OUT-LAW ANALYSIS 8 min. read
24 May 2021, 9:54 am
Without targeted amendments in secondary legislation, the National Security and Investment Act has the potential to undermine investor confidence in the life sciences sector at a time when it has shown both its worth and significant growth during the Covid-19 pandemic.
The provisions could capture a significant volume of transactions involving UK biotech companies
The National Security and Investment Act 2021 (NS&I Act) received Royal Assent on 29 April this year. It strengthens the UK government’s powers to intervene in mergers and acquisitions on national security grounds.
Although the NS&I Act is now law, most of the provisions have yet to come into force – much of the detail of the new regime is to be set out in secondary legislation and the provisions that have taken effect to-date are focused on handing UK government ministers the power to draft those regulations.
The central plank of the NS&I Act is a new requirement on businesses to proactively notify the UK government – specifically the Department for Business, Energy and Industrial Strategy (BEIS) – of certain transactions taking place in 17 defined sectors of the economy.
Examples of the transactions that will require notification include where there is an acquisition of more than a 25% shareholding or voting rights in an entity, or where a transaction entails the acquisition of a material influence in a company.
Where transactions have been notified, businesses will have to wait up to 30 days to find out whether BEIS will subject their plans to further scrutiny. If a deal is subjected to detailed scrutiny, businesses could face a further wait of 30 days, potentially extendable further, before a decision on whether to approve the deal is made. BEIS has powers to compel the sharing of further information and obtain witness evidence during the review period.
The mandatory notification regime applies regardless of whether the acquirer is a UK or foreign entity. Businesses that complete notifiable acquisitions without BEIS approval face potential fines and could be ordered to unwind those arrangements, while directors of investee companies might also be prosecuted and face time in prison.
Under the NS&I Act, BEIS has an ability to 'call in' any non-notified transaction for review where it raises national security concerns. As a result, businesses are encouraged to voluntarily notify BEIS of transactions they are involved in which do not meet the criteria for mandatory notification but which they consider may nonetheless raise national security concerns. A business that has not voluntarily notified its transaction and then completes the deal could be ordered to unwind those arrangements by BEIS if it subsequently 'calls-in' the transaction, having identified a risk to national security.
The power to 'call in' a transaction applies to the whole economy, and it captures a broader range of transactions, including where buyers gain control of certain assets of the UK target company, including land and tangible moveable property, as well as ideas, information or techniques which have industrial, commercial or other economic value.
Companies in the life sciences sector need quick access to cash. If the review and assessment process is overly bureaucratic it might delay how quickly they can be funded
Of the 17 sectors specifically targeted by the new Act, there are two particularly relevant to UK biotechs – the artificial intelligence sector, and the synthetic biology sector.
Not only will certain deals in those sectors be subject to the mandatory notification regime, other transactions involving the trade of ‘qualifying assets’ will fall within the umbrella of the voluntary notification procedure – such as where buyers seek to acquire a right or interest in biotechs’ intangible assets, including software, trade secrets, databases, source code, algorithms or formulae.
Though the definitions of the AI and synthetic biology sectors have been tightened, meaning fewer deals would be subject to the new Act than had initially been proposed, they have yet to be finalised. However, considering both the importance of digital technology to biotech companies and the fact that the Covid-19 pandemic has only served to demonstrate the link between those companies and national security, the provisions could capture a significant volume of transactions involving UK biotech companies.
There are a number of ways that the new Act could significantly impact the UK biotech sector.
The legislation as it stands will require an increased level of due diligence to be carried out on transactions to determine whether they require mandatory notification or whether voluntary notification is nevertheless advisable. The timing implications of the NS&I Act’s review and assessment periods will also need to be catered for in transaction documents, with sufficient protections built into transaction documents for both buyers and targets. Until there is some precedent of how the NS&I Act is going to be implemented in practice, there will be a challenge in catering precisely for how to deal with the NS&I Act’s procedures in deal documents. The extra level of due diligence and procedural unknowns present a risk to deal certainty.
Companies in the life sciences sector need quick access to cash. If the review and assessment process is overly bureaucratic it might delay how quickly they can be funded.
Venture capital investment is vital for early stage companies in the sector which burn through cash quickly as a result of their R&D activities. Cornerstone investors usually take stakes of greater than 25% in the life sciences companies they invest in, particularly when providing seed funding and other early funding rounds, often with veto rights over certain company decisions. Where the target company falls within one of the defined sectors, those arrangements would be subject to the mandatory notification regime and thus potentially delay investments.
Deals concluded since 12 November 2020 can still be looked at on a retrospective basis, so there is a level of risk and uncertainty still involving deals that have already been done as these could still be unwound, albeit that BEIS has stated that any retrospective review is primarily designed to prevent avoidance with the new regime. That uncertainty is not going to help the general investment environment.
