Build-to-Buy and Option Structures

Hello M and A Scientists. This podcast is sponsored by our business lines. Firm Room is the world's most intuitive virtual data room that meets public company security standards at a fair price. We all know paying per page for a VDR is a scam. Firm Room has helped Companies save over $80 million in VDR fees. We actually did the math. Don't let your investment bank dupe you into paying per page for a VDR. That that's just dumb. Visit firmroom.com pricing to see how much you'll save when you switch to Firmroom. And you could do a free trial right there on the spot and do a side by side comparison so you can see why it's a better product for a better price. Deal Room is a leading M and A lifecycle management platform. It manages your pipeline and combines diligence and integration into one process so that the integration is faster and easier. Even if an investment bank is driving the sale process. Dealroom helps you take over once the LOI is signed and drive better integration results. Learn more about deal room@dealroom.net See why the best in M and A are using Deal Room I often get asked how we make money. There it is. Check them out in the show notes. It's the best way you can support this podcast when you need to get your team up to speed on the latest and best M and A practices. Obviously this podcast is a great place to start, but when you need to step up your game while earning some credentials, the M and A Science Academy provides over 40 courses and a library of templates. Coming soon, we're offering Agile M and A Diligence and integration certifications. Visit mascience.comacademy to learn more. Now onto our interview. I'm Kisan Patel and you're listening to M and A Science where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during M and A deals. Hello M and A Scientists. Welcome to M and A Science where leading M and A practitioners share lessons learned from their experience. If you're interested in keeping up the latest from M and a science, visit mascience.com and subscribe to our free newsletter. Every Monday we share highlights from our interviews and invitations to events as we build the greatest community of forward thinking M and A practitioners. Again, that's mascience.com I'm your host Kisan Patel, CEO and Founder of M and A Science. Joining me today is Finn Haley, Senior Vice President, Corporate Development at Edwards Life Sciences. Edward Life Sciences is A global medical technology company headquartered in Irvine, California specializing in patient focused innovations for structural heart disease. They have a leading position in the transcatheter heart valve replacement and hemodynamic monitoring traded on NYSE under eye. Today we're going to talk about an investment and acquisition structure that's grown in popularity with medtech innovators in recent years. The option to acquire structure, sometimes referred to as a build to buy option structure. Ben, how you doing today?

Good. Thanks for making the trip here and meeting in person.

We are live in person at the Edwards Life Science headquarters.

That's right.

The this is awesome. I haven't done it in person in a while, so no, this is a.

Special treat that it worked out that your travel allowed for you to be here and we love hosting you. So this is fantastic.

It was great. I appreciate the tour of campus. This should be a fun conversation. Could we kick things off a little bit about your background?

I've been at Edwards now for three years. I joined in 2020 right before the pandemic. I've been a long time corporate development, business development, strategy guy and healthcare. Even though the move out west was fairly recent and all we can get into what we do here at Edwards. I have probably 20 year career in and around healthcare and medtech. Before I moved out here to the west coast, I was in the Midwest at 3M actually for 13, almost 14 years. So I know you've had Jerry Will on the podcast before who runs corporate development there. Jerry was my boss for a number of years and we did a whole bunch of really interesting transactions when I was there and I was pretty much exclusively focused on healthcare and med tech at 3M. So that whole business that 3M is in the process of spinning out, I was part of that for many years and my roles were for a while I was in corporate development, for a while I was in business development, I did strategy and I even briefly had a product line in the surgical wound care space there. So you can have lots of interesting experiences when you're at 3M. And like I said, that was 13, almost 14 years. And then prior to that I came from investment banking. So I was at Piper Jaffrey, the now Piper Sandler in their healthcare investment banking group and then prior to that was in Chicago at Duff and Phelps. Even though on paper mostly look like someone who's focused on deals and transactions. I've had a little bit of diversity of experience too on the strategy side and then I was fortunate enough to get the opportunity to come here to Edwards Move out of the Midwest to the west coast in this wonderful weather, although today it's a little windy, and have functional responsibility for the corporate development group here.

It's a good run. It's a nice career going from IB into the corporate side. How many deals do you think you've ran through?

I used to have a deal sheet that I updated pretty regularly and it was more just out of habit last time we looked at it. If you added M and A transactions, carve outs financings. And we used to do IPO work as well on the equity side at Piper. 60, 70 deals that are closed somewhere in that neighborhood. But I think for every deal you close in this industry, it's like you've looked at probably 10, right? The funnel's pretty narrow and that was certainly true at 3m. We looked at a lot of things and were very disciplined. We're the same way here at Edwards. We're very careful about the investments we make. And so you'll spend a lot of time working on something, then you get to the end and then decision is made not to move forward. So a more interesting thing might be how many deals have I worked on that didn't get done over those 20 years?

That's true. That is true. So this thing in your space where you employ this option structure on certain deals, walk me through it. What does this stuff mean?

