Royalty financing provides a new avenue for life sciences companies to generate capital while keeping control of critical IP

Universities, research organizations, and young biotech firms uncovering exciting new life sciences discoveries often face significant hurdles when it comes to raising quick capital for moving their discoveries forward. Enter royalty financing. Unlike traditional debt or equity, royalty financing offers organizations the upfront funding they need to fund their product pipelines and other capital needs, in exchange for a small percentage of their future cash flow. Arlene Chow, partner in Hogan Lovells’ New York office, and Adriana Tibbitts, counsel in Hogan Lovell’s Baltimore office, discuss this financing alternative and what companies approaching these types of deals should anticipate.

What are the most common types of royalty financing deals?

Tibbitts: “There are two primary types of royalty financing deals. Traditional royalty financing is where an intellectual property (IP) owner will license IP to a third party, the third party pays royalties back to that licensor and then the licensor has the right to sell that royalty stream to a third party. Synthetic royalty financing is where an IP owner or licensee will have the right to sell a product and they will decide to sell the right to future revenue to that product in exchange for cash, whether in a lump sum or in staggered payments.”

What role do patents play in a royalty financing deal?

Tibbitts: “Patents are incredibly important in this space. The basis of any right to receive royalties down the line for a product is all based on the strength of the [seller’s] patent. Before a transaction lands on my desk, parties will have typically spent months analyzing an IP portfolio to assess its strength ahead of setting up a potential royalty stream.”

Chow: “A lot of our clients assume that the sheer volume of patents in a portfolio means their product is well protected from a potential validity challenge. That's not the case. In the last five years the patent landscape has dramatically changed. There are new proceedings called Inter Partes Review and Post-Grant Review which provide new avenues for challengers to attack the validity of patents. Careful vetting of a patent portfolio will help companies identify the hidden gems that will provide them with the certainty and protection they need to form a valuable royalty stream.”

What major challenges do buyers and sellers face during a royalty financing deal?

Tibbitts: “One of the biggest challenges is the risk surrounding the [buyer’s] investment and the stage of development when the royalty stream is sold. What we've been seeing in the market recently is that many companies are selling royalty streams at earlier and earlier phases of product development. As this trend continues, both royalty sellers and purchasers are increasingly concerned with mitigating risk when there can be millions of dollars in play (for a royalty stream) years before a product has even been approved.”

What actionable advice do you have for companies considering a royalty financing deal?

Chow: “The very best advice that we would give to a company considering royalty financing is to vet the patents associated with their product very carefully. Look at each patent in a portfolio on its own terms. It's only through pressure testing each patent on an individual basis that a company can really come to understand which patents in the portfolio will produce a royalty stream that will help move their business forward.”

For additional insights from Tibbitts and Chow on royalty financing deals, watch the video above.

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