Pharma Due Diligence: Why It Is So Important and How to Go About It

The tightly-regulated pharmaceutical industry is a prime example of the importance of due diligence. In this article, we look at why due diligence is so vital to the pharma industry. We also provide a pharmaceutical due diligence checklist to help orient you through the process.

The importance of due diligence

When a company considers a prospective merger or acquisition (M&A), information is of the essence. To know exactly what it stands to gain with acquiring another entity, as well as to learn about any possible risks, a company conducts in-depth research and investigation — that is due diligence.

In a few words, then, due diligence seeks to ultimately answer this one simple question, “To buy or not to buy?”

Best VDRs for pharma due diligence

Due diligence in the pharmaceutical industry

While due diligence is a vital process for corporations across all industries, it carries even greater weight and significance when it comes to pharma or biotech due diligence. This is due primarily to two reasons — government regulations and the number of M&As. 

Regulations

The pharmaceutical and biotechnology industries are as tightly regulated as they come. That is no coincidence, of course. We are talking, after all, of manufacturers and distributors whose business directly impacts the health of the entire world.

With that in mind, it is hardly exaggerated to say there is an enormous potential danger in acquiring another company without a full understanding of what you’re getting into. A case in point was the $63-million Bayer takeover of Monsanto¹, in 2019, which saw the German multinational suffer heavily from liability suits brought against the acquired company — one of the most expensive examples of “acquisition indigestion” on record.

Large quantity of M&A deals

The second reason has to do with a unique aspect of the supply chain in the pharma sector: patent expiration. Essentially, the products offered by pharmaceutical companies aren’t like any other product. Drugs come with built-in patent expiration periods. 

Increase in the number of due diligence deals in the pharma industry, 1985-2018. Source: Statista

This means that if a pharma company wants to stay in business, it needs to be continually on the lookout for new drugs, either producing its own (hardly a speedy process) or acquiring the rights to production and distribution from other companies. Enter the M&A.

As a result, there is something of a categorical imperative in the pharma sector: absorb or die. This explains the ever-increasing number of annual M&A deals in the industry², a trend that has only accelerated because of COVID-19³. And, because of this large number of deals, acquisitions tend to be done quicker. They tend to be hastier, leaving more room for error.

• Why is due diligence so important in the pharma industry?

Now you know: because, paradoxically, the industry with one of the highest levels of responsibility and regulation also sees more, speedier mergers than any other.

Initial steps of pharma M&A

After your corporation has set its sights on a target for a merger or takeover, the key issue turns to determining whether the perceived value of the target is also its actual value. 

The better you answer this question, the greater your chances for a successful deal.

1. Have a team in charge

The first thing your company will want to do is put together a dedicated team charged with researching and investigating the potential merger or acquisition. Needless to say, this task force should consist of well-seasoned professionals with broad expertise in financial and legal services, as well as marketing and product distribution, among other areas.

2. Make use of an effective VDR platform

Any team is only as good as its level of organization. To ensure optimal communication and efficiency as the due diligence pharma effort moves forward, you’ll want to take advantage of what technology has to offer. Using a virtual data room for the pharma industry can make all the difference between a good research job and a great, thorough one.

With a VDR, you get:

• the highest level of security for sharing sensitive data
• a controlled platform for highly-effective communication and cooperation
• a plethora of resources fine-tuned for processing massive amounts of data
• a dedicated support team available at all times
• simple and intuitive interface designed to meet the needs of busy people without the need for learning technical complexities

You can read more about the benefits of using a VDR for your due diligence processes here.

3. Prepare a checklist

Each M&A deal process is different, and it will be up to your task force to come up with a list tailored to the specific demands of your merger or acquisition. That said, there are a number of aspects that should not be left out of your due diligence process.

Further, you will find a due diligence pharma checklist, which is ready to use.

A pharma due diligence checklist

As a starting point, we’ve prepared a guide that you can lean on as you go about your research. It’s not only a checklist in healthcare aspects, but an extended list that will help you ensure no stone is left unturned in your investigation.

For the sake of clarity, we’ll organize our checklist around six major aspects that are essential for understanding any pharmaceutical company. These are:

1. products and assets
2. company structure
3. financial data
4. commercial landscape
5. legal aspects
6. cultural considerations

Let’s dive in.

1. Products and assets

You want to list everything the target company owns or has legal rights to — medications and/or other products, intellectual property, real estate, equipment, and so on. You need:

I – A comprehensive inventory of company products, both existing and in development, with relevant information such as patent terms.

Also include:

1. relevant correspondence, such as investigational new drug applications (INDs), applications for products being developed, and deficiency letters, if any;
2. clinical investigation records. Clinical information in due diligence is key. Find out whether these have been audited by the FDA (or other relevant national authority);
3. list of products undergoing or having undergone regulatory oversight, if any;
4. ongoing, planned, or terminated clinical research.

II – A list of intellectual property and relevant specialists. Include:

1. a complete record of existing patents;
2. active patent applications;
3. patent licenses;
4. any agreements on the acquisition or cession of intellectual property;
5. relevant expertise in specific areas;
6. list of leading scientists working in or for the company.

III – Listing of real estate assets, including:

1. physical business units and production facilities;
2. real-estate leases and other relevant documentation.

IV – Physical assets such as equipment, machinery, vehicles, etc.

2. Company structure

Here the aim is to get a clear picture of the company’s internal organization, as well as key external connections. You want to find out how the organizational structure of the target company compares (and potentially adapts) to yours. 