Maybe before I kind of get into what the option structure is, maybe I'll tell you a little bit why we employ it. I think that'll inform a little bit on the value of it. At Edwards, we're a unique medical technology company. We're very focused on patient focused innovation. We really target breakthrough innovations. So these are innovations that are oftentimes new to the world. They change the practice of medicine in a meaningful way. Frequently they extend life. So our TAVR procedure does that. And what goes along with that is this commitment that we're going to be involved with the companies we invest in over a journey, over their clinical journey. So it's usually like we're going to start testing in animals, we're going to go into patients. It's a multi year process. The way we think about where we make investments, we have a filter that served us well. We start with is there a really big unmet patient need that needs to be addressed? Is there an opportunity to have a break through innovation in that space? Not incremental, not something that improves patients lives a little bit, but like a meaningful change. We also say, is there a pathway to leadership? So at Edwards, I Think we have number one positions in 95% of the segments we're in. So we're very interested in being a leader and we like moving first because when you're first in developing a segment, you get to shape how it develops and you get to work with the regulatory bodies and you get to work with the governmental agencies. That's a position we're very comfortable in. And then finally it needs to be a segment where we can create value, obviously for AdWords and our stakeholders. But when you have that lens and you're very focused on cardiovascular segments, you have this screen. What ends up happening is you go very early in your investments. We engage with companies when they're very early in their clinical journey. They can be raising Series A. We're willing to talk to companies at every stage of their life cycle. The way we engage with them, whether it's investing in equity and debt, an option like we're going to talk about today, or just outright, M and A falls out of the opportunity and what our needs are and what the company's needs are.

So I wrote down some ingredients here, but we have long process, big market with this identified unmet need. Breakthrough innovation, not incremental, something big, dramatic opportunity to be in the lead position, great value for the stakeholders and get in early by some other little smaller ingredients as well.

Oh, that's right. What the option structure really is, it's a way to work with companies where we're interested in building a relationship with them, helping them develop the type of company that we would like to acquire in the future and solving some of their financing needs in the process. So it sits a little bit between just us making a straight equity or debt investment and M and A. We kind of think of it as maybe the best of both worlds. So what it is is we would approach a company and say, okay, tell us what your clinical and development plan is. They'll say, we have this technology, it's going to take three years to develop it. We have to do this kind of clinical pathway. And we say in our experience, we think what you're developing could have a lot of value for patients. How about we make your journey a little easier? We'll invest into your company. It could be a mix of what we call option premium, which is an investment that's wholly non dilutive to their cap table, so doesn't dilute their investors. And they like that. We could buy some equity. You could even put in convertible debt or any mix. But we basically fund their development timeline. So let's imagine Our example, it's three years to a meaningful value inflection point, maybe a readout of clinical data. We'll fund the whole pathway and we'll also put in place today a merger agreement. So we'll actually do all the negotiation of what the acquisition will look like, and we'll set a purchase price today. As a leadership team for this company, there's a ton of benefits. They basically take a lot of that financing risk off the table because they know they're not going to be out trying to raise money constantly, which is what a lot of these founders have to do. They know that they, if they execute, they'll have created a business that, at least in theory, Edwards is interested in acquiring. And there are a range of other benefits we can talk about too, but that's really what it is. And then Edwards has the option, but usually not the obligation, to acquire the company. At that milestone point in the future, we can decide we want to acquire it and bring it in house, or we can pass. It's a really nice structure. I think it's been used in a lot of industries for a long time. I'd say going back to 2014 and 15, it started getting used more frequently in medtech. And these days, a lot of the big medtech players are using these routinely.

I want to make sure I understand this structure. Essentially, you'd come in and we're at a certain stage in building this technology. You would provide funding and a few different structures to do that with that. You would also essentially create this option to acquire the company at a point down the road. But then it's not a must have. You don't have to. You may not acquire the company, but you will definitely have that option, too. And you put a price point on it.

Exactly. And so if you're sitting in the shoes of a CEO or the board of this company and Edwards approaches you and said, we're interested in doing that, you probably go through questions, okay, what do I get out of this? Why is this a good structure for me? And I would probably make a case that would go something like this first. I already touched on it removes your fundraising risk. Not perfectly. There's always the risk that we're going to agree on a budget and the budget's not going to be the right budget. But for the most part, you're not going to spend a ton of your waking hours thinking about calling investors, talking to VCs and saying, how can I get more money? Focus on execution. So that's a big piece of it. I mentioned the fact oftentimes the funding has a non dilutive component so it doesn't mess with your cap table. Investors like that. I think a really big benefit is you're partnering with a strategic in the space. When we talk about these deals, we say options with an alliance and the alliance piece of it is you're going to be able to get to know people within Edwards should we decide to do this. You can draw on our capabilities. So let's imagine that you're a target and we say, listen, we want to do one of these. Build the buys. This is the type of business we want you to be in three years. And here are some milestones that we want you to hit. And if you hit these milestones, you're going to be a really attractive target for us. Oftentimes we'll work with them to say, would you like us to give you some guidance on those milestones? If it's something around setting up a quality system or a regulatory or manufacturing, we can agree that you can draw on the capabilities we have inside of our company, which is super unique. Right. And so we view it in many ways as a partnership where we get to learn about the company. It's like a prolonged diligence for us because we have this strong relationship with them and they benefit from our expertise. And if everything goes well and the milestones are hit and the opportunity is still we thought it was going to be, there's a really nice but predetermined exit for those investors and we've locked in a purchase price. And so the ultimate acquisition can become pretty mechanistic and just play out once you get to that future point.

