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Encouraging Mergers & Acquisitions in the UK Biotech Sector

A Survey of Chief Executives’ Views Posted on: 21 Oct 03


It is clear that the UK biotechnology industry is undergoing widespread consolidation, driven by difficulties in raising capital to fund research programmes.

Executive Summary
Consolidation of the biotech industry is now firmly on the agenda as the only practical mechanism to inject and/or preserve cash for future survival. The importance of encouraging M&A and removing any barriers, where a business case makes this a justifiable avenue, cannot be overstated and is the reason that Ajilon Executive Healthcare have undertaken research amongst biotech Chief Executives, focusing on Board compensation, contracts of employment and competency profiles.

Notice periods in the event of M&A and share options were highlighted as the most important mechanisms to encourage the consolidation process. However, whilst share options were once a favoured incentive for senior managers, it is worrying that their shine has been diminished as company valuations have plummeted. A sizeable minority of managers believe that share options are no longer a sufficient incentive to encourage consolidation. A further worrying finding is that a majority of respondents had contracts which did not cover the specific issue of stock options linked to M&A and they did not have any formal agreement with the Board of Directors on this issue. Cash elements of compensation, whilst important, could become a barrier because managers would instinctively try to protect these.

In a complex and changing environment, it is vital that rigorous attention is paid to identifying the personal characteristics of senior managers to ensure success of the company. Our research, which sought to identify trends in this area, showed that adaptability, flexibility, strong leadership abilities and sector expertise are all key attributes. Further, that high selfregard, personal philosophy and a degree of selflessness are all important. Lastly, relationship-building is crucial, especially within the context of the relationship between CEO and Chairperson. Reassuringly, a majority of CEOs spoke of the strength of their relationship.

Our research concludes by suggesting that, with share options lacking their traditional incentive status, other mechanisms are used to achieve a more equitable balance between the risk experienced by senior managers who engage in consolidation and their reward for concluding merger discussions successfully. Such mechanisms might still include shares and share options, notice periods and cash awards, all of which are specifically linked to M&A activity.

It is clear that the UK biotechnology industry is undergoing widespread consolidation, driven by difficulties in raising capital to fund research programmes. An example is the merger of British Biotech with RiboTargets which then announced a merger with Vernalis. More recently, oncology specialists Xenova and KS Biomedix have said they will merge. For those who have not merged, fund-raising difficulties have sadly led to companies being forced into administration, PPL Therapeutics being the most recent example.

Given that rationalisation is therefore likely to continue, Ajilon Executive undertook research amongst the Chief Executives of UK biotech companies to identify and quantify any barriers to consolidation, specifically in the areas of Board compensation, contracts of employment and competency profiles, and to make suggestions for change to encourage further M&A.

A total of 42 CEOs responded to our research, either by a structured telephone discussion or by completing a paper questionnaire. Thirty two (76%) worked for private companies whilst the remainder worked for those with a stock market listing.

In an industry where the return for investors is only seen after many years of research and which is currently starved of such investment, Merger & Acquisition activities are seen by many as the only nearterm avenue to ensure survival since technologies can be combined, cash-burn can be reduced and cash reserves can be preserved. The vast majority (93%) of CEOs identified that where a merger of two or more companies makes good business logic, it is often a critical step to their survival, with 52% expressing “strong agreement”. Several participants commented that, even as recently as a year ago, the logic behind a merger would have been justifiable only in those cases where the companies concerned had complementary technologies. Now however,  reducing cash burn is the watch-word, meaning that even mergers between companies with dissimilar technologies is considered. In an industry so dependent on technological advances,
it is perhaps a worrying trend that, in the battle to survive, little attention is paid to technology.

Contracts of Employment
Set against this background, and in order to encourage any M&A process towards a successful outcome, a majority (69%) of participants believe that changes are needed in the compensation and benefits of senior executives, or in other elements of their employment contracts, the most important of which were awards of stock options and notice periods linked to M&A. Also rated as important were cash bonus and base salary, although it is of interest that the proportion of CEOs rating these as “highly important” was not as marked as for stock options and notice periods. This may be because, as some participants noted, high base salaries and/or cash bonuses could act as a barrier to the M&A process because of managers’ desire to protect them. Offers of non-executive roles in the merged entity was rated overall as only of moderate importance, with several participants pointing out that continued involvement in the merged company might be perceived as lacking the independence that non-executive directors must demonstrate. Not surprisingly, executive career counselling was deemed to be of low importance. These data are summarised in Table 1 below.

