Equity Investment + Licensing: The NewCo Model Paves a New Path for Chinese Pharma Companies to Go Global

In mid-May, Jiangsu Hengrui announced the establishment of a joint venture in the US, named Hercules CM NewCo Inc. (“Hercules”), with several major global fund companies. Hengrui contributed its drug candidate pipelines, while the fund companies provided capital to jointly advance the clinical development and potential commercialization of GLP-1 candidate drugs, which target diabetes and obesity—currently hot areas in the biotech sector.

The announcement of Hercules has invigorated the Chinese biopharma sector, which experienced a painful downturn in the last couple of years. The new business model of the NewCo (“the NewCo model”) sparked excitement, demonstrating that life sciences business development can be structured in a creative fashion.

Why did Hengrui adopt the NewCo model? What motivated the fund companies to participate? Which types of companies and scenarios are ideal for exploring the NewCo model? How does the NewCo model differ from the traditional drug asset licensing model? What legal risks should be considered?

Transaction Overview

In the NewCo deal, Hengrui adopted a hybrid model of equity investment + licensing.

Candidate Drugs Involved in the Transaction:

The pipeline at stake includes Hengrui’s three innovative GLP-1 candidate drugs, equipped with intellectual property rights:

- HRS-7535: An oral small molecule GLP-1 receptor agonist for type 2 diabetes and weight loss, currently in Phase II clinical trials.

- HRS-9531: A GLP-1/GIP dual-target agonist for overweight/obesity, also in Phase II clinical trials.

- HRS-4729: A new generation incretin product undergoing preclinical development, expected to have better efficacy in treating weight loss and metabolic disorders.

Equity Investment:

Hengrui and four global capital market giants established the joint venture Hercules CM NewCo, Inc. in Delaware, US. The four participating fund companies are:

- Bain Capital Life Sciences Fund: Invested $225 million, accounting for 39.4% of the total shares,

- RTW Capital: Invested $110 million, accounting for 19.3%,

- Atlas Venture Capital: Invested $50 million, accounting for 8.8%, and

- Lyra Capital: Invested $15 million, accounting for 2.6%.

These four entities invested a total of $400 million, holding 70.1% of the shares in Hercules. Hengrui holds 19.9% of the shares as the second-largest shareholder. The remaining 10% shareholding is reserved for the employee stock ownership plan (ESOP).

Licensing Framework:

Hengrui exclusively licensed to Hercules the rights to develop, manufacture, and commercialize three GLP-1 drugs worldwide (excluding Greater China). The licensing revenue obtainable by Hengrui includes:

Upfront and Near-Term Milestone Payments: A total of $110 million, comprising an upfront payment of $100 million and a near-term milestone payment of $10 million after the completion of technology transfer,  

Clinical and Regulatory Milestones: Up to $200 million, subject to the clinical development progress of HRS-7535 and the first FDA approval for market authorization,

Sales-Related Milestone Payments: Up to $5,725 million, based on the actual sales revenues of these three products after their launch in the relevant geographic markets, and

Royalty Payments: After the products are launched in the US, Hengrui will receive royalty payments based on actual annual net sales, ranging from low single-digit to low double-digit percentages.

Source of Investment for Hengrui’s 19.9% Equity: News reports generally did not provide detailed information on this topic. Based on the transaction framework aimed at capitalizing the GLP-1 candidate drugs, it can be inferred that Hengrui did not inject cash for the 19.9% equity. Instead, Hengrui likely allocated a portion of the total licensing fees for the three drugs in exchange for equity in Hercules. Considering the cash injection and share equity received by the four fund companies, the cash value of Hengrui’s 19.9% equity is approximately $113 million. In other words, in addition to receiving licensing payments such as the upfront payment and royalties, Hengrui received $113 million worth of equity investment in Hercules.

The Past Pitfall Versus the Current Glory

A business development (BD) deal struck by Hengrui last August was seen as an unfortunate lesson in tapping the overseas market. In that deal, Hengrui licensed a drug under clinical development for severe asthma indications to a small US company called Aiolos Bio (formerly One Bio). The upfront and near-term milestone payments totaled US$25 million.

Subsequent to the BD deal, Aiolos Bio grew at a fast pace. It successfully completed a $245 million Series A financing and, in January 2024, entered into an acquisition deal with GSK. This acquisition included an upfront payment of $1 billion, in addition to various milestone payments totaling $400 million.

