9 The M&A exit from science-based firms

Mattia Cattaneo, Michele Meoli,
Stefano Paleari and Silvio Vismara

Abstract

This chapter investigates the valuation and M&A dynamics of the population of 254 biotech firms that went public in Europe over the last two decades. Among these, we identify a high proportion (40 per cent) of firms affiliated with a university or another public research organization. After controlling for intellectual capital and other possible determinants, we find that the affiliation with a university is recognized as beneficial by investors and enhances the propensity of being targeted in subsequent M&A deals. Our message is that IPOs and acquisitions by incumbent firms are mechanisms to complete the technology transfer process and to effectively exploit academic innovations.

Introduction

So far, most studies on academic entrepreneurship have analysed factors promoting the creation of new ventures (Rothaermel et al., 2007). From a strategic perspective, however, the tasks of starting a company and achieving competitive advantage are very different. Entrepreneurial firms must not only discover and exploit opportunities, but also manage their resources and capabilities in such a way that their venture outperforms others in the marketplace. Academic firms in particular may lack experience with the latter activity. This distinction implies that policy programmes aimed at stimulating academic entrepreneurship may not provide enough support for post-entry development. It is, therefore, of interest to investigate the implications of university affiliation in the long run. Also, if universities want to maximize the profits of their entrepreneurial initiatives, they should devote attention to their most successful cases.

This chapter studies a selection of ‘successful’ science-based firms, i.e. those that went public. An investigation of such firms is relevant to both academic entrepreneurs and their supporting universities. The initial public offering (IPO) also represents a crowning achievement for the parent university, whether it seeks to advance its reputation as a catalyst for economic development or simply to generate financial returns as a stockholder.

Despite such motivations, the current state of knowledge on IPOs held by science-based firms is fragmented. For example, Shane (2004) observes that university-based firms are 108 times more likely to go public than the average new firm. Zhang (2009), on the other hand, finds no significant difference in IPO rates between the two types. Both studies consider the IPO a final successful outcome, putting aside questions of how these firms are actually perceived by external investors. By contrast, Bonardo et al. (2011) expand the context from the product market to the financial market, analysing the long-run performance of university-based IPOs. In this work, we further deepen the post-IPO path of university-based firms, moving from the financial market to the ‘market for assets’.

This chapter aims to narrow this gap. Precisely, we focus on one of such exit strategies, the decision to go public, and relate the research affiliation with the involvement in merger and acquisition (M&A) deals. This provides substantial information about the strategic dynamics of these companies and their ability to interact with other key actors in the global market in both directions: taking part to M&A deals either as acquirer or target. From one side, indeed, successful firms often grow through acquisition of promising start-ups. From the other, being the target of an acquisition does not necessarily have a negative connotation. Policy makers should recognize that IPOs and acquisitions by incumbent firms could often be the most efficient mechanisms to complete the technology transfer process and to effectively exploit academic innovations. Therefore, policy schemes may be adjusted accordingly.

This chapter focuses on a particular industry, biotechnology. There are several motivations of interest. It is one of the high-tech industries whose development is largely based on the creation of research-intensive small and medium enterprises. These are a leading force in a science push context, while the role of large firms is mainly to integrate new discoveries into their products after they have been developed by small and medium-sized enterprises (SMEs) (Mangematin et al., 2003). Also, because of the novelty of this scientific field and the risks attached to biotechnology, large established firms channel their investments in biotech research to SMEs (Arora and Gambardella, 1990). SMEs, in turn, may enter into long-term equity relationships to obtain complementary assets, such as product testing, or capabilities to market the products (Teece, 1986). To this extent, our study aims to relate two critical resources: access to scientific competencies and access to capital markets.

Our empirical analysis focuses on the population of 254 biotech firms that have recently gone public in Europe. Among these, we identify 101 firms affiliated with a research institute such as a university or another public research organization. This high proportion (40 per cent) of research-based firms promises to contribute to the EU's objective of becoming a dynamic knowledge-based economy (Lisbon European Council in March 2000).

The chapter is organized into five sections. The next section provides the literature review. The following section describes our research design: sample, variables and methodologies. Then we report the econometric results. Finally, we discuss the conclusions of our research and their implications.

Literature review

For this study, we investigate whether affiliation with a research institution affects the propensity of being a target in an equity deal.

