Contingent Value Rights in Public M&A Transactions

Contingent value rights, or CVRs, are used as a form of merger consideration in certain M&A deals. While still relatively rare, it is particularly common to see CVRs as a component of the merger consideration in M&A transactions involving companies in the biopharmaceutical and life sciences industry. This is partly attributable to the unique nature of the biosciences industry, in which a company’s overall success can be heavily dependent on the performance of a small number of drugs, treatments, or technologies.

CVRs broadly fall within two categories—price protection CVRs and event-driven CVRs. The majority of M&A deals that offer CVRs as a form of deal consideration provide for event-driven CVRs that are cash-settled and non-transferable. Event-driven CVRs are tailored to the unique circumstances of each transaction, often resting payment upon the achievement of certain milestones that may occur a few months or a few years after closing. For example, the CVRs may be structured as payments owed to CVR holders upon FDA approval of a drug being achieved by a specified date. The CVRs are typically paid out exclusively in cash, as opposed to buyer stock or a mix of both.

CVR Agreement:

In most cases, CVRs are governed by a standalone agreement called a CVR agreement. A trustee or rights agent will act on behalf of the CVR holders. The CVR agreement is entered into between the buyer and the rights agent. It is typically attached as an exhibit to the merger agreement.

In negotiating a CVR agreement, the seller is usually focused on receiving specific contractual commitments from the buyer and getting assurances that the buyer will make a good faith effort to achieve the specified milestones that trigger the payment of the CVRs. The seller will want to make sure that the buyer devotes sufficient resources toward reaching the milestones and does not prioritize other programs at the expense of achieving the milestones set forth in the CVR agreement. Meanwhile the buyer is looking to retain flexibility in the future in how it runs its business.

Price Protection CVRs:

While relatively rare, price protection CVRs can be used to protect target company shareholders from drops in the buyer’s public company stock price after closing of the merger. If a buyer’s stock price falls below a certain value post-closing, the price protection CVR will provide a payout equal to the amount by which the target market price exceeds the actual market price.

The target company often requests that price protection CVRs be transferable. The downside of CVRs being transferable is that they are generally considered securities under U.S. federal securities law, requiring registration under the U.S. Securities Act of 1933. This results in regulatory requirements for the buyer and may also lead to reporting obligations under the U.S. Securities Exchange Act of 1934 for the buyer. In some cases, transferable CVRs may also have to be listed on a stock exchange.

The buyer in an M&A transaction typically tries to avoid having their CVRs classified as registrable securities. Instead, the buyer attempts to have the CVRs classified as contractual rights. The determination of whether a CVR is subject to registration requirements under U.S. federal securities law is based on a five-factor test. If all five criteria are met, the Securities and Exchange Commission (SEC) will generally conclude that the CVR is a contractual right, not a security. The five factors are:

  1. The CVRs are an integral part of the consideration to be received in the merger;
  2. The holders of the CVRs have no rights common to stockholders such as voting and dividend rights;
  3. The CVRs bear no stated rate of interest;
  4. The CVRs are not assignable or transferable except by operation of law; and
  5. The CVRs are not represented by any form of certificate or instrument

Event-Driven CVRs:

Event-driven CVRs are more commonly used in deal structures than price protection CVRs. Event-driven CVRs help bridge the valuation gap when there are major contingencies affecting the target company’s value post-closing, such as regulatory approval of a new drug, clinical trial results, commercialization of a product, or the outcome of significant litigation.

According to a survey of public M&A transactions that included CVRs between 2018 and 2023, approximately 84% of the deals were in the life sciences industry. CVRs tend to be a valuable tool in biosciences transactions due to the contingent nature of many regulatory, clinical trial, or product commercialization milestones that can take years to achieve and often involve significant uncertainties.

Considerations Before Using CVRs in Public M&A Transactions:

While including CVRs as a form of merger consideration can offer a host of benefits, there are a number of considerations companies should take into account before deciding whether to offer CVRs. While CVRs can help bridge valuation gaps between buyers and sellers, particularly when the performance of the acquired business is contingent upon specific milestones that will not be achieved at closing, they can also lead to post-closing disputes. Additionally, CVRs are subject to unique accounting and tax treatment that may present complexities for the buyer.