Okay, I'll be the startup here because I like being the startup. Our value prop here is that we're de risking funding because I don't have to do as much to chase down capital. This structure is going to be provided. It's non dilutive in the form that it's weighted more on. The option is the value driver for you.

Yeah.

And then I get to partner with you. There are some opportunities to leverage some of the maturity you have and helping us get to market faster and getting through our R and D process. The downside for me is that there's essentially a cap on this exit.

Yeah, you got it. One feature of these transactions are that they are almost always very frequently capped. So we're agreeing today on what the value is now that can cut both ways. There are times where we may agree to a price that maybe is too high when we get to the option. But of course, it's our right to walk away. The company is agreeing and they get approval. If in some structures, most of the structures the shareholders will have and the board will have to agree to it to do this deal, their degrees of freedom are much less to walk away from the deal. So if we get to our option period, and we've agreed on a price and we want to exercise, by and large, we're going to exercise, we of course, can always walk away, so the upside is capped. That's one thing that they do have to think through and they do have to puzzle a little bit. The other thing they always, I think in your shoes, people think through is, okay, what happens to me if Edwards doesn't exercise? Am I stuck? Is the perception in the marketplace going to be that I'm not a valuable company? And we work very hard to say that's not really the case. There could be different reasons why we don't exercise. Certainly, maybe the market opportunity isn't. We thought when we entered into this agreement, three years later, the market's just never developed. In a way, we thought it was okay, then we're probably not going to exercise. You could have a change in strategy so Edwards could decide that we don't want to go into this segment, or we could have a change in leadership, or maybe the criteria that we agreed for this build to buy, the things we said we wanted the technology and the business to look like were never achieved. So each of those is a little different. But what I say is if the company delivers on the criteria that we agreed to, chances are they're going to have one amazing product and someone's going to want that product. If we decide, because we just, hey, we're not going to go in that direction. We're going a different strategy. Another strategic is going to want that business, and it's certainly going to be financeable. Ipoable something. And by the way, we're still an investor in the company, usually, so we want it to succeed as well. And there are all sorts of mechanisms that companies negotiate for in those circumstances to protect their downside. Oftentimes it's what you call like a break investment. So if you walk away, you got to give us a little bridge financing so that we can go out and raise more money. And so we negotiate those types of things to protect in those downside scenarios where Edwards doesn't end up exercising the option.

So what are the drivers for your organization on this structure?

There's a number of them. The primary is very Strategic. So remember I kind of alluded to the fact that we want to go early. It would be excellent if Edwards had enough resources to innovate. Everywhere we want to innovate, but R and D teams necessarily have constraints, so we can't do everything. So this structure allows us to work with innovative companies at a very early stage, but preserve that optionality, which is I think very valuable and pursue a lot of these breakthrough technologies, which are a ton of work and a very big commitment to develop. But we can do it both with a mix of organic and inorganic. To be clear, 80% of our investment at Edwards is still on the organic side. We're primarily organic innovation company. Probably 20% ish is inorganic like we're talking about. But we also spend a lot of money on innovation, period. So like we spend 17% to sales on our R and D budget, which is crazy. It's really awesome that we do that. It's a really big number. Medtech overall is about 10% and a lot of big industrial companies, maybe 3 to 5%. Edwards is running at 17%. You have to be committed to this type of innovation. That's what we're trying to do. We're trying to get in early with them. And the way we think about it is you're trying to learn and you're trying to influence them. That's what's great about this option structure. You learn as they go and you influence the way they go. It's a really nice thing for us. We also love that you get a pre negotiated deal. So imagine they succeed. This is a little bit of what just the reality of it. If the company went on its own clinical journey and succeeded, it would probably be worth more than the price you lock in today. If they actually hit every milestone, did it by themselves, their valuation would probably be more then we're willing to lock in our merger agreement today. So we get a bit of a fixed price now. They get the certainty, but they cap the upside. That's a little bit of the value that we see in it. There are other ancillary benefits that don't drive it. But you'll hear people talk about utilizing the balance sheet for R and D. These investments do sit on the balance sheet. So that's a, that's another benefit to the company, but it's not the driver of why we do it.

It's interesting, it sounds like this fundamentally expands the scope of your R and D. Yeah. How do you think through that with your strategy? Are you placing these bets in alignment with this Strategy or are you generally broadly looking for the bets to make and then thinking through how it ties to strategy from there.