The IPO market and the M&A market are not as independent as is often assumed. First, the fresh capital raised through IPO could make available the funds needed to fuel the firm's external growth. Besides cash acquisitions, the IPO may also facilitate stock deals, as the establishment of a market price and the creation of public shares allows stocks to be used as currency to participate in M&As. Indeed, the prospects of future deals grow as valuation challenges for would-be-investors are alleviated with the IPO placing a price on the firm. Forming a currency of stock for future M&A deals is actually one of the most important motivations for going public (Bonardo et al., 2010). Second, the IPO may also mitigate inefficiencies in the M&A market in another way. IPOs can be part of a larger process of transferring control rights, where owner-managers of private firms use the IPO as part of a divestiture strategy. In order to identify potential acquirers and to increase a firm's visibility, shareholders of private firms could decide to use sequential divestitures through IPOs rather than outright sales. The process of going public would therefore be responsive to adverse selection problems by increasing the amount of information available on the firm (Reuer and Shen, 2003). The IPO and the contextual move from the private to the public domain increases the level of a firm's disclosure and of investors' monitoring. The consequent decrease in information asymmetries may, in turn, increase the opportunities of equity deals. To the extent that the process of going public credibly reveals information on a firm's value, the IPO market can enhance the efficiency of the M&A market. Such a certification role in the process of going public is typically played by investment bankers involved in the IPO pricing. They are expected to credibly certify the quality of firms because of the repeated nature of their business, which encourages them to preserve their reputational capital and to desist from opportunism (Paleari et al., 2008). As a consequence, existing shareholders of private firms can maximize their firm's value by adopting the strategy of divesting after taking the company public, rather than directly selling a still-private firm at a value limited by illiquidity (lack-of-marketability) discount (Silber, 1991).

Third, in knowledge intensive industries, such as biotechnology, M&A negotiations tend to be lengthier (Coff, 1999) because of the poor contacts between the research-based firms and the industry, as well as because of the concrete difficulty for bidders to evaluate their potential targets. For these reasons, the investigation of successful science-based firms consequently involved in M&A deals, includes, almost necessarily, IPOs. By definition, a firm must be successful to gain the attention of new stakeholders, whether they are industrial partners, venture capitalists, or the stock market. In these terms, the link between IPO and M&A markets can be particularly strong in these industries. Specifically, post-IPO acquisitions by incumbent firms might be mechanisms to complete the technology transfer process started in a research institute.

In the biotech industry, the role of technology-driven acquisitions is highly relevant. Companies get acquired primarily because of the tacit knowledge and the technologies that they are assumed to embody. On account of their organizational specificities, research-based spin-offs identify opportunities more successfully than incumbents (Fabel, 2004). For the latter, takeovers of entrepreneurial firms allow them to acquire innovations, such as new and sophisticated variations of products or services that they (the incumbents) already offer (Lehmann et al., 2012). Moreover, the alliance literature contributes to explain the interest of incumbent firms for research-based firms, emphasizing the synergistic gains that alliance partners can realize by combining complementary assets and capabilities (Teece, 1986). Consequently, the acquisition of technologies, competencies, and knowledge from external sources has become one of the major motives for corporate mergers and acquisitions in recent years (Dushnitsky and Lenox, 2005). Affiliation with a research institute can be a proxy of such internally available technological capabilities (Jones et al., 2001; Blonigen and Taylor, 2000). This scenario can lead to a higher proportion of intra-industry deals in which research-affiliated firms are targets. In other words, we expect that affiliated firms show a greater share of inter-industry deals in which they are targets.

In industries characterized by complex and rapidly expanding knowledge bases, innovation lies within a network composed of incumbent firms, new entrants and research institutions, rather than within the boundaries of individual firms (Powell et al., 1996). Networks provide access to knowledge and resources that are not readily available via market exchanges (Gulati et al., 2000). In biotechnology, scientists play this boundary-spanner role by providing connectivity to universities and other sources of knowledge (Arora and Gambardella, 1990). Indeed, differences in coding schemes exist between large established firms, research institutions and start-ups (Allen and Cohen, 1969), which can be alleviated by entrepreneurial academics. They provide access not only to knowledge through their own research, but also through their participation within the international scientific community (Hess and Rothaermel, 2011). This access will be even greater in the future, because the international mobility of researchers and ‘brain circulation’ (Johnson and Regets, 1998) are increasingly becoming an integral part of academic careers (Freeman, 2010). This scenario enriches the international flow of knowledge, cognitive integration and opportunities for technology transfer (Edler et al., 2011). Therefore, affiliation with a research institute is expected to improve the international exposure of a firm. We argue that, in terms of signals, this affiliation improves the legitimacy of the firm on an international stage. In terms of resources, affiliated firms dispose of higher and more internationalized relational capital (Hsu, 2007). We consequently expect that such firms are more frequently targeted, even in an international context.

Because of all the related value-added benefits, investors may quickly realize the value of firms affiliated with a research institute. In addition to exploiting dedicated and possibly unmarketable resources, they also have the opportunity to access international networks, alternative relationships and on-going contact with emerging technologies. In other words, the acquisition of affiliated firms could be a strategic choice to maintain the competitive advantage in the long run.

HYPOTHESIS 1 The affiliation with a research institute increases the propensity that a firm will be acquired.

