IP due diligence in the life sciences sector
January 2025 | TALKINGPOINT | INTELLECTUAL PROPERTY
Financier Worldwide Magazine
January 2025 Issue
FW discusses intellectual property due diligence in the life sciences sector with Kristi Gedid, Maurus Schreyvogel, Jonathan Stevens and Ana Maria Romero at Ernst & Young LLP.
FW: Why is a strong intellectual property (IP) portfolio such an important asset for life sciences companies?
Gedid: A strong intellectual property (IP) portfolio is crucial for life sciences companies for several key reasons. First, it provides a competitive advantage by safeguarding proprietary innovations, enabling companies to differentiate themselves in the market. IP rights are fundamental to encouraging costly research and development (R&D) that leads to new medicines. Second, it serves as a valuable tool for revenue generation through licensing agreements, partnerships and collaborations. Additionally, a robust IP portfolio can enhance a company’s valuation, opening more investment opportunities. Finally, effective IP management helps mitigate risks by protecting against potential infringement and costly litigation, ensuring long-term sustainability and growth. It also helps life sciences companies ensure access to safe medication, for example by leveraging trademarks to block counterfeited products.
Romero: From a transfer pricing (TP) perspective, the patent IP is the most valuable piece of IP that a company owns and can be reliably priced to support intercompany transactions. It drives profitability across the organisation. A robust IP portfolio is the underpinning of a company’s documentation and controversy tax management strategy. It is also crucial to determine whether there is evidence of IP being licensed or if there are collaboration agreements involved in the M&A process. These elements can serve as comparables in a TP analysis. Therefore, it is essential to identify any differences between these agreements.
“It is essential to understand among other factors whether AI generated its own IP, whether it is creating efficiency, whether it constitutes new IP and whether economic ownership is well-defined.”
FW: In your opinion, when undertaking an M&A transaction, do life sciences companies typically focus enough attention on IP due diligence? What are the risks of failing to do so?
Schreyvogel: Life sciences companies recognise the importance of IP during M&A transactions, however the level of attention paid to IP due diligence often falls short. IP is a critical asset in the life sciences sector, where patents, trademarks and proprietary technologies form a company’s competitive advantage. Unfortunately, companies often focus more on financial results, compliance and other operational factors, overlooking the nuances of IP.
Stevens: Although IP due diligence is always a focus of life sciences companies as part of tax due diligence, how it is conducted could result in tax risks. Strong coordination is needed between tax and the other stakeholders performing IP diligence. From a historic risk perspective, it is critical to understand how and where IP is funded and developed. It is common for taxpayers to take advantage of tax incentive programmes in various jurisdictions. To the extent there have been incentives taken, it is important to know whether the requirements have been met, and what is required to continue to meet such requirements, on a going forward basis. On a prospective basis, IP due diligence is needed for integration planning. If a buyer wants to transfer IP to another entity post-closing, the information gathered during IP due diligence will be the starting point. Even if there is no current plan to move IP post-closing, there are other areas such as TP and review of development, enhancement, maintenance, protection and exploitation functions that are impacted by the IP diligence process.
Romero: It is important to understand the target’s tax position regarding IP and how it will affect integration. The target company likely has licensing transactions with third parties, and the manner in which these licences are drafted could potentially grant the new company IP rights upon integration. Poorly written agreements can lead to significant repercussions. Therefore, it is essential to comprehend the tax implications related to IP ownership, as this is a critical factor in the integration of IP. Additionally, tax positions related to funding and substance will influence integration efforts and future tax risks.
FW: What items should be on the checklist when evaluating a target’s IP portfolio during the due diligence process? What practical considerations do acquirers need to be make?
Gedid: When evaluating a target’s IP portfolio during due diligence, it is essential to comprehensively review a company’s IP portfolio to ensure a thorough understanding of the assets and potential risks. Regulatory approvals and compliance with relevant standards must also be verified. Furthermore, understanding the target’s IP strategy, management practices and related contracts is key. Finally, IP valuation reports should be considered to determine the contribution of IP to the target’s overall business value. This comprehensive approach ensures informed decision making during the M&A transaction.
Stevens: From a tax perspective, there are a number of items to include on a checklist. These include IP legal ownership, the funding of IP development, the location and function of employees developing IP, the location of clinical trials, the review of in-licences and out-licences, and the location of and requirements for any incentives. Upon evaluation of responses to the checklist, acquirers can conclude where IP is held both legally and beneficially as well as where changes may need to be made to reduce risk that IP could be deemed held in jurisdictions where a taxing authority could assert that there is IP held in that jurisdiction with considerable value and that taxable income should be attributed to the IP.