When we think of the corporate development group and out of our group, we do corporate venture capital, so we'll do VC investing, we'll do debt investing, we'll do these option deals, and we'll do control transactions or ma. We think our job is to literally support the company's corporate strategy. So very closely linked to what we're trying to do. And the nice thing about our strategy here is it's very focused, it's super focused. So we're always clear on what we're trying to do. So we go very deep in the areas that we go in past lives. I spent a lot of time looking at new spaces, white space, M and A. In fact, I did white space, M and A for a long time. And it was like, what segments should we go and try to get into? Like 3M did a lot of that, right? It was like, we're in these segments. What segments should we be in that we're not? Of course, at Edwards, we do ask ourselves those questions. But we have a strategy that's worked very well for us, this breakthrough innovation, focused and driving for leadership. It's easy for me to say, okay, what do we have that's emerging in the areas that addresses these patients? Again, it starts with the patients and we just support that strategy. And so it naturally leads to these types of structures. And so the folks that are in cardiovascular, a lot of the players, Boston Medtronic and others, I think we all to some degree race to find these early stage companies. I think they're sometimes surprised. You'll get calls very early in their development cycle. They'll say, we've done 20 cases with patients. Why are you calling us? We'll say, because you've done 20 patients, tell us how they went. We do the same thing. What signals are you seeing in the clinical data? And that's really cool because when you have that level of depth of knowledge behind us, we know that the innovation process is messy. So sometimes a company will say, yeah, we did a few patients, but gosh, half of them were pretty messy. We had some safety signals, we had some adverse events. So tell us about it. We're not scared of that. You don't get to where we are if you're scared of that kind of innovation.

It sounds like part of the other challenge is once you get these terms locked in, getting to the acquisition point is monitoring the progress of the milestones between what does that look like is that quarterly check ins weekly, annually.

Yeah. It probably won't surprise you. That's one of the things that companies spend a lot of time thinking through. And in the legal documents that govern these transactions, and they're fairly extensive because you have various agreements that govern both the option investments and the way that's structured purchase of equity and also the ultimate acquisition. And all these documents get negotiated at the same time. So it's a lot of paper. We spend a lot of time trying to figure out what is the relationship because no one wants to be slowed down. They want to benefit from our collaboration, but the worst thing they can do is have someone who's constantly looking over your shoulder.

You're not taking any board seat.

It depends.

Depends. Okay. Eventually you may take board seats and then yeah, I would be super interested in understanding the governance.

We may take a board seat. Maybe board observers. Depends a little bit on the transaction. But remember, whether or not we have a direct board seat, whether we're a board observer, whether or not we have a formal alliance, meaning we're working with them on certain components and criteria of the build to buy. Regardless, there's a lot of connective tissue between us and the companies. They're independent still. And this is always that tension. Right. As a CEO operator, you're trying to build a company that Edwards wants to buy, but you have to have an eye towards what happens if they don't buy it. You have to have a company that could exist on its own too. They try to walk that, I try to walk that line and we try to make sure that what we ask for is reasonable. Right. So we, in the very least, we know what's going on the company through at least an observer or some kind of function with the board. We also have the alliance team that can be working with them, getting feedback. We're helping them, we're not controlling them. It's a bit of that walk that you have to do.

My initial phobia of working in large companies is it's going to slow us down. They don't move nearly as fast as a little startup here. How do you handle that? Objection.

First of all, we think we move pretty fast. But the objection companies do. But that objection is not without merit. If we structure this in a way that we slow them down, we've completely deactivated the whole deal structure's value. It's completely ruined it. So we're not interested in that. I think of it as make us aware of the things that are going to impact the desirability of the acquisition. Remember, part of the build to buy component of it is we should agree in the beginning on what the criteria of success look like. So if you can set up a company that is capable of doing this and this boy, it's super likely that we're going to exercise that option. We want to be able to monitor the progress, we want to make sure that you're avoiding pitfalls, but we don't want you to spend all your time doing PowerPoints. For us, that's like the fear is that every two months you have to do all these data downloads and prepare presentations and your team gets distracted on what they're doing. We go to great lengths to not do that. But it gets negotiated and a lot of times the founders will say, yeah, you're asking for this every quarter. Can I give you this data every quarter? But can we meet less frequently on these things? And we try to be very reasonable about that. It's that balance, right? It's knowing that your investment is being protected and we're moving in the right direction. But we're giving the company autonomy, letting them hit the right value inflection points and maintain the independence, because they are, they're still an independent company. But you're right, there's always going to be that tension there. But I think we have really good partners and folks that do this and teams that do this a lot. So we're pretty skilled at understanding that it's not in our interest to have the companies presenting to us all the time. You think about it, all the effort that goes into an hour long update can take weeks. And when we're innovating in this manner, that's valuable time.

On the other side, what happens if the startup blows through all their money and they don't get out to market?

