The Perils of a Right of First Refusal: How to Inadvertently Turn a Platform into an Asset
At KdT, we seek to partner with and support teams that in many cases have created a computational technology platform. A defining characteristic of a platform technology is that in refining one possible business case for the technology, the platform is able to (i) find new, novel use cases for the technology, and (ii) optimize the effectiveness of existing use cases.
Part of the beauty of a platform lies in the flexibility it provides: it may license or sell certain aspects of the technology or applications of the platform (e.g. the field) to third parties while preserving for itself the balance of the technology and applications. If done properly (i.e. if strategically licensed or sold to the highest bidder for each sub-application), this can unlock extraordinary value for the company’s stockholders. If done poorly, the platform’s value can be reduced to that of a single asset. Teams can inadvertently reduce a platform to an asset by agreeing to restrictive right of first refusal agreements. Let’s explore how this plays out and how we can ensure a platform doesn’t revert into an asset.
As early-stage computational biology or chemistry companies seek market validation (and revenue), they often pursue partnership agreements with larger pharmaceutical, chemical and agricultural players. We encourage our portfolio companies to actively seek these partnerships. We nonetheless are mindful of any attempt by the larger company (pharma or otherwise) to insert a right of first refusal (“ROFR”) for the reasons described below.
As a broad principle, a ROFR grants one company (“BigPharma”) a right to purchase or license a defined technology in the event the other company (“CoolCo”) should decide to sell or license that technology. BigPharma may ask for this term under the guise that “BigPharma will invest heavily in the licensed technology, and thus would like the opportunity to purchase/license the same in other fields should it become available.” For example, if BigPharma licenses the right to exploit a novel molecule within its current oncology commercial strategy, it may request a ROFR with respect to any license of the same molecule in unidentified oncological commercial offerings (or, in any autoimmunity or infectious disease commercial campaigns). CoolCo will likely be tempted to acquiesce to this term, reasoning that this partnership agreement satisfies a critical KPI, provides revenue and market validation, and the risks are mitigated by the fact that there are no current plans to sell the company. We should all resist such myopia.
The original form of the ROFR will almost always come from BigPharma and thus will likely be vague and unduly onerous to CoolCo. For example, it may provide some iteration of “if CoolCo should intend to license or sell a controlling interest in the Technology (broadly defined to pick up all the CoolCo’s technology) or CoolCo, CoolCo shall (i) stop negotiating with such prospective buyer, (ii) provide BigPharma with all relevant terms, and (iii) BigPharma shall have 30 days to match such offer, in which case CoolCo agrees to accept such offer.” Agreeing to this isn’t necessarily fatal, but it raises a whole host of issues that will materially undermine CoolCo’s ability to both effect future licenses and, eventually, sell itself. Simply put, that’s bad for business.
Before investing the resources to engage in deep diligence, sophisticated prospective licensors and buyers will ask if a ROFR exists. If so, depending on the nature of the terms, then as I’ve seen throughout my career, the prospective licensor or buyer may decide it is not worth the resources to deeply engage. After all, if they strike a good deal, BigPharma will exercise its ROFR and the prospective buyer will end up sourcing and pricing this deal (at a discount!) for a rival. On the other hand, if they end up overpaying for the asset, BigPharma will pass (and not exercise its ROFR). Not an appetizing set of outcomes for a prospective buyer.
Now, sometimes CoolCo will determine that agreeing to a ROFR, for all of the potential complications, is the best course of action for the company. This is not inherently wrong, as that first partnership can catalyze growth and ignite revenue. But before doing so, CoolCo should explore various ways to redesign the rheostat to mitigate the impact of the ROFR. Some of the most effective options are: (i) in lieu of a right to match the offer, provide BigPharma with a right to notice of a sale (with no details), (ii) insert a sunset provision (whether gauged by time or capital raise), and (iii) in lieu of including relevant details of the offer, either provide none (i.e. give notice that it’s coming down the pipeline), or agree to identify only the correct band of the proposed offer price (to ensure BigPharma can’t simply offer $1 more) and either confirm or deny that the acquirer is included on a previously agreed to short list of potential acquirers (to ensure the prospective acquirer’s identity isn’t disclosed). The principle here is to provide as little information as possible, keeping in mind, there are ways to set the sale price bands (e.g. $1–100M, $100–500M, and >$500M) and list of potential acquirers that could ultimately work in CoolCo’s favor.
Teams go to great lengths to position their company as a platform technology and for good reason. We strive to ensure our portfolio companies preserve the optionality of a true platform. Helping them navigate these issues is just one way KdT supports its companies.
If you are working on a computational biology or chemistry technology platform, we’d love to see if a partnership makes sense.