“With many countries having adopted Pillar Two rules in 2024, or set to adopt them in 2025, many taxpayers’ historic IP holding structures may no longer be optimal from a tax perspective.”
FW: Could you outline the issues and challenges that may arise when confirming inventorship and ownership? How can acquirers overcome these challenges?
Schreyvogel: Confirming inventorship and ownership of IP is a critical aspect of due diligence in M&A transactions in the life sciences sector, where IP assets are the most valuable components of the business. Challenges related to confirming inventorship and ownership can be complex and multifaceted, including incomplete or inconsistent documentation, joint ownership issues, ambiguous collaboration agreements, assignment of transfer rights and post-termination clauses.
Romero: From a TP perspective, it is crucial to ascertain who funded the IP and who manages and controls the critical risks. It is important to identify both the legal and economic owners of the IP and understand how they support each other. Understanding who holds economic ownership of the IP is essential, as it will determine the allocation of value and the appropriate remuneration.
FW: Have any recent legal, policy and regulatory developments influenced the approach toward IP due diligence in the life sciences sector?
Gedid: Recent legal, policy and regulatory developments have significantly influenced IP due diligence in the life sciences sector. Changes in patent eligibility and validity standards, particularly for biotechnology and pharmaceutical inventions, require more rigorous scrutiny of patent portfolios. The rise of biosimilars has increased focus on patent landscapes and exclusivity periods for biologics. Evolving regulations around data exclusivity and market protection periods necessitate careful evaluation to understand competitive landscapes. Globalisation demands consideration of international IP laws, making multijurisdictional IP asset evaluation essential. Increased IP litigation, especially in pharmaceuticals, heightens the need for thorough due diligence to identify legal risks. Advances in digital health and personalised medicine introduce new IP considerations, such as software patents and data privacy, requiring updated due diligence approaches. These developments underscore the importance of staying current with changes to effectively manage IP risks and opportunities.
Stevens: The Organisation for Economic Co-operation and Development’s Base Erosion and Profit Shifting Project under Pillar Two always casts a large shadow when considering new approaches toward due diligence, and IP is no exception. With many countries having adopted Pillar Two rules in 2024, or set to adopt them in 2025, many taxpayers’ historic IP holding structures may no longer be optimal from a tax perspective. Enhanced diligence on a target’s historic IP planning and how it can impact a buyer’s Pillar Two profile is critical. There are special global anti-base erosion deferred tax liability recapture rules that tie to the life of IP that could lead to unexpected tax consequences. In addition, the US recently changed its rules under Internal Revenue Code section 174 regarding a taxpayer’s ability to expense R&D expenses. For costs borne in the US, taxpayers must capitalise and amortise R&D expenses over five years. If costs are borne outside the US, R&D expenses must be capitalised and amortised over 15 years. Although this seems relatively straightforward, development of IP is often not. One legal entity may perform services on behalf of another legal entity in the IP development process. It is possible for one entity to be considered to provide deductible services while the other entity would be required to capitalise and amortise the expenses. If this is a company’s position, it is important from a diligence perspective to understand the arrangement. Also, under these section 174 rules the amortisation expense does not follow the asset. Thus, if an entity disposed of an asset that was the subject of the R&D development, it still continues to amortise its expenses even if it no longer owns the asset. These rules require some level of IP diligence for IP that may no longer be held by an entity.
“Altering the typical approach to IP due diligence in the life sciences sector is crucial when AI is involved, due to its unique complexities.”
FW: To what extent is artificial intelligence (AI) manifesting itself in the life sciences sector? How important is it to alter the typical approach to IP due diligence when AI is involved?
Schreyvogel: Life sciences companies are actively exploring opportunities to leverage artificial intelligence (AI) across myriad functions, ranging from R&D, supply chain and manufacturing to finance, human resources and legal. Altering the typical approach to IP due diligence in the life sciences sector is crucial when AI is involved, due to its unique complexities. AI inventions often face patentability challenges, requiring a deep understanding of current patent laws and guidelines specific to AI. Protecting AI algorithms and data sets as trade secrets necessitates robust evaluation measures. Given AI’s reliance on data, it is essential to assess data ownership, licensing agreements and compliance with data privacy regulations. Additionally, evaluating the originality, functionality and potential infringement risks of AI software and algorithms is critical. AI technologies must also comply with evolving ethical standards and regulatory frameworks, making thorough due diligence vital to ensure adherence. By adapting the IP due diligence approach to address these AI-specific factors, life sciences companies can better manage risks and capitalise on opportunities associated with AI innovations.