That does happen. Not necessarily with investments we've made, but it does happen with structures like this. So there's a couple things. One, we do our best to stress test the budgets going into this. So again, I made the point that the option premium, the investments we make, in whatever form that additional investment comes in, ideally it carries the company to that milestone or value inflection point where we're ready to make a decision. But let's imagine we're not. Couple different ways that could play out. Maybe the company has done their best and they just haven't delivered on the technology and the criteria that we agreed to. You need more money. How does that look? Certainly is going to be a negotiation. Probably negotiation to us. They come with us and say, would you help us? Would you bridge us? Depends how long the bridge is. You may have to go to their existing investors and say, hey, we just need a little more time. Would you put more money into the company to carry us? There are lots of different levers you could pull, but it's almost always negotiation. You could also imagine a scenario where for whatever reason, the option holder, the strategic just wants more time for a decision. You could also put more money into the company and say, hey, we want to see a little more of this. We want to see this. But that's a negotiation. It's changing the deal. And then the company has the right to say, do we want to do that or not? Do we want to extend out the option further? I think again, if you're partners with these companies and you're in it and you've been going on this journey together, you're pretty incented to find solutions there. But if it's a complete bust and hopefully we don't find ourselves in that situation, One does not find themselves in that situation very often. Then I think you got to have hard decisions around whether you want to keep financing or not.

That sounds like it's a pretty big variable. There's that if you have interest, because then you may back up and see if they have somebody else pick it up.

No, exactly. And sometimes they do. Again, it depends on how successful the company's been, what the opportunity is, and why we decided not to exercise. It's not like we're doing 30, 40 of these, but we're doing them selectively and strategically for the right investments and for the right opportunities where it makes sense. And we want to go on this journey together.

How do you think about risks on these deals? And I think of traditional M and A, where you're modeling out synergies and how well you can execute to capture those synergies. What's your view on risk on these type of deals?

It's very different than what I did before. So I'm thinking back on time both in investment banking and working corporate development at 3M. We spent a ton of time in the synergy models. Cost, sales, all that. It's interesting. That was probably the lion's share where we spent our time, deal modeling. I remember sessions when Jerry and I were working on those, and we'd spend hours going through the detail on the cost side and the sales synergy side. Much easier to capture the cost side than the sales side, I would say. We spend less time doing that now, where we spend a lot of time on my transactions now are understanding the patient opportunity. So we'll be digging through clinical and healthcare data, understanding what's the incidence and prevalence of certain conditions and what is the population of patients who could benefit. What are their alternatives, how do those alternatives work? It's like the time I used to spend on cost energy and sales energy is now understanding patient populations, just different. And we have these really big multi tab Excel models going through and figuring out what the opportunity is for patients to treat. It's amazing. There's all these different classifications of patients and patients that respond to this and not that, and patients that have this comorbidity and patients, before you know it, they're just like a hundred rows in Excel just to understand at a very granular level who are we going to be treating and what their benefit is going to be. So it's just different. There isn't a bunch of infrastructure to take out in a cost deal. It used to be really simple to go through and say, what's the redundant functions of this business here? It's maybe 10 people, maybe five people working on some.

Yeah, it is interesting because you don't have the control. It's like what you described. You're doing diligence like a venture capital at this point?

Yeah, yeah, very much. And again, I think it's great. But it was a change for me when I came here to Edwards. It was energizing. It forced me to develop a whole new muscle because I thought of M and A as one thing. I thought of it as, you got a company and it generates EBITDA and we get to look at the cost structure and figure out where the value points are, how are we going to take their sales, run it through our channels? Where are the leverage points in international, in the matrix? All that. And back in banking. Nothing against my former colleagues in banking, but it was an assumption. The synergy was just a percentage assumption. It was like, what's the sales acceleration put in? X percent sales acceleration cost, X percent. Now it's very much like when you're going this early, you have to really believe in the opportunity. And we're not talking about capturing little shares. We're like, if we're the leader in this really big opportunity, how does it change patient lives? Just a different conversation. And it's one that energizes us. It energizes the companies we invest in. And I think they respond to it and that's why they get excited a lot of those people, that's what gets them going. So they'd rather not spend all their time raising money and doing all that work that calling venture capitalists. They're like, let us focus on the innovation and if you can help us, great. And we're willing to go on that journey with you and partner with you. They're the ones for whom this structure makes a lot of sense. If it's someone who believes that they want to have a really big public company and they want to maximize their exit. And by the way, nothing wrong with that. There are folks for whom that's the right kind of business they're building. They want to probably just go on the traditional journey, raise VC money in subsequent rounds and do all that. Maybe an ipo, maybe an exit. But if you have a really cool breakthrough technology that's focused and you want to work with us and we can help, that's where the natural fit is.

Yeah, really good points around that. Just very different into how you got to think about this.

Very different. I had to learn a whole new way of thinking about it. I was more traditional. Later Stage M and A what's neat about this is it's sort of in many ways the benefits bridge traditional venture capital investing or traditional equity investing. And later Stage M and A. It's like the hybrid between the two.

Can you tell me about when it comes time to exercise your option? Are you still doing some of those mechanics or are you just going straight to sign and close?

