Seeing the Fire Behind the Smoke Jul 1, 2011 By: Todd C.

Davis Pharmaceutical Executive In today's market nothing is standard. The partnering landscape has become more pressured, competitive, and complex in terms of deal structure. But business development and licensing executives should not overlook certain license terms and conditions once the economics have been finalized. In fact, it is often boilerplate language or lack of common-sense terms that can derail or hinder the use of licensed assets and influence their long-term value. Licensing is a mainstay of biopharmaceutical companies and academia. Over 600 deals valued at approximately $25 billion were announced in 2010, and these numbers will continue to grow as large pharma increases its reliance on in-licensed technologies and new molecular entities to fill pipeline gaps. To maximize the value of intellectual property (IP) and not leave money on the table requires vigilance. While crafting license agreements involves all of the tactical tradeoffs expected in a negotiating dynamic, one should try to pay attention to these 10 licensing pitfalls: 1) Limited ability to assign or grant security interest in the license. Many years after the license is signed, when the product is being marketed and the licensor has moved on to other pursuits, the license agreement may well be considered a non-strategic financial asset. But with any financial asset, the more restrictions that exist, the less valuable it is. A license agreement that cannot be assigned (including assignment of the right to receive royalties), or one that cannot be pledged as collateral, is at a serious disadvantage if the holder wants to sell downstream. By clearing these hurdles upfront, the license agreement will be both more marketable and more valuable. 2) Complex and unclear royalty terms. Uncertainty reduces the value of any asset. It's the "ifs, ands, or buts" in these agreements that make it hard to decipher how much money is due and when; what seems clear to those who hammer out the deal can often be confusing years later. At a minimum, the license should clearly specify the royalty rate, how it is calculated, when it will be paid, and for how long. It seems like common sense, but clarity is critical when assessing how much the asset is worth. 3) Maintaining third-party royalty obligations. This can be a significant liability for a licensor, unless the contract explicitly makes them the obligation of the licensee. In the worst case, if the licensee were to stop paying royalties and the agreements don't appropriately address the issue, the licensor could still be on the hook for royalties due to any third-party royalty holders. These obligations can also complicate and ultimately impact how much money the licensor takes home. Once all the royalty payments have been calculated, a licensor's net percentage could be significantly less than the original forecast. Third-party obligations should be assumed by the licensee.

4) A narrowly defined royalty payment term. It is important to look at not only the patents to be licensed, but also at the underlying value of what is being transferred as part of the agreement. Leaving the know-how or other components unaccounted for can leave the innovator emptyhanded after delivering significant value. Take, for example, a license that ties specifically to one cell line. The licensee ultimately changes cell lines but still uses the additional art and know-how transferred as part of the deal. Unless the license requires payment for the know-how, the licensor will receive no royalties. Define the components of that value as broadly as possible. 5) Lack of information rights. A license for commercialized technology is one of a licensor's most important assets. Access to key pieces of information during the development and commercial stages is imperative. In the development stage, it is important not only to be able to validate how things are progressing but, at the most basic level, that the product is actually being developed. Once the product is on the market, it is critical to be able to validate the calculation of the royalty rate and estimated payments. Royalty reports by geography, audit rights and reports, regulatory information, and license communications will give a licensor the tools to do this and are indispensable parts of a well-crafted license agreement. In addition to having access, a licensor needs the ability to share this information confidentially with a potential acquirer or investor. Without that right, it will be impossible to fully realize value for this license downstream. Establishing these rights out of the gate will provide greater autonomy over the long term. 6) Inadequate termination rights. License agreements are formed and terminated every year. While every contract is drafted when the parties expect success, be certain to negotiate a reciprocal right to terminate under certain adverse conditions, including conditions of significant underperformance. It is also best to regain all of the rights owned prior to the agreement, such as ownership of the IP, upon termination of the license. Additionally, the effort and thought spent structuring the agreement to ensure that regulatory approvals and clinical data are available following termination will be richly rewarded by keeping the commercialization timeline as close to on track as possible. 7) Assigning versus licensing intellectual property. A license agreement has special protection in bankruptcy court that exists to ensure that any royalties due under the agreement be paid. Therefore if a licensee goes bankrupt, and the product or technology ends up in the hands of a new owner during the bankruptcy process, the rights to receive royalties and enforce the agreement maintain their value with the new licensee. If a licensor sells or assigns the IP, rather than licensing it, a bankruptcy trustee is free and clear to sell it in bankruptcy for the benefit of creditors, and the economic value is lost. Use a license agreement to transfer IP rights whenever possible, and especially whenever a material part of the value rests in downstream economic rights.

8) Combining a supply agreement with a license agreement. Combining these agreements can actually devalue a license. It also creates complexity once the product is commercialized. If the licensor decides to monetize the license, the potential acquirer could be subject to a tax liability in that the sale could be characterized as other income rather than as an asset purchase or a financing. This characterization creates incremental tax liability for some acquirers and would therefore reduce the value for them. Keep these agreements separate if possible. 9) No contingent valuation clause. Suboptimal circumstances arise that can impact the royalty rate of a license. Many of these circumstances can reduce the value, but do not eliminate the value of the license entirely. In these cases it is appropriate to have a stepped-down royalty rate rather than a complete termination of royalties due. One example of this may be to have a royalty step-down upon generic entry, or to leave a royalty rate in place upon generic entry as long as net sales remain above a certain threshold. Many licenses still hold significant value even after adverse events. That should be anticipated and provided for in the agreementnot after the event has taken place or during renegotiation. 10) Not defining comprehensive reversion rights. Licensees will commonly make improvements to a product during the development stage. But if a license doesn't adequately cover the rights to improvements, it could limit how the licensor uses its own underlying technology. This is a significant issue with platform technologies today. Work to ensure the freedom to exploit the IP outside of the field of use regardless of improvements made by the licensee within the field. Licensing is critical to product development, but many agreements are developed years before a product ever reaches the market. The baseline economic terms are important in terms of measuring and realizing the value of IP, but it is in negotiating the numerous key terms of the agreement that the full range of value, such as the "know-how" value of the IP, can be exploited. Experience has shown that clarity and attention to licensing terms will ease the due diligence process and simplify future transactions but, most importantly, also preserve the intended value of the deal in the myriad circumstances that will inevitably occur following the execution of the agreement. The time to optimize a license agreement is prior to signing, when the only certainty is the inability to predict the future. Attention to these key terms will reduce restrictions on the ability to respond to adverse situations, and will help a licensor better navigate the uncharted waters ahead. Todd C. Davis is managing director at Cowen Healthcare Royalty Partners. He can be reached at todd.davis@cowen.com