Earn-outs – tying part of the acquisition price to the achievement of future milestones – have become increasingly common in medical device M&A. In April 2010, Start-Up Magazine reported that earn-outs were used in 9% of the medical device acquisitions in 2008, 13% in 2009 and an astounding 31% of deals in the first quarter of 2010. As an example, in August 2010, Hologic completed its acquisition of Sentinelle Medical for $85 million, plus an earn-out tied to a multiple of incremental revenues over the next two years.
On 7 September 2010, St. Jude Medical and CardioMEMS announced a milestone-based deal with a twist. St. Jude made a smaller than usual up-front payment, and received an option to purchase later, at a fixed price. Why this deal structure?First a little background. The “small up-front payment, with an option to buy later” deal structure is a re-appearance, not a new creation. Rich Ferrari of De Novo Ventures, described the structure in a great article in the October 2005 issue of Start-Up magazine.
When the economy warmed up in 2006 and 2007, earn-outs disappeared from the scene. Most notably, in 2006, Johnson and Johnson bought Conor Medsystems for $1.4B, prior to knowing the outcome of the COSTAR II pivotal trial. In May 2007, investigators reported the failure of the COSTAR II trial to meet its clinical endpoints. J&J could not have been very happy.
Flash forward to February 2009, when Medtronic announced its acquisition of CoreValve for $700M plus “additional payments contingent upon the achievement of agreed milestones.” You can bet that CoreValve’s owners will get a big chunk of money only if the pivotal trial meets its endpoints.
Earn-out deal structures reduce the risk for the buyer while preserving the upside for the seller. The seller gets a deal done today, but the price depends on events that happen in the future. So earn-outs are a great way to get deals done.
With CardioMEMS, St. Jude invested $60M up front for 20% of the seller’s stock, and received “the exclusive option to acquire the company for an additional payment of $375 million during the period that extends through the completion of certain commercialization milestones.” In this case, the up-front payment of $60M is only 14% of the full acquisition price. For St. Jude, this deal dramatically reduces buyer risk compared to the typical acquisition with earn-outs. If St. Jude does not eventually buy CardioMEMS, they can still sell their 20% ownership and get part or all of their $60M investment back. So their risk is really quite nominal. To close a deal like this, St. Jude needed to offer a very sweet total purchase price of $435M.
What’s in it for CardioMEMS? First, while I don’t have any inside knowledge of the deal, I’m sure that the CardioMEMS management and board are confident of their ability to hit the deal milestones. Their CHAMPION pivotal trial has already been successful. So they will accept the execution risk to achieve a very attractive exit. Second, CardioMEMS needed to raise money to bring their heart failure product the rest of the way to market, and the $60M investment probably gets them to cash-flow positive with a cushion. (According to the Minneapolis / St. Paul Business Journal, CardioMEMS plans to spend $30M to commercialize their device.) So even if St. Jude doesn’t buy them, it’s not the end of the line.
Compared to the typical earn-out deal, the CardioMEMS deal structure shifts even more risk from buyer to seller. Confident sellers might be willing to accept that risk, in return for a higher ultimate reward. In 2010 and 2011, this might be one of the best ways for a pre-revenue medical device start-up to get a deal done.
Related Articles
- St. Jude Medical to Invest $60 Million in CardioMEMS with an Option to Purchase (eon.businesswire.com)
Jay Caplan on Medical Devices 
Nice writeup. Do you see a downside in these types of deals? In particular, the possiblity that if the earn out structure (i.e. milestones) are not very clearly thought through there could be difficulties on the back end?
Bob, Good point. As in any deal structure with future contingencies, there is always room for interpretation at a later date. So changes to the negotiated deal, such as time extensions or price changes, are not uncommon.