A growing number of pharmaceutical companies are monetising their intellectual property by selling partial revenue interests in their promising, but not yet commercialised, products. A small number of private equity and hedge funds are making these investments, supported by a large pool of institutional investors. The investor base is attracted by the non-correlated absolute returns of these investments.
To illustrate these investments, consider the following: “Small Pharma”, a small pharmaceutical company with limited capital and a limited portfolio of products, is seeking financing. One of its products is the subject of an outlicense with Big Pharma, which will invest, or has invested, in the operational infrastructure required to distribute and sell the product. Small Pharma has nearly completed the relevant regulatory processes. At this point, the investor—willing to assume the commercialisation risk but not the intellectual property or regulatory risks of the product—approaches Small Pharma. The investor offers to pay, upfront, for the right to receive a portion of Small Pharma’s revenue generated from future sales of the product. The basic economic deal is simple: Small Pharma is monetising its future revenue stream, and the investor targets a private-equity-type investment return. This economic simplicity, however, masks a number of legal complexities.
What Is the Investor Buying?
Among the many legal issues facing the parties is the definition of the “purchased interest”. If Small Pharma has an existing license agreement with Big Pharma, then the investor is typically buying a portion of the royalty payments that Big Pharma will pay Small Pharma. If Small Pharma is selling the product itself, or through a different third party, then the investor is ordinarily buying a percentage of the direct sale revenues of the product.
In either case, the description of the relevant revenue stream is highly negotiated. In an existing royalty deal, other interests (inventors, legacy investors, etc.) must be accommodated. If the investment is in direct sales revenues, the calculation of “sales revenues” (Gross or net? What is “net”? Sales of what, exactly? The compound only or product extensions and reformulations?) must be well-defined.
Security Interest: UCC
If Small Pharma files for bankruptcy in the United States the investor’s principal protection for continuing to receive revenue or royalty payments is an argument that it “bought” the purchased interest (a true sale). As a backstop, investors also require a security interest in the “purchased interest”. If a true sale did not exist, then investors assert that they have a perfected security interest in the “purchased interest” ahead of other creditors. Absent a valid security interest or true sale, other creditors of Small Pharma may assert claims on the revenue stream on the product. The regulation of security interests in the United States will be heavily driven by the Uniform Commercial Code (UCC) and the US Patent and Trademark Office rules and procedures.
Investments in royalty streams will necessarily involve issues regarding the underlying out-license. Most outlicenses prohibit Small Pharma from assigning any of its interest under the license to a third party. Does this mean Small Pharma cannot assign the “purchased interest” (i.e., the right to receive payments) to an investor? UCC Section 9-408 is on point and suggests a non-obvious resolution to this issue by permitting security interests in contracts despite antiassignment provisions. The investor will also typically further minimise potential bankruptcy risks by taking security interests directly in the relevant intellectual property.
While generally still in its infancy, this is already a large market, and one which raises several fundamental legal questions.