Traditionally, the way it works is let's imagine that we've set. We call like, sometimes called like milestone delivery points. So there's a time at which a milestone is achieved and the option begins to expire. So again, there's different ways these can be structured. So I'm going to try to generalize for simplicity. Sometimes the option is live the entire time and we can exercise at any point. Sometimes the option becomes live, but let's just generalize a little bit. At some point, the option has to begin expiring. So one way this could work is you set a milestone and say, let's imagine it's some clinical data from a pivotal trial, the big large trial that they're doing to get approval to market and sell this product. And we say, once you get the results of that trial, give us the results and we have a window to decide. So there is a diligence window that would open up and it's basically triggered off. The time it takes for us to make a decision could be 90 days, it could be a few months where we do final diligence and make our decision. And if not, there's some period of time and then the option would expire, our right to buy would go away. So you do get to do confirmatory diligence of some kind. And again, everything's negotiated. There are times where the company is like, you shouldn't need that much time. They want a tight window. Other time, we always say we want time to process whatever it is that you've delivered to us, whether that's data. Other times you just say, listen, the trigger is approval and once the FDA approves the product, that's when we'll make our decision. Depends. And sometimes again, it's very early. Sometimes it could be like we'll just see the results of an early feasibility study. Whatever it is, it has to be something where we get conviction. We have to get conviction that it's going to be efficacious and make a difference to patients. That's really what we have to get conviction around. And whatever it is that gives us that, that's where you make the decision. If we walk, the option has to expire. It can't just persist forever. Companies don't let us do that because then of course their strategic value is diminished. It's a finite instrument. There's a time at which it ceases to exist. And there's risk for us in that because we pay money to acquire that right. That option has value. If we don't exercise it, there's a charge that goes along with that for us. So there is downside risk for us. The risk is that the company doesn't meet the criteria we want and then we have to just eat that investment and it expires worthless. So that money that we gave it was non dilutive. That didn't result in ownership of the company. There wasn't a return on that at that point.

A hard time wrapping my head around that, but I get it. If the whole intention is down the road, it would be an acquisition for your portfolio and it would have made sense. And essentially you're making similar bets through your own organic R and D function.

And listen, we do a lot of diligence on the upfront. It isn't something where you say, well, technology is. The concept is interesting. Therefore let's just buy a bunch of options. Let's just option everything that's interesting out there. You can probably tell, given that we, the players in the space don't. We're very judicious about how we think about these. And so you do diligence going in, but you can't Diligence everything like you would in a normal acquisition, because it's not all there. Company probably doesn't have a built out HR department, for example. They don't have a giant manufacturing infrastructure, for example. So your diligence looks different but you diligence the investments before you make them and then you diligence again before you exercise the option.

Yeah, you're running a lot of the same components you would in a typical M and A deal. At least the confirmatory diligence.

Yeah. And it's done very similarly to what you typically see. So you'd have functional experts that do diligence for a living by function, that do these on a number of deals and they go through and look at their respective areas and report back on what they find. So that's the confirmatory looks. There's just much less of it before you make an option investment or a build to buy option, because not all that's built out yet. You put a fair amount of money at risk. Based on the conviction you have from being so focused in the space and knowing what might work.

Can you give me the reasons why you ultimately wouldn't end up doing the M and A deal?

One of them is probably the most obvious is through these build to buys. You usually agree on the criteria you want to see the company develop. So whatever it is, we'd say, listen, we want the company to look like this. We want to have this, have this manufacturing capability. By the time we exercise, we want it to have this sort of impact. If they don't develop a technology looks like that we may not exercise. The market could never develop. There are technologies that are really interesting. So let's imagine that it's a new disruptive breakthrough technology, but it has competitors in the market already. Maybe that market is just not ever developing. It wasn't as impactful as we thought it would be. So we just say, you know what, that makes sense. There can be a range of strategic reasons. We might make the decision that for whatever reason, we're not going to play in a certain segment anymore. And the last one, people often ask us about it. We hear a lot from founders about this. I know that you're convicted, meaning I know that this leadership team at Edwards really believes in this strategy. But what if you're not in your roles when you go to exercise the option? And why this matters is sometimes these are long term agreements. It could be three, four, five years out before we're going to exercise the option. So it's a long journey. What happens if The C suite turns over and the new people in those seats don't care about this deal or they don't care about it. So they're like, yeah, I get it, I believe you. You can look me in the eyes and tell me you think this is really amazing, but how do I get comfort that the next administration will. So what we try to tell them is again, if you have your North Star, and that's patient focused innovation, making a difference to these patients in this particular population, whoever is occupying the roles in Edwards is likely to feel pretty similarly.

Okay. So it could come on both sides. They could have change in leadership, or they don't deliver what you expected, or they go in a different direction.

Right. We try to protect against that. Right. We have all kinds of things in the agreements that say if you set off to be a company that's going to develop something really interesting for Mitral valve repair or replacement, you can't take all our money and decide actually you want to develop an ice cream company in Austin. I'm joking. But there's a lot of protections in there. But you negotiate over what the protections are and the degrees of freedom. And we negotiate around how much of the money goes to certain things versus other things. Because again, we do want our money to go to developing the technology we want. But you're right, they can take it in a very practical way. They can squander it in efforts to advance, in my hypothetical example, a Mitral replacement product, they could still squander it, not invest it wisely. Once they have the money, they have the money.

