The Value Of A Dual-Track Process For Raising Capital

By Alex Castelli, technology and life sciences industry practice leader, CohnReznick LLP

Through the first half of 2016, market volatility has continued, and both IPO and M&A transaction activity is down in the middle market when compared to each of the previous two years. Until some stability returns to the capital markets, life sciences companies may find it more challenging to complete a capital-raising transaction.

When stability does return to the capital markets and investors become more confident, life sciences companies with an interest in raising capital may want to create a competitive buzz surrounding their prospective offering, referred to as “friction” in the investment banking community. Creating competitive friction is largely the function of the seller and the seller’s investment banker in an M&A process. The intent behind creating competitive “friction” is to maximize the purchase price of the deal. In addition to creating friction between groups of potential private investors, the same can be accomplished when a company pursues an M&A transaction and an IPO at the same time — the dual-track process.

So often thought of as an exit strategy for private equity firms, the dual-track process can certainly be utilized by life sciences companies that are considering raising capital by selling equity. The dualtrack process involves pursuing both an IPO and a private-sale process simultaneously. As both transactions progress, one will emerge as the best to meet the needs of the company and its shareholders.

Even though the dual-track strategy is typically most effective when the IPO market is more vibrant than it has been recently, life sciences IPOs, albeit fewer, still seem to be finding their way through the pipeline. So the dual-track process remains a viable option for life sciences companies to consider.

ADVANTAGES OF THE DUAL-TRACK PROCESS

• A more competitive sales environment (referred to as an auction process by investment bankers). If the life sciences company discloses that it is pursuing both an IPO and an M&A transaction simultaneously, this may lead to a more competitive auction process driving up the company’s purchase price.
• Increasing speed to respond and close the deal. Pursuing a dual-track process could encourage private investors to be more responsive and increase the speed to close, as they are competing against the timeline of the IPO.
• From an efficiency perspective, life sciences company management teams can utilize diligence and other materials from the electronic data room to satisfy the needs of both transactions.
• To most companies, the process of preparing a company to go public will require improvements to governance, internal controls, and financial management and reporting. Even though these improvements will be implemented to prepare for the planned IPO, private buyers will find them to be attractive selling features.
• A seller never knows when market factors impacting IPO or M&A activity may change to their benefit or detriment. Pursuing a dual-track introduces additional flexibility and removes the temptation to time the market. Be mindful that a life sciences company’s ability to achieve certain milestones in accordance with their strategic plan can either help or hurt an IPO or M&A transaction.
• The seller can delay a final decision until after all of the benefits and pitfalls of both transitions have been exposed.

In addition to the above referenced advantages, the “testing the waters” and “confidential filing” provisions of the JOBS Act, both used by almost all life sciences companies to go public, although not intended to directly support a dualtrack process, have done just that. Thanks to the “testing the waters” provisions of the JOBS Act, life sciences companies can communicate with investors earlier in the IPO process and with a greater flexibility, gathering valuable intelligence that could help bolster their negotiating position with private investors. And as a result of the “confidential filing” provisions of the JOBS Act, it has become easier to pursue a dual-track process without publicly revealing information during the IPO process that may be beneficial to a buyer involved in the M&A process.

CONSIDERATIONS FOR MANAGEMENT
To maximize the value of the dual-track process, the life sciences company’s management team must be prepared to exercise a certain degree of flexibility concerning the outcome of the process. After all, when the process begins, the management team may not know whether a public or private entity will emerge when the deal is done. The management team must believe in the company’s ability to survive and thrive as either a public entity or a private company.

Even if the management team can become comfortable with this aspect of the dual-track process, there are several other aspects that require thought and consideration.

• A dual-track process is far more costly than pursuing either an IPO or an M&A transaction.
• Running a dual-track process will consume more of management’s time. Remember, unless management feels comfortable in their ability to run two parallel processes, as well as focus on the day-to-day operations of the business, they should consider another option.
• If the shareholders of the life sciences company desire an immediate exit post-transaction and as a result of the dual-track process, an IPO is issued, the deal may not satisfy the desires of the shareholders.
• Getting stuck with a form of capital or a relationship that does not match the strategic plans of the seller could be detrimental to the growth of the company.
• Management will need to be skilled communicating with different investors, who will each have different sets of expectations and requirements.

As with any capital-raising endeavor, it is important to weigh all of the risks and rewards associated with the final disposition of the deal. The characteristics or personality of the best-fitting form of capital will be those that fulfill the strategic needs of the company. In a sluggish IPO and M&A market, life sciences companies may be unique in their ability to pull off a successful dual-track process. Because even though overall equity transaction activity may be lagging, investors continue to view life sciences companies as worthy investment options.