United States: Advice of Counsel February 2000- Q&A On Tech Transfer - I Understand That Co-Promotion Deals Are Becoming More Common. What Are The Key Terms Of A Co-Promotion Deal?

Advice of Counsel Q&A On Tech Transfer

Answer: Yes. Currently, there are approximately three hundred biotechnology products in late-stage clinical testing, and the biotech companies which own these products are increasingly looking to third parties to provide help. They need funding for completion of Phase III clinicals, product launch, and the first few years of marketing, and they need a sales force. But they also want to retain the right to sell the product itself to customers in particular market segments, thereby keeping more of the drug's upside that would normally go to a pharmaceutical company marketing partner.

Co-promoters are equally interested in these arrangements. They can use co-promoted products to keep an underutilized sales force profitably busy until their own products are ready; to gain sales experience in particular product classes; to add a reason for coming back to the physician on another sales call; and, sometimes, to earn significant returns.

Sometimes, the returns can be so significant that the co-promotion can turn ugly. Pfizer Inc. decided to take over Warner-Lambert Co. rather than allowing Warner to merge with American Home Products Corp. and thereby potentially undoing its co-promotion on what is likely to become the biggest drug in the world, atorvastatin (Lipitor).

The Pfizer/Warner battle has clearly focused attention on structuring co-promotions sensibly. The biotech owner needs to clearly understand the following key elements:

1. Who will book and set the price of the product? The biotech product owner has a keen interest in booking all sales arising from the co-promotion; the larger the company's revenues, the healthier it looks to investors. Keeping the right to book sales is not easy to negotiate, however. The pharma company will be equally interested in both booking the sale and setting the price. Often, a compromise is reached on a territory-by-territory basis. Alternatively, payments to the product owner can be divided between supply profits (booked by the biotech) and a share of the profits on sales to the end user (booked by the co-promoter).

2. What is the payment structure of these deals? Payment structures cover a wide range. While historically co-promoters receive base, incentive, and residual compensation, newer deals have been considerably more creative. For example, CV Therapeutics Inc.'s deal with the Innovex Inc. unit of Quintiles Transnational Corp. involved payments to Innovex (as co-promoter) based upon the lower of three times Innovex's selling expenses or 25-33% of net sales (the exact amount depending upon the level of sales). In return, CV received $5 million in equity on signing, a $10 million loan repayable out of a subsequent sales milestone, and $20 million per year in committed sales and marketing expenditures ($110 million total) by Innovex for the first five years after launch. In addition, CV has the right to take over the Innovex sales force after five years in exchange for payment of a 4-7% residual royalty (depending on sales volume). (As the Innovex/CV deal illustrates, pharma companies are not the only parties offering rich co-promotion deals, and CSOs are increasingly interested in bidding aggressively for late-stage products.)

The fundamental question is the degree of risk the co-promoter will assume for product launch in exchange for the right to sell the drug. The more risk the co-promoter is willing to assume, the higher can be the up-front payments to the product owner during late-phase clinicals and the early stages of product launch. These payments could be in the form of loans which are then repaid out of sales when milestones are achieved. Once the product is launched, the product owner will obviously prefer to compensate the co-promoter according to a fixed base compensation structure, probably per detail call.

Co-promoters also want incentive payments. The biotech would prefer to base these payments on a royalty on total sales above a specified level. The drug company co-promoter will want to share profits. From the co-promoter's point of view, the best profit sharing is based on net income, a method which allows it to repay itself for all its expenses, including various indirect costs, before allocating the biotech's share of the profits. To avoid giving up its income to pay the pharma's costs, the biotech product owner will, in response, insist that its return be based on as much of a "top line" figure as possible, such as the operating margin. It is also possible to carefully define "cost of goods sold" from a direct cost stand point, and the biotech will try to limit this to the lesser of actual direct selling cost or a percentage of the average selling price of the product. In case the product turns out to be a blockbuster, it is also a good idea for the biotech company to negotiate an option to increase its share of the operating margin in exchange for expanded coverage of the co-promoter's selling expenses. Finally, to the extent that the co-promoter is working with affiliated companies as part of the distribution process, the biotech company should make sure that these arrangements are on an arms-length basis and can be audited. More generally, the biotech company's audit rights should extend not only to the co-promoter, but to all of its sublicensees and sub-distributors.