There's factors on your end where you may change your appetite for that segment or just general strategy.

It can happen. In our case, we are very clear on what our strategy is. So when we enter into these, we've thoroughly vetted it, but certainly that's the case. And I know that if we looked at the universe of option deals that have been done, it's absolutely certain that companies changed their strategy and didn't exercise these.

If you go through all this and you don't ultimately exercise your option to acquire the company, is everything a total wash at that point?

No, it's not. But it depends a little bit on how it's structured. Like I said, if you give some money that's non dilutive, to acquire the option, you have to give consideration for the option. The option has value. So you're paying money for that option. Yes. If it expires worthless and we don't do anything, there's a charge you'd have to take. And so that's like you reacted earlier. You went, wow, you can throw all that money and get nothing out of it. If you don't exercise. Yeah. The portion of the money tied to the option. Yes. Because the option had value along the way that would just expire and you take a charge for it. If a component of your investment was in equity or maybe convertible debt, that would convert into the next financing or a subsequent ipo, then we still have something for our investment. These get structured different ways. Sometimes there's a piece that's option premium, that's the part that is tied to the option, to buying the option. There's a convertible debt component. Maybe there's an equity investment. It just depends on the individual needs. Other times as well, you can bring in a venture capital partner. So imagine a really long development timeline. So let's pick for example, four or five years to get to that value inflection point. Maybe the amount of capital that we need to raise is sufficient that we will want to go approach a venture capital firm or a private equity firm that would consider these types of investments and say, would you like to invest alongside us? And they get interested in that for similar but different reasons than maybe the company does. The return is relatively fixed. They can look at it and say, okay, if everything goes according to plan, I can put in this much money and I'll get this return in this many years. So we partner with a venture capital firm. So then you have a three way negotiation where it's us partnering a venture capital fund to put a big investment into the company that finances them through their development timeline. We get to partner with the VCs. I think all of us that look at these types of deals consider those structures as well. And there are various reasons why bringing those partners makes sense. Sometimes they add a lot of value. Sometimes those VCs have operating partners that are really good at this and you want their expertise. There's a range of reasons why it can make sense to do that.

A lot of variables in this structure, my friend.

Yeah, no one said this stuff was simple, but you've been doing this a long time. I mean M and A. The reason we love doing this stuff is it's constantly challenging. Right. It's like you can spend your whole career in these areas and you're constantly learning new stuff. And when you think you know it, there's innovation in the way things get structured and the way risk is allocated. These have been around for a while. It's just I think in the last Eight years or so. It feels like they're picking up in terms of medtech utilizing them.

I'm curious, is that innovation in the way we're structuring deals or is the market competitive that's driving you to do this?

It's definitely both. If there's a bit of a race to form relationships with these truly innovative companies, it necessarily forces you to engage earlier. If all you did was just acquire early stage technologies, you'd probably have a lot of write offs. And if all you do is invest and then go on a long journey, then you potentially miss the relationship. To help guide influence, we would say where the company goes, we get the early engagement with them, you get the influence, you give them some benefits and we preserve that optionality, which I think is very valuable.

Yeah, your space. You guys really play the long game. That's good. I want to ask you, how do you bring this up when you approach a company? What's your approach? What's that conversation like and how you bring up this kind of structure? Because I can imagine it being fairly foreign to somebody that's a founder of a startup.

You're right. You see all different levels of sophistication in these startups and a lot of times founders may be very clinically minded but less familiar with all the deal options that are out there. A lot of them go to healthcare conferences now. I'm hearing more from the podiums about these types of structures, which is why I think it's a good topic for us to be talking about. So I think they're getting more used to hearing about them. But a lot of times it's just about listening to them and hearing them describe the technology and then saying, hey, this is something that feels very strategic to us. It feels like you're aligned with our direction and explaining to them the options that exist. I think it makes sense for some technologies. We may say to them, we want to go on the journey with you, we want to learn. And it's more about staying close. There are others that feel to us to be so on target, on strategic target, and also demonstrating something already that we see that looks unique, something, whether it's an early patient experience, whether it's something in animal data or just a novel, unique way to treat a condition. And in that case, we may say we want to learn, but we want to influence meaningfully. And that's where I think you go and you say, would you be open to something like that? Are you familiar with these types of structures? And yeah, sometimes they are not increasingly they are. But I think you have a candid conversation that's not dissimilar to the one we're having right now, where a lot of the questions you're asking are the exact ones that we get. If you're honest with the companies, they'll also tell you if it's right for them. And sometimes the investor base, not all, but many of the companies that you'd be kind of considering for these types of investments have some pretty sophisticated VCs in the cap table frequently already who have experience with these. So the founder may go to their board members, go to their VCs and say, hey, Edwards is interested in a deal like this, and they're going to have their view of it, too. Some have had successful exits through these types of arrangements. Others maybe have a different view. So you have to incorporate that a little bit as well. But there's a moment where you have to think about as a founder, that one of my colleagues I work with in corporate development always says it this way. He said, I don't know if his numbers are right, but he said 80 to 90% of these really amazing breakthrough technologies will fail. His number's not mine. I don't mean 89% of the investments we make. I mean just people pursuing this type of innovation. It has a very low success rate because the challenges we're trying to solve are so hard. So if you look at that as a founder and say, this is going to be a long journey, I have to be really committed to it. If you had an opportunity to de risk that process by working with someone who goes through, like Edwards, who goes through this, it's all we do is this type of really long, committed innovation to de risk it and then also allow you to focus. That's what gets them excited. They definitely give up the uncapped potential of a giant IPO and all that. But I think sometimes it's worth it, given the journey they're going to go on, Given the risk that's inherent in this type of work, you got to decide.