Romero: For tax purposes, IP generated from AI is often the result of a collaborative process, making it important to determine who funded it and who owns it. This new type of IP introduces technical considerations, such as its useful life, making it more similar to technology than traditional patents. It is essential to understand among other factors whether AI generated its own IP, whether it is creating efficiency, whether it constitutes new IP and whether economic ownership is well-defined.
FW: What steps can acquirers take during the due diligence process to ensure they maximise the value of a target’s IP in the post-deal phase, and lay the groundwork to effectively monitor and enforce associated IP rights?
Gedid: During the due diligence process, acquirers can take several key steps to ensure they maximise the value of a target’s IP in the post-deal phase and lay the groundwork for effective monitoring and enforcement of IP rights. These steps include a comprehensive review of the entire IP portfolio, which should focus on identifying any unprotected IP, confirming IP ownership and rights, reviewing licensing and collaboration agreements, ensuring clear chain of title, evaluating IP protection strategies, checking for pending IP applications, and assessing the role of IP in the product strategy.
Stevens: During a tax diligence process, acquirers can perform diligence on a target and suggest structures that result in step-up of the tax basis in IP assets. If an acquirer cannot convince a seller to sell IP assets directly, there are tax elections that can be made to treat a stock purchase as an asset purchase. Tax due diligence is effectively the first phase of post-acquisition integration planning.
“Globalisation demands consideration of international IP laws, making multijurisdictional IP asset evaluation essential.”
FW: Looking ahead, how is the IP due diligence process for the life sciences sector likely to evolve in the years ahead? Is technology likely to provide additional efficiencies and enhancements?
Schreyvogel: The IP due diligence process in the life sciences sector is likely to evolve significantly over the next few years, driven by advancements in technology, increasingly complex regulatory environments and the growing importance of intangible assets. As life sciences companies continue to innovate and grow globally, the IP landscape will become more intricate, and the due diligence process will need to adapt accordingly. Some key trends include technology enhancements, such as the integration of AI and machine learning for patent and trademark searches, enhanced collaboration tools for cross-border due diligence, and the automation of routine due diligence tasks.
Stevens: IP due diligence will become more complicated for tax departments in the life sciences sector. Constant tax law developments in the US and abroad will bring extra scrutiny on a target’s IP function with respect to historical risks and reporting compliance, as well as prospective impact on an acquirer. Modelling the tax cost and benefit of IP ownership and possible restructuring of IP will require more data inputs and assumptions. Technology may provide efficiencies to design and maintain these models.
Kristi Gedid is a managing director and the global and Americas life sciences leader at EY Law. Based in EY’s Pittsburgh office, she has more than 20 years of experience serving global life sciences clients. She has led legal departments through a multitude of transactions focusing on strategic planning, transformation, organisation and operating model design, cost optimisation, technology, and transition service agreements exits. Prior to joining EY Law, she served at a global pharmaceutical company as head of legal operations. She can be contacted on +1 (412) 804 7540 or by email: kristi.gedid@ey.com.
Maurus Schreyvogel is the EY EMEIA legal transformation leader. His role involves conducting current state assessments of legal functions, designing outside counsel programmes and legal spend management capabilities, as well as designing and helping to implement enterprise contract lifecycle management processes and technologies. Previously, he served as chief legal innovation officer at a global healthcare company. He has experience helping legal teams to develop process innovation and leverage technology to simplify, expedite and improve quality legal activities. He can be contacted on +41 79 701 7922 or by email: maurus.schreyvogel@ch.ey.com.
Jonathan Stevens is a principal in EY’s international tax and transactions practice. Based in EY’s New York office, he has more than 27 years of experience serving primarily multinational life sciences, manufacturing, consumer and retail companies. He also has significant cross-border transactions experience, with transactions ranging from buy-side to sell-side, tax-free to taxable, and pre-transaction separation to post-transaction integration. In addition, he has advised on many joint ventures in the life sciences sector. He can be contacted on +1 (212) 360 9203 or by email: jonathan.stevens@ey.com.
Ana Maria Romero is a transfer pricing principal with over 16 years of experience. She works closely with her clients to develop sustainable tax models that align with the company’s operating objectives. She also has extensive experience advising on the transfer pricing implications of transactions and modelling the impact of legislative changes on client’s existing tax operating models. She received a BA in economics and accounting from Illinois Wesleyan University, and an MS in accountancy from University of Notre Dame, Mendoza College of Business. She can be contacted on +1 (212) 773 7165 or by email: anamaria.romero@ey.com.
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