates that the commercial milestone earnout achievement rate is just 3% this year. The overall biopharma achievement rate is only 22% by events and 16% of earnout potential. This compares to 34% for both measures recorded in 2021.
SRS Acquiom has worked on deals for many of the biggest names in pharma like AbbVie, Astellas, AstraZeneca, Vertex Pharmaceuticals, Eli Lilly and Johnson & Johnson. The deal term data come from 383 deals, including 272 that had an earnout.
“They get to put those numbers in their press release announcing the deal, but now this data is coming home to tell us that, [while] that upside did exist when they closed the deal, those sorts of things rarely hit,” Wallen said.
With such a low return rate, why do companies keep agreeing to these milestones?
“If they hit, they're really lucrative earnouts. And they add a ton of potential upside to the post-closing side of the deal via the earnout,” Wallen said. “But we're just not seeing achievement rates.”
Also, when a small company seeks an M&A exit, the executives and scientists may want to stay with the drug through the development process. So having milestones involved can keep them engaged and driving toward success, Wallen explained.
“It's motivation for the sellers, particularly if they're gonna stay on board and continue to develop the drug that the buyer now owns, right? They're motivated, knowing that, hey, if this ends up being a unicorn, billion-dollar sales drug, we'll see some of that upside,” Wallen said. “The likelihood, though, right? That's the question.”
And for pharmas, pegging milestones to such a major $1 billion sales benchmark can help hedge some risk in the buyout.
The billion-dollar question
Earnouts are not always defined with specificity in deal announcements. But one example is Bayer’s 2021 purchase of Vividion, which had an upfront payment of $1.5 billion with success-based milestones up to $500 million.
When Pfizer bought ReViral for its RSV vaccine program in 2022, the deal had a total consideration of up to $525 million, including upfront and developmental milestones.
“If successful, Pfizer believes annual revenue for these programs has the potential to reach or exceed $1.5 billion,” Pfizer said at the time.
Rewrite Therapeutics' shareholders were up for $45 million immediately when Intellia bought the genome editing biotech in February 2022. Down the line, the deal included an additional $155 million in pre-specified research and regulatory approval milestones.
Most of the deals that are now seeing the low achievement rates were closed prior to 2021, when the pandemic was raging and the general market and life sciences industry went through a slowdown in deals, Wallen noted.
Now, the billion-dollar milestone offers are becoming rarer, but they are still happening occasionally, Wallen said. That could be simply because deal volumes across the sector remain down, but many larger pharmaceutical companies have to restock their pipelines no matter what.
SRS Acquiom also calculated earnouts that, based on the terms available at time of signing, the financial services company considered should be due by now. It estimated that $7.5 billion worth of payments should be "due," but well under $1 billion has actually been paid out. While these could still pay out, acknowledged Wallen, he said it shows that the milestone numbers in a deal announcement can be much harder to achieve than they seem at first.
In terms of dollar amount, phase 2 and 3 milestones have paid out the most, but even here the achievement rate is only 20% and 15%, respectively. While the amounts are smaller, earlier development milestones are more reliably hit, with 32% of phase 1 milestones and 61% of preclinical milestones reached, according to SRS Acquiom's calculations.
Wallen said there’s no one reason earlier-stage milestones seem to pay out more reliably. It could be that these particular earnouts are just easier to craft for success. They could be simply entry into a phase 1 trial or reaching a certain regulatory step. “They’re a little bit more concrete,” he said.
“Buyers are really looking for those really exciting new drugs, biotechnology or pharmaceuticals that show a lot of promise, that grab people's attention, make good headlines, [where] there's a lot of motivation to see those drugs succeed in their early-stage development,” Wallen said. “That sort of selection bias, I think, might be driving some higher achievement rates for early-stage milestones as well.”
While the overdue milestones are a discretionary calculation for the purposes of the report, Wallen says these data are important to show that “these milestones are technically still pending. It's just the likelihood that they're going to pay out seems pretty low in our view.”
Devices and diagnostics/research, meanwhile, continue to get paid out at rates of 20% or 30%, respectively, and usually within a few years of closing the deal. This applies to older and more recent deals as well as development and commercial milestones, according to the report.
Earnouts can also be renegotiated later. For instance, maybe the first two milestones weren’t achieved to a high degree, but on the third one, the buyer “blows it out of the water,” Wallen explains. The seller may come back and seek a bigger piece of pie for the third one to make up for the lackluster initial milestone payments. These renegotiations are fairly common, and the amount that’s due to be paid out can shift “in good faith,” Wallen said.
“It's important to be really careful when you're structuring these earnouts … but also understand how it actually plays out post-closing,” Wallen said. “It can vary dramatically, particularly if the deal parties decide to reopen those negotiations.”
So, when a deal is announced with massive earnouts, Wallen recommends a bit of “healthy skepticism.” Because just like the larger biotech universe, surprises happen. Deal terms can change, or companies can take the matter to court when they’re not happy. He remembers a recent American Bar Association meeting where a litigator asked him why transactional attorneys even bother with the earnouts given the potential for protracted legal battles.
“You're basically just inviting litigation,” the litigator told Wallen.
But that won’t stop biotechs, because the potential high is just too great to not try.
“It's really fun to put out this sexy press release that says, ‘Look at all this potential upside,’ but I think those who work in the industry know the reality is [it’s] probably not going to hit—especially those commercial milestones,” Wallen said.