Table 1: Importance ratings of elements of CEO Contracts of Employment

Awards of stock options are linked to the achievement of company performance criteria and/or valuations in the majority of cases (71%); 70% of CEOs stated that such criteria are achievable. However, it was disturbing that, although 79% of CEOs are allowed to retain and/or exercise their options post-M&A, a sizeable minority (43%) did not feel they were a sufficient incentive to engage in merger activity, with many participants commenting that low current valuations compared to when the awards were made has taken the shine out of their worth. Of further worry is that a majority (57%) had contracts that did not cover the specific issue of stock options linked to M&A and that an even larger majority (76%) did not have any formal agreement with the Board of Directors on this issue. The nature of discussions between a CEO and the other various stakeholders/investors is revealed in the Graph 1 below; once again, a worrying 41% have not had any level of discussion, however informal, on the effects that M&A would have on their employment contracts.

Graph 1 : Nature of discussions on the specific effects of M&A activity on contract of employment

Personal Characteristics Profile of CEOs
Our research attempted to gain an insight into whether the changing environment facing biotech companies would necessitate changes in the profile of personal characteristics required of CEOs - in other words, whether the future successful CEO has an inherently different profile from successful CEOs of the past. A clear majority (69%) stated that changes were needed in the profile of CEOs, hinting that adaptability in a changing and evolving environment is a key strength. Anecdotal comments highlighted that since the traditional CEO has been the scientific founder of the company, who generally tries to protect their technology, merger activity tends to be avoided because it is seen as failure. Such a background may then tend to act as a barrier to progress. There was agreement that additional characteristics as facilitators of consolidation, were personal philosophy, leadership profile, self regard and the strength of their resume (i.e. sector expertise, employment history etc). Lastly, thoughts of personal financial gain was viewed as an important characteristic which would encourage M&A, but with the added comment from many CEOs that first thoughts should be towards what is best for the company and its shareholders; i.e. a certain degree of selflessness is desirable.

There was also broad agreement that the quality of relationship between the CEO and his/her chairperson is important in facilitating M&A; reassuringly, a substantial majority (72%) of the participants in our research rated the quality of this relationship as 8 or higher (on a 1-10 scale), and 100% of respondents gave a 5 or higher rating.

Impact of Changes
Discussion on the two major subjects of our research, namely contracts of employment and the ideal personal characteristics profile of CEOs, would be largely academic if the implementation of any changes did not lead to a material and positive impact on their preparedness to engage in M&A. The vast majority (92%) of respondents stated that implementation would have a positive impact, of which 54% stated that such an impact would be significant.

The funding crisis which has enveloped the UK biotechnology sector is acute and has forced many companies to engage in merger or acquisition discussions. The trend of several examples
of merger completed recently is set to continue. Since the survival of so many such companies is dependent on the successful outcome of these discussions, the evaluation of Chief Executives’ contracts of employment and personal characteristics profiles as potential barriers to consolidation have been explored.

Shares and share options have been used historically to great effect as a way to link a senior manager’s reward directly to their performance. However, very low valuations have removed the incentive to perform and it is critical that alternatives are sought. One suggestion, highlighted by a number of executives who participated in this research, is to include an outcome reward in the form of cash or shares as a specific clause in the contract of employment. It may also be appropriate to include penalties for poor performance. The balance between risk and reward may then become more equitable.

However this issue is handled in individual cases, it would be wise to agree and formalise the discussions, either as part of the contract of employment or in a separate document. Anecdotal comment from our research highlighted that there are often differences in the objectives and agendas of the different stakeholders involved (e.g. executives, board members, investors), emphasising the need for clear and formalised agreements.

Notice periods which are activated once a merger or acquisition is concluded were also highlighted as an important way to remove the personal risk to a senior manager. A cautionary note would be to avoid excesses since it may become a barrier to consolidation and therefore be counterproductive.

There was general agreement that a changing environment requires Chief Executives to be flexible and adaptable, to inspire the people around them with strong leadership, personal philosophy and self regard, and to build strong working relationships, particularly with their Chairperson. It is reassuring that a substantial majority of respondents in this research clearly have a high-quality relationship with their Chairperson.

The authors thank the many Chief Executives who gave their time to participate in the research presented in this document. Particular thanks go to Dr Andy Richards who provided many original thoughts and inspiration to our work.

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Dr Christopher Baxter-Jones and Mark Sharp

Last updated on: 27/08/2010 11:40:18

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