From a business strategy perspective, Aiolos Bio could be regarded as having leveraged information disparity and its US network resources to earn a significant amount of profit, taking advantage of the clinical asset originated from Hengrui. Industry players including lawyers have tried to learn from these pitfalls, pondering how to fix the loopholes during deal negotiations and contract drafting.

Hindsight is always 20/20. In the course of running a BD deal, company founders, CEOs, and other senior executives often pressure BD teams to hurry up aiming for signing the deals as soon as possible. Such tough experiences are not unfamiliar to those who have worked on BD projects in China. Balancing the need for speed with the goal of avoiding loopholes is a great challenge for BD professionals and lawyers, requiring both experience and risk-spotting sensitivity.

Under the present NewCo deal for launching Hengrui’s GLP-1 candidate drugs onto the global market, Hengrui, as one of the shareholders, will be able to share in the future growth upside of Hercules in commercialization and potentially also in the capital market. NewCo’s name, “Hercules,” reflects Hengrui's high sense of honor. The word “Hercules” is derived from the name of the Greek hero Heracles. Hence, “Hercules” carries the meaning of “the glory of Hera.” With the launch of Hercules, Hengrui seems to have stepped out of the previous shadow and now proudly presents a glorious deal to the market.

NewCo Hybrid Model for In-Depth Incubation of New Drugs in the Pipeline 

For financial investors, there are two major exit opportunities for investing in biotech companies for drug innovation: one is that the biotech company goes public through an initial public offering (IPO), and the other is that the company is acquired by a larger life sciences player. In the case of Hengrui, it was already listed on the Shanghai Stock Exchange a number of years ago. Also, as a leading pharma company in China, Hengrui’s cashflow situation is much better than small biotech companies, which, for survival, are keen to strike out-licensing deals to big pharma companies. For promising assets like GLP-1 drug candidates, Hengrui can wait a bit to grow their scientific maturity.

Therefore, the NewCo model presents a unique solution to Hengrui. It supplies capital injection to meet the financial need for continued research and development of GLP-1s. In terms of corporate governance, the NewCo, Hercules, is an independent enterprise, setting the stage for future new rounds of financing on private and even public markets.

Supposing the GLP-1 pipeline had remained within Hengrui, an investment fund would hardly be able to get involved. Only when the said pipeline got spun off as a NewCo, investment funds would be able to step in to devise participating investment.  

The NewCo model is suitable for sizable companies of a certain scale. Although funding is sought to support the resource-consuming drug R&D process, it is not as urgent for such companies as it would be for small biotech. Sizeable companies have time to raise the “golden goose” before the strategic next move becomes clear.   As Bruce Booth who is a co-founder of Atlas Venture Capital, said, it takes a village ... or at least a collaborative ecosystem ... to bring drugs to patients. In Hengrui’s deal, the funds, as “village neighbors,” came to join the efforts.

Drug Pipeline Spin-Off as a Common Practice by Global Big Pharmas

In the life sciences space, pipeline spin-offs happen often, especially in the western marketplaces. For example, Johnson & Johnson in 2021 began spinning off its consumer business line to incorporate a separate company which went public. AbbVie was another well-known case study where around 2013, Abbott Pharmaceuticals spun off its drug innovation business licenses as AbbVie. AbbVie then focuses on innovative and brand drugs, including Humira, a blockbuster drug for the treatment of rheumatoid arthritis. The remainder of Abbott engaged in the manufacturing and sale of nutrition products, generic drugs, and medical devices.

A company spin-off is widely believed to enhance focus on the new business, thereby improving resource allocation and management. For large companies with multiple business lines, new business lines or products that present potential upsides but also carry uncertainty or require time to develop might not receive the same amount of attention as established, cash-cow businesses. Spin-offs would allow both companies to set clearer business priorities, unlocking value for shareholders. 

For Hengrui, the spin-off strategy marks a fresh beginning. The NewCo is akin to a newly-built ship, with Hengrui and the fund investors collaborating to navigate its course together.

