Royalty Interest Investing: Addressing the Out-License Assignability Issue

Legal considerations for effectively managing royalty interest transactions.
May 01, 2009
Volume 22, Issue 5

The sale of interests in discrete product revenue streams has taken hold as an alternative financing source for holders of biopharmaceutical intellectual property (IP). Holders of these IP assets are often either constrained in their reasonable access to capital (e.g., small fast growing pharmaceutical companies) or limited in their interest in managing an IP portfolio, which may be diffuse or require commercialization beyond the development of the basic science involved (e.g., university medical centers). These sale transactions fall broadly into two categories: structured sales of portions of future revenues from a specified compound or biopharmaceutical IP asset over a defined field for a specified period of time (revenue interest transactions) and structured sales of future revenues from an existing out-license, typically to a much larger pharmaceutical company (royalty interest transactions). Although these transactions have similar considerations at their core, such as strength of the underlying IP and assessment of the likelihood of longer-term commercial success, they also present distinct issues from the perspectives of the typical financial investor (the buyer) and the owner of the compound or biopharmaceutical IP asset (the seller).

In royalty interest transactions, a core consideration is the allocation of rights and responsibilities with respect to the specific out-licensing arrangement. The same issue is substantially less significant for revenue interest transactions because they are modeled on the basis of a non-counterparty specific revenue stream and are documented to contain substantial consent protections relative to future out-licensing and other transfer transactions. Therefore, revenue interest transactions are generally independent of risks associated with obligor or counterparty concentration and are not subject to the pre-existing contractual regime present in a typical royalty interest transaction. Below, we examine the practical and legal considerations for evaluating the out-licensing arrangement in a royalty interest transaction, including the allocation of rights and obligations with regards to the out-licensing counterparty (the licensee). We also discuss mitigating considerations for resolving the often competing interests of the buyer and the seller relative to this core arrangement.


The essence of a royalty interest transaction is the monetization of a generally well described, yet commercially speculative future cash-flow stream, from an existing out-license with an identified licensee of a specified product. From an analytical perspective, valuing the out-license presents two challenges: (1) assessing the likelihood of successful future commercialization by the licensee and (2) determining the rights of an assignee (whether in whole or in part) as a legal matter under the out-license agreement (especially in relation to the licensee).

The analysis of the likelihood of successful future commercialization involves a combination of regulatory and IP due diligence to assess the likely success of subject IP in the marketplace. From a legal perspective, the focus is on the rights of the assignee (the buyer) under the out-license, including a review of the out-license to determine the scope of the field covered by the out-license to establish the benchmarking against which the competitive landscape can be measured, and the mechanics for determining the amount payable by the licensee to the licensor.

The standard out-license usually contains a broadly drafted, often bilateral, prohibition on assignment (e.g., "... neither party shall assign any of its rights or interests under this [a]greement"). This provision is, at first look, very problematic to the buyer of the subject royalty interest. Although the buyer's principal consideration is its analysis of the likely future cash flows from the out-license, it is necessarily concerned with its ability to ensure that its rights to those cash flows are superior to the rights of the seller and the seller's creditors, with respect to that asset.

The prophylactic measures taken by the buyer include structuring the transaction with the seller to maximize the possibility that the transaction will be treated as a sale rather than as a financing in a seller insolvency proceeding. Usually as a backstop, and less frequently as a primary position, the buyer takes steps to ensure that it enjoys the status of a senior secured creditor with respect to the cash flows.

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