The following are important aspects to study.

I – Internal company organization, including:

1. distribution of authority: relevant hierarchies and their levels;
2. reporting/oversight structure;
3. how are business/production units organized.

II – Corporate charter and bylaws, as well as any relevant conclusions derived from their analysis.

III – Minute book covering all board and shareholders’ meetings, committee resolutions, and so forth.

IV – List of shareholders.

V – Key external connections, including distribution or manufacturing partners.

3. Financial data

I – Financial statements, audited and unaudited, for a period of 3-5 years is common;

II – Company balance sheet, an accounting statement that lists assets, liabilities, equity;

III – Projections for the future;

IV – Cash flow statements;

V – Capital expenditures;

VI – Relevant analyses of budgets and fixed expenses;

VII – Tax information, including:

1. tax returns for the period of time deemed appropriate by your team (typically 3-5 years, but may vary);
2. employment tax data for the relevant period;
3. recent and pending audits;
4. applicable tax exemptions or reductions and connected products/services

4. Commercial

This includes all research aimed at understanding the current market presence and potential future reach/established business goals for the target company. An important subsection here is publicity/marketing, to establish just how present the company is in the minds of consumers. You should:

I – Review the company’s business plan. Ask yourself:

1. how realistic is it in light of current realities?
2. how does it stack up against past performance?

II – Analyze the market, including:

1. company position in its current market;
2. points of overlap with your company;
3. points of difference with your company;
4. customer base;
5. geographical reach

III – Analyze product and service pricing, including projected changes and margins.

IV – Investigate relevant market trends and their impact on the company.

V – Review marketing history and outstanding marketing applications.

5. Legal

Here the main goal is simple: to make sure you are not inheriting trouble. To that end, you have to be aware of any pending copyright, intellectual property, or liability lawsuits. You also want a firm grasp on areas such as compliance and insurance. Be sure to cover:

I – Any existing or threatened malpractice, criminal, or other liability suits;

II – Active, past, or pending copyright/intellectual property litigation;

III – Actions taken by foreign authorities regarding company or company products, if any;

IV – Environmental considerations, including:

1. list of environmental permits, licenses, audits, and certificates;
2. records of environmental litigation, both past and current, if any;
3. list of company-handled substances that pose or may present an environmental hazard;
4. record of company procedure for the handling and/or disposal of such substances;
5. a report on the company’s environmental (good or bad) standing.

V – Contracts, including:

1. distribution, supply, and sales agreements;
2. bank agreements: loans, securities;
3. contracts from past M&A operations, if any;
4. partnership or joint venture agreements, if any;
5. contracts with executive directors and shareholders.

VI – Insurance coverage documentation, including: 

1. company, product and personal liability;
2. history of insurance claims for established period.

6. Cultural

Culture is one of the most overlooked aspects of due diligence research, nevertheless, it plays a key role in the success or failure of M&A deals. 

As far back as 2010, a McKinsey study⁵ revealed that 92% of executives dealing with M&A believed that their past mergers would “have substantially benefited from a greater cultural understanding prior to the merger”. 

While all other factors may look promising, a marked difference in the internal culture and values of the two companies can make for a very bad combination indeed.

Because culture is an intangible and not easily quantified area of analysis, it calls for a different approach. A good idea is to have the issue of culture constantly in mind. As your team goes through the “hard” data required for the above sections, the question of culture should constantly be on the surface. Take note of the impressions you form and why.

You should aim at answering such questions as:

• Does the company have a good history of compliance? 
• Does it show a good record for major business decisions?
• Is there a good history with former executives?

The answers to these and similar questions help establish a general image of the corporate culture, which helps predict, to a certain extent, the likelihood of future trouble.

Other “soft” aspects worthy of consideration:

1. long- vs. short-term orientation: whether the company follows a long-term, sustainable vision or tends to opt for short-term profit;
2. environmental aspects: the extent to which the company is environmentally-minded and how “green” it is perceived to be;
3. public image: are there widespread perceptions related to company-owned or -distributed brands? Are they good, bad, or neutral?
4. values: is there a strong value-based corporate culture?
5. ethical considerations: 

• Is the company known for moral practices?
• What is its history with GLP?
• To what extent does it manufacture its own products?
• What is known about the practices and public image of its associated manufacturers?

Your team should also seek to schedule one or more visits to physical company locations. This, as well as your interaction with the opposing M&A team, can be helpful to form an idea of the company’s internal environment, a spirit of cooperation, and executive values.

Final considerations

The importance of proper due diligence for a successful M&A deal simply cannot be overstated. 

As you go forward with your pharma due diligence planning and operations, keep your main goal in sight: to clearly establish the benefits and risks of integration and produce a final report that will orient your company’s final decision.

Second-guess yourself and perhaps even appoint one of your team to act as a devil’s advocate of sorts. Do not underestimate the many pitfalls lurking in every M&A deal. Particularly, be beware of:

• over-optimism, overlooking the potential dangers behind a shiny façade, such as in the Bayer deal mentioned above
• consistency/sunk cost traps: as you get into talks with the other company, expectations can run high. Weeks of due diligence effort can have the effect of leaving you committed to “making it work”. Forget that. There is no shame in not letting “yourself get attached to anything you are not willing to walk out on in thirty seconds flat if you feel the heat around the corner”. Stay objective.

The above checklist is a good starting point, but remember, in the end, the quality and impact of your due diligence work — and ultimately of the whole deal — hinge on the competence and dedication of you and your team.