Hercules is actually not the only example. In July this year, Hong Kong-listed KeyMed Biosciences Inc. (“KeyMed”) announced the establishment of a joint venture, Belenos Biosciences Inc. (“Belenos”), with OrbiMed, a renowned global fund company. KeyMed held 30.01% of the shares in Belenos. Meanwhile, KeyMed provided exclusive licenses to this joint venture for the development, manufacturing and commercializing of two bispecific antibody candidate drugs in the global market (excluding Greater China). In return, KeyMed would receive an upfront payment of US$15 million, a milestone payment of US$170 million, and a certain percentage of sales revenues. It is foreseeable that more Chinese biopharma companies will use this sort of hybrid model to onboard their new drugs in the pipeline to the global co-development initiatives.

Capitalizing Technology

As described above, leading Chinese life sciences companies, represented by Hengrui and KeyMed, stepped into the overseas markets by way of establishing joint ventures with their global partners, leveraging their innovative drug R&D pipelines. This newly-emerging NewCo model in the life sciences space is somewhat similar to the scenes of foreign investors setting up joint ventures in China dating back to the 1990s. Yet the roles are reversed - now Hengrui, KeyMed and others are actively heading out from China with their promising innovations, while in the 1990s it was the foreign investors who brought new technologies into China.

In both the US and China, besides cash, tangible assets (e.g., real estate, equipment) and intangible assets (e.g., intellectual property, including patents and proprietary technology rights) are permitted to be capitalized for corporate investment. For the injection of intellectual property as the form of investment, how and how much the IP is valued becomes a key issue.

How to value the invested technology into a NewCo, or in other words, how much share capital the technology investor should hold in return? When establishing a company in the US, generally there is no mandatory valuation requirement. In most cases, parties to a joint venture may, under the principles of fairness and rationality, agree on the value of technology for conversion into share capital, and record it as such in the contract. To facilitate the negotiation, the parties may engage a third-party valuation firm to assess. Generally, the international good practice is that the proportion of technology investment should amount to no more than 20% of the company’s total share capital.

Technology investment into a company would bring certain other challenging issues. For example, what if the concerned patent were invalidated and hence entered the public domain? Then how should the capitalized value be adjusted? What if a patent infringement lawsuit were raised against the joint venture, incurring high litigation costs as the joint venture defended against the claim? And what if the court ruled for the infringement claim? In these circumstances, how should the value and capital conversion of the technology be adjusted? All these specific issues need to be delved into to lay out a good plan to handle such contingencies and get addressed in the contract at the commencement.

Corporate Governance: Regulating Related-Party Transactions

In Hengrui’s case, the NewCo hybrid model includes both equity investment and licensing transactions. This means that Hengrui plays a dual role as both a shareholder of Hercules and as a licensor of the pipeline rights. In view of Hengrui’s rich drug development experience, Hercules is destined to require a number of related-party transactions with Hengrui regarding pipeline further development since the inception.

Under the modern corporate governance system, related-party transactions are a sensitive or even sticky point, even for private companies. The basic principle of corporate governance is to protect all shareholders’ rights, including minority shareholder(s)’ rights from the majority shareholder(s). The principle of “arm’s length basis” requires that a related-party transaction between the company and a shareholder be fair and reasonable, in a way equivalent to how the company will deal with a third party. Furthermore, the company Board’s decision on a major related-party transaction should be voted on only by disinterested directors, whereas the Board director on behalf of the transacting shareholder should abstain from such voting.

How to balance corporate governance requirements against the needed active participation of industry shareholders like Hengrui? The parties probably should outline collaboration guiding principles clearly from the beginning of the venture, such as drug R&D budgetary arrangement and phased allocation, in order to minimize shareholders’ misalignment down the road.

Tax Considerations

In the course of pipeline spinning-offs and establishing a joint venture, tax undoubtedly is an essential consideration, sometimes even a complex issue, that could determine the structure of the transaction. Parties should evaluate tax implications of various deal options carefully to aim for compliance and tax efficiency.

Conclusion

The core of life sciences investment is about the clinical value of therapeutics. Although geopolitical challenge makes it increasingly difficult for global expansion, the US and EU markets remain attractive, as these mature markets offer greater returns on drug innovation to reward innovators and investors. China’s life sciences R&D is expected to continuously have a good future, as long as excellent clinical value is displayed. With such an endpoint in mind, newer cross-border collaboration models are expected to continuously emerge.