Interesting.

Yeah. Build to buy, build to buy, option deals. We think it's an elegant solution, but again, it's one tool. It's one lever we have, and we can structure lots of different things.

What's the craziest thing you've seen in M and A?

I have seen multiple times in my life, and this was a lesson I had to learn. When you're in a corporate development role at a big strategic, you have to be on guard. Or this tendency to kind of go to smaller companies that go to targets and tell them how to do things. We know everything. We're the ones who know everything. And I've seen multiple times, I think this is crazy, but it's maybe crazy, but also very principled. I've seen multiple founders over the years who have been so offended by the way big companies come in and do diligence and treat them and do all this that they've sold to other entities, other companies for tens of millions of dollars less. I saw one founder sell for 50 million less on a deal of 400 million. And I've seen that happen many times over the years. And when you see that, you go, wow. But what you realize is a lot of the people in this space that start these companies, a lot of them already have a ton of money to begin with. And they're doing it on principle. They're doing it because they are doing it for pride. All sorts of other things too. And if you come in with this arrogant attitude and tell these you have to bend to our will as the big acquirer, these people will put you in your place. And so I've seen this happen time and time again where people are like, you know what? I'm willing to take an inferior deal and forego tens of millions of dollars. Now there's supposed to be fiduciary responsibilities that prevent that, but I'm telling you, I've seen it multiple times. So it's like this reminder to me, have a degree of humility. This industry attracts people that are very self confident, very type A, all this. You have to have a degree of humility in this industry and do genuinely care about the targets you work with. Because if you go in there with that attitude, it's not going to work. So I think that's definitely one of the things that's amazing to me is that it's not always about maximizing profit. And if you forget that this is a relationship business, at the end of the day, you will get reminded in some pretty tough lessons you'll get taught.

Absolutely. It's so much better relationships, isn't it becoming our core theme of M and A Science here?

But I think what you guys are doing exactly that, it's bringing the human element to it. I love watching and listening to the podcasts you have because it's people that you know, but you get a little sense for what they're like as people. It's in many ways not as big a network of folks you've. You're showing this, but it's great to get to know these people. And it's not like this is all math. It's not like it's all just legal agreements and things. It's also people and relationships. And that's true. Even of the companies that we work with, there was this old school way of doing thing which is like we're just tough negotiators and you send in the team and you pummel the other side into submission and you just say no. A bunch in the legal agreements is no, you'll take this term, you'll take that term and no, the escrow needs to be bigger. And what we're finding is like it doesn't work long term, it doesn't work. It's not good for your reputation, it's not good for the relationships. And certainly when we're talking about option deals, can you imagine pummeling a target on every deal term and then having to work with them for four years? Doesn't work. So it's like you have to work together and genuinely care. I'm obviously a big fan of what you're trying to do, but I think the more we humanize this, the more we make it about people and less about this idea of negotiating for the best terms possible. I think you've picked really good people too to talk to that again, show that side of it. The more we know each other, the less it's going to be about that and more it's going to be about let's come up with things that are win win.

That's what makes it fun. Nothing but the best here on M and A Science.

I totally agree with you.

Oh, this has been great, Finn. I appreciate taking the time helping me become a better M and A scientist.

Here and I was flattered for the opportunity. I'm grateful that you made it to our campus. You're welcome back anytime.

Well, I'll do it again. Maybe a little group hang out here. Those of you still with us, thank you. Till next time. Here's to the deal.

Foreign.

Thank you for taking the time to explore the world of M and A with our podcast. We love hearing feedback. Tag us on a LinkedIn post. Add a review on Apple Podcasts. We'd love to hear from you. If you need help standing up an M and A function or optimizing one that you already have, we're here to help. And if we can't help you, we probably know someone that can. You can reach out to me by email. Kisan K I S o n a science.com or you can text me directly at 312-857-3711. If you just want to keep learning at your own pace, visit mascience.com for a lot more content and resources. That's where you can also subscribe to our newsletter. Again, that's mascience.com here's to the deal. Views and opinions expressed on M and A Science reflect only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual. This podcast is purely educational and is not intended to serve as a basis for any investment or financial decisions.