There is currently uncertainty in the UK biotech sector as to which transactions fall within the mandatory or voluntary notification regimes, not least because of the broad definitions given to the 17 sectors.
From a small, leanly staffed biotech’s perspective, determining whether transactions are notifiable could be an unwanted drain on resources – given the technical detail in the definitions, the scientists are likely to be best placed to establish whether the NS&I Act applies to their company’s deals.
If businesses err on the side of caution and make a voluntary notification, there is a risk that BEIS could be overwhelmed with notifications to review. This calls into question whether the department has sufficient resources and the necessary expertise to evaluate those deals within the prescribed initial 30-day review period.
Because biotech companies tend to carry out multiple fundraising rounds, the legislation risks having a disproportionate impact on prospective investment and innovation in the sector – each transaction at each funding round would be subject to potential detailed scrutiny. It is a distinct risk that delays in deals being approved could lead to early stage biotechs running out of cash.
Some investors could see the legislation as overly onerous and choose simply not to invest in the sector. This could deprive early stage UK biotech businesses, which are often run by scientists rather than experienced businessmen, of the necessary business expertise to grow.
Co-investment strategies could also be affected if partners in that arrangement are seen as a potential political concern. Similarly, exit strategies could be impacted if there is likely to be a reliance on ‘high risk’ acquirers – some investors are likely to think twice about investing if it is going to be difficult for them to offload their holdings.
If the legislation is considered burdensome, it could drive UK biotech companies to move away from equity investments and instead look for debt financing. Debt financing would inevitably make companies less attractive to equity investors in the future as the debt providers would rank higher in the event of a winding up of the company. Also, with companies in the sector highly unlikely to be profitable at an early stage in their life cycle, debt terms imposed are likely to be punitive.
Licensing deals could also be caught by the NS&I Act under the voluntary notification regime. Licensing deals are an alternative way for life sciences companies to bring in revenue through milestone payments. Biotechs are likely to consider that having this route to finance also subject to BEIS scrutiny as a major constraint on their potential growth and viability.
Alienating foreign investment would risk a funding shortfall
The UK government is keen to ensure that, post-Brexit, the life sciences sector is seen as open for business. The government has accepted, however, that the NS&I Act will place increased burdens on life sciences companies – for instance, it has acknowledged the difficulty in separating out synthetic biology products and techniques that could have ‘dual-use’ application in a military context, which is one of the other sectors subject to the NS&I Act, and that that may lead to more notifications of transactions being made. The overlap in definitions between the synthetic biology and artificial intelligence sectors has also been recognised as a difficult area for biotech companies to assess.
The UK government has published a draft 'statement of policy intent' which is due to be further refined before it is finalised. The document sets out key considerations in assessing when BEIS will use its 'call in' power, and by extension provides an insight into how BEIS may assess these issues in general.
The statement focuses on: the target risk – the nature of the target and whether it is in an area of the economy where the government considers risk more likely to arise; the trigger event risk – the type and level of control being acquired and how this could be used in practice; and the acquirer risk – the extent to which the acquirer raises national security concerns. Further detail on how these principles will apply to the biotech sector would greatly assist life science companies conducting a risk assessment on the application of the NS&I Bill to a particular transaction.
Other options could be considered by the UK government too, such as exempting certain repeat investors in the sector from notification requirements once they have been initially cleared by BEIS, only re-visiting that exempt or approved status every 12 months.
Another alternative might be to make investors that are regulated by UK authorities such as the Financial Conduct Authority or Prudential Regulation Authority, exempt from having to make notifications under the NS&I Act. In both cases this would have the advantage of making sure investments were completed quickly and with minimal administrative burden, whilst also signalling that the UK is open for business and that the government is willing to take a pragmatic approach.
The NS&I Act promises to be less burdensome in some respects than its US equivalent, the CFIUS regime, where businesses can face a wait of five months for national security concerns arising from prospective transactions to be assessed. Statutory timelines for NS&I reviews will help with deal timetables in situations where a notification is made.
The CFIUS regime in the US specifically targets Chinese and Russian investors. The volume of capital life sciences companies can access domestically in the US market means this regime has not had a great impact on the overall levels of investment in the sector. However, the UK government will want to keep in mind that the pool of specialist life sciences investors is not as deep in the domestic UK market, and so alienating foreign investment would risk a funding shortfall.
It is therefore incumbent on the UK government to take prompt action to give effect to any efficiencies that can support the UK biotech sector and encourage investment.
OUT-LAW ANALYSIS
22 Apr 2021
