Current trends are driven by various strategic and financial considerations from both established pharmaceutical companies and development-stage biotech firms. Understanding the valuation and accounting implications of these transactions are crucial for stakeholders to navigate the complex landscape effectively.

By Kristen SeaverThe biotechnology industry has witnessed significant shifts in recent years, particularly in the realm of both mergers and acquisitions (M&A) and collaborative agreements. These trends are driven by various strategic and financial considerations from both established pharmaceutical companies and development-stage biotech firms. Understanding the valuation and accounting implications of these transactions are crucial for stakeholders to navigate the complex landscape effectively.
Trends in biotech transactions
One of the prominent trends in the biotech sector is the acquisition of clinical-stage companies with compelling clinical development programs. Established pharmaceutical companies are increasingly acquiring development stage companies with promising clinical stage programs to bolster their drug development pipelines and mitigate the risks associated with patent expirations on key products.
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Collaborative agreements between biotechnology companies also continue to be a vital trend. Terms vary for these agreements and can include the sharing of drug development responsibilities with no consideration paid for services being exchanged between the parties. Alternatively, one party may pay consideration for the commercial rights to a drug program and/or future performance obligations such as R&D and manufacturing services. Such collaborations enable companies to diversify their portfolios while sharing the financial risks and rewards with their biotech partners.
Drivers of these trends
Many established pharmaceutical companies are facing the looming expiration of patents on some of their most profitable products. To sustain growth and maintain their competitive edge, these companies are actively seeking access to new, innovative drug candidates from biotech firms via acquisition or collaborative agreements. This strategic move helps them to diversify their portfolios and reduce dependency on a limited number of key products.
Development-stage biotech companies often struggle to secure sufficient funding due to volatile and constrained capital markets. In a weaker market, these companies may not have the necessary funds to finance their internal development programs independently. Collaborative agreements with more established companies provide a vital source of capital and resources, enabling them to advance their drug development efforts.
Valuation and accounting implications
With more targeted acquisitions of earlier stage companies, there has been an increase in biotech transactions designated as asset acquisitions rather than business combinations for financial reporting purposes. Qualifying for an asset acquisition is favorable to the acquirer for two reasons:
The acquirer can immediately expense the in-process R&D associated with a clinical development program; and
Cash earnout consideration is typically recorded when probable and estimable.
A screen test is performed to determine whether a transaction qualifies as an asset acquisition or meets the definition of a business for financial reporting purposes. One of the primary screening criteria is whether substantially all (in practice, 90% or more) of the acquisition’s value is concentrated in a single asset or a group of similar assets. A valuation analysis of each of the development programs is typically performed at this stage to confirm if this criterion is met. Even if this criterion is not met, a transaction may still qualify as an asset acquisition depending on the nature of inputs and processes received.
Advisory and valuation service professionals play a critical role in applying this framework including the technical accounting requirements and the valuation support required to determine if the 90% threshold or other input/processes criteria are met. Since there are no definitive rules for the screen test, it is important to discuss with the audit team early in the process to confirm all teams are aligned on financial reporting requirements.
Terms of a collaborative agreement can add complexity to financial reporting requirements related to revenue and expense recognition. In a typical arrangement, a development stage biotech company (IP owner) has a compelling clinical program but does not have an established distribution channel to maximize revenue upon approval. The IP owner may enter into a collaborative agreement with a more established company (licensee), whereby the IP owner performs R&D services to complete the clinical studies and the licensee obtains the rights to commercialize the clinical program upon regulatory approval. In exchange, the licensee pays consideration to the IP owner, which typically includes both fixed or variable consideration.
When a collaborative agreement is entered, a technical accounting analysis is performed to determine whether elements of the contract constitute a customer-vendor relationship and fall within the scope of accounting standards codification (“ASC”) ASC 606, Revenue from Contracts with Customers. Depending on the agreement terms, elements can include R&D services, production services, technology licenses, among others.
If multiple performance obligations are identified under the scope of ASC 606, a detailed valuation analysis may be required to allocate the consideration paid to the various performance obligations on a relative fair value basis.
Given the complexity of transaction terms and agreements, it is imperative for clients to involve their entire professional services team early in the process. This means engaging advisory, valuation, and audit teams to ensure everyone is in sync with the financial reporting requirements and to facilitate a thorough and accurate analysis to avoid potential issues down the line.
The biotech industry’s evolving landscape, marked by M&A and collaborative agreements, necessitates a nuanced understanding of valuation and accounting implications. Established pharmaceutical companies are driven by the need to counter patent expirations and diversify their portfolios, while biotech firms seek financial stability through strategic partnerships. Accurate valuation and adherence to financial reporting standards are crucial for transparent and compliant financial reporting, ultimately supporting the growth and innovation within the biotech sector.
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