May 24, 2023

Contingent Value Rights: Key Components & Trends

Contingent Value Rights, or CVRs, are the public company analog of an earnout, and like earnouts are a tool for bridging valuation gaps between buyers and sellers. This Sidley memo reviews all announced public transactions from January 1, 2018 through April 30, 2023 that included CVRs as part of the considerations, and identifies the key components of CVRs and trends in their terms.  Here’s an excerpt with some of highlights of their findings:

– CVRs are more common in life sciences transactions than in other industries. Of the 1,119 public deals announced across all industries from January 1, 2018 through April 30, 2023, only 37 (or 3%) included CVRs; however, of those deals, 84% were in the life sciences industry.

– CVRs have been gaining popularity in recent years, particularly in the life sciences industry. From May 1, 2022 through April 30, 2023, approximately 29% of the announced life sciences industry M&A deals included the use of a CVR, as compared to 17% in the period from January 1, 2018 through April 30, 2023 and 10% in the period from January 1, 2013 through December 31, 2017.

– The use of CVRs is also much more concentrated in relatively smaller public M&A transactions in the life sciences industry, with CVRs used in approximately 45% of all public life sciences M&A deals announced from January 1, 2018 through April 30, 2023, where the transaction had less than a $500 million equity value.

– The life sciences industry has also shown some standardization in the terms of CVRs—the strong majority of life sciences deals provided for event-driven, non-transferable, and cash-settled CVRs. From 2018 through April 30, 2023, of the 31 life sciences deals using CVRs, only one provided for CVR stock consideration and one provided for CVR consideration to be paid in cash and/or stock at the buyer’s election, and only one deal provided for transferable CVRs.

CVRs can be used as a form of price-protection to protect the downside risk faced by the target’s shareholders when a portion of the merger consideration will be paid in a buyer’s public company stock (i.e., “price-driven” CVRs). More commonly, however, CVRs are structured to become payable upon the achievement of certain milestones or the occurrence of specific triggering events after closing (i.e., “event-driven” CVRs). They can be transferrable or non-transferrable, and settled with cash, securities, or a mix of both.  The memo notes that CVR terms in life sciences deals are showing signs of standardization, with the vast majority of transactions providing for event-driven, non-transferrable and cash-settled CVRs.

The average potential value of a CVR was 50% of the deal’s guaranteed value over the period surveyed and the median potential value was approximately 18% of the deal’s guaranteed value.  However, those valuation statistics were influenced by a couple of outlier transactions with much higher potential CVR values.  Backing those out, the average maximum payout available under the CVR agreements represented approximately 24% of the upfront value guaranteed to a shareholder in cash or stock and the median maximum payout remained approximately 18%.

John Jenkins