Aside from incentive compensation, since co-promotions are often short-term arrangements (typically three to five years), the biotech typically offers a residual payment after completion of the term, so that the co-promoter's representatives have an incentive to sell the product in the last year as vigorously as they did previously. As an aside, it is also important for the product owner to make sure that the co-promoter's reps are compensated on the same basis for selling the biotech company's product as for the pharma company's other products, so that there is no disincentive to sell the biotech product.

3. What is the territory? Territorial divisions can simply be geographical. Most often, the initial co-promotion territory is limited to the United States, leaving the biotech product owner with the ability to sign on additional distribution partners for Europe and Asia. An interesting question is whether the product owner and the co-promoter can sell to the same customers, and, if so, whether they can sell for the same or different indications. Usually, the goal will be to match the skill set of each party's sales force to a particular market segment. It is certainly to the biotech company's advantage to carefully allocate sales responsibility by non-overlapping, specialized market segments, as well as requiring the co-promoter to commit a minimum number of sales reps for its allocated customer base. By contrast, the pharma co-promoter will want to do the opposite, limiting the biotech's co-promotion sales to a small group of specialists or a narrow indication or product formulation.

An over-arching question is the degree of collaboration between the parties during the co-promotion. Will both parties use the same promotional materials, protocols for training reps, and customer service organizations? Will there be free information sharing during the course of the co-promotion; clearly this is to the advantage of the biotech product owner. It is also important for the biotech product owner to have a say over how the product is sold; discounting and sampling policies employed by the co-promoter should be subject to consent by the biotech company.

Finally, a related matter is when the biotech can choose to grant co-promotion rights in an additional territory. Typically, the biotech will want to force the pharma co-promoter to make decisions on additional territories as early as possible, while the co-promoter will want to delay these decisions as long as possible. If the initial arrangement with the pharma company is world-wide and exclusive, then the biotech will want to negotiate reversion rights for a specific territory if specified sales thresholds are not met.

4. What is the term of the co-promotion? Arrangements vary. The longer the term, the higher the up-front amount likely to be paid by the co-promoter to the biotech, but the less flexibility the biotech has to respond to any changing situation in the co-promoter's business. Moreover, the longer the term, the higher the residual payment obligation of the biotech to the pharma co-promoter. As noted above, the biotech product owner should negotiate the right to terminate the arrangement if sales milestones are not met. Alternatively, the co-promoter can keep the arrangement in effect if it agrees to bear the risk of sales shortfalls and make the biotech product owner whole for any disappointments in sales performance.

5. What is the permissible scope of the co-promoter's activities? For example, can the pharma company appoint sub-distributors? Typically, the answer is yes, although the biotech should be entitled to a higher percentage of revenues received by the co-promoter from these sub-distributors, since the co-promoter will not be exerting the level of effort originally contemplated. Also, the appointment of sub-distributors should be subject to the biotech's consent.

Usually, the deal will prohibit the co-promoter from selling competing products. The devil, of course, will be in the details; does "competition" mean distribution of a product for the same therapeutic category or indication? To the same customer base? Aside from competing products, the parties will have to decide whether the co-promoter can solicit interest for and/or sell other products during the same sales call or bundle the biotech company's product with other products. Usually, these activities are permissible, so long as the biotech product owner receives a fair economic return based on sales of its own product.

6. Should a change-in-control trigger an option to exit the deal? Provisions for terminating a co-promotion because of a change in control can cut both ways. Sometimes, the product owner will want the ability to end a co-promotion in the case of a change in control because it sees its highest value in the rights to sell the product. Since much of the biotech's value lies in owning its product, an acquirer may only be willing to pay a high price if it is able to get 100% of the product's rights. Accordingly, the product's owner will often want a standstill agreement with the co-promoter, preventing the co-promoter from trying to take it over without simultaneously losing its co-promotion rights. This provision was at the crux of the Pfizer/Warner Lambert battle. Warner Lambert maintained that Pfizer was bound by the terms of the standstill agreement contained in the co-promotion agreement and thereby precluded from making a bid, while Pfizer countered that Warner Lambert had breached the standstill by encouraging American Home Products to proceed with the takeover.

On the other hand, sometimes a co-promotion with a large drug company is itself of significant value to the biotech, particularly if it's merging with another biotech. Usually, such an acquisition will not pose a threat to the pharma co-promoter and therefore such acquisitions should be excluded from a change of control provision. If the biotech company is not successful in maintaining this position, then the change of control provision should at least require there to be an auction for the product in the event of a change of control or product sale, with the high bidder receiving the rights to sell the product only in exchange for an additional payment to the biotech product owner.