Research design and methodology

An explicit goal of current public policy in Europe is to promote the development of markets for risk capital in order to sustain innovative entrepreneurship and to assist the expansion of existing small firms (European Commission, 2005). In the last two decades, the launch of second-tier markets has, at least in part, fulfilled the aim of providing small firms in high-tech sectors with the means for finance growth (Vismara et al., 2012). The availability of these markets provides the ideal setting for investigating the final stage of the technology transfer process with research-based spin-offs eager to go public (Shane, 2004).

The company's primary tool for communicating information at this stage is the ‘offering’ prospectus. Potential investors carefully scrutinize this document to assess the prospects of an equity position. In particular, companies going public are required to describe their history and to report the curriculum vitae of their board members and top managers (upper echelons). We refer to these sections of the prospectuses to identify the eventual affiliation of firms. We differentiate between independent and affiliated firms, splitting research affiliation between the case of affiliation with a university or with another public research organization (PRO). We also identify and distinguish affiliation with large established pharmaceutical firms.

University-based firms are defined as companies that either were developed by faculty members based on their own research, or were created specifically to capitalize on academic research. This definition is consistent with the literature (Shane, 2004; Lockett et al., 2005; Rothaermel et al., 2007; O'shea et al., 2008; Colombo et al., 2010; Bonardo et al., 2011). PRO-affiliated firms refer to affiliations with hospitals or government-based institutions, such as national science foundations. We define a corporate spin-off as a separate legal entity that is concentrated around activities that were developed originally in a larger parent firm (Clarysse et al., 2011).

Sample selection and description

We studied the population of biotech firms that went public in Europe in the period from 1990 to 2009. The list of IPO firms was taken from the EURIPO¹ database, which provides prospectuses and detailed information on all companies that have recently gone public in Europe. During this time, 254 biotech companies went public in Europe, mainly in the UK, France and Germany. Although all of the firms in our sample are biotechnology firms, they compete in different niches within this industry. To account for sectorial differences, we included dummy variables representing participation in various segments of biotechnology. Following Stuart et al. (1999) and Zheng et al. (2010), we identified four categorical variables to indicate whether the start-up firm operated in the immunology, diagnostic, genetics and protein engineering, or new drug investigation sectors. We added two categories to this taxonomy, dedicated to instruments and services, and controlled for subindustry effects throughout the work.

The sample of companies, classified according to the different forms of affiliation and disaggregated by country, age at the IPO, year of IPO and subindustry, is described in Table 9.1. Of the 254 biotech firms, 101 (40 per cent) were research based, whereas 89 (35 per cent) were affiliated with large, established pharmaceutical firms. A peculiarity of this industry is that many more biotech startups emerge from university research laboratories than from corporate research

Table 9.1 Sample characteristics

laboratories (Shane, 2004). This high percentage of affiliated firms confirms the notion that the biotechnological sector is strongly associated with research spinoff activity (Zhang, 2009). The remaining 64 firms (25 per cent) were classified as independent (or, at least, they did not publicize any affiliation in their prospectus).

Predictably, the United Kingdom dominated the sample with 110 firms. Of these, 52 were research based (i.e. 47 per cent of the biotech IPOs in the UK were either university-based or PRO-affiliated). This is because the UK has the most highly developed stock exchange in Europe, and its university system is the most entrepreneurial (Mustar and Wright, 2010).

Variables

The study takes a dynamic perspective that is centred on the M&A activity of sample firms. We identified 790 M&A transactions involving our sample firms after their IPO and up to March 2011 (3.1 M&As per IPO-firm).² Among these, 341 were deals in which the sample firms were targets, and 449 were deals in which they were acquirers.

As far as controls are concerned, they are grouped into three categories, as reported with detailed definition in Table 9.2: (1) general characteristics of the firm and of its offer, (2) innovation and (3) upper echelons. These variables may affect the firm's capacity to raise capital and the investors' perceptions of the firm.

The first set of variables includes controls related to the firm (e.g. size and age) or offer (e.g. dilution or participation ratio) and dummy variables for the industry, country and year. The effects of innovation variables, the second category, were quantified by using both measures of input (R&D investments) and measures of output (number of patents held).³ The third group of variables refers to specific qualities and roles of the upper echelons (Audretsch and Lehmann, 2006), which is the combination of the top management team and non-executive directors.⁴ We considered account proxies of the educational and experience capital, such as the proportion of directors with MBA or PhD degrees, and the proportion of those in the upper echelons who had prior experience managing biotechnological or pharmaceutical companies. We also measured the agency role of upper echelons, proxied by their number (size) and the proportion of non-executive directors.

In Table 9.3, we report the descriptive statistics with reference to all variables employed in the empirical analysis. First, we found that M&As are fundamental to the evolution of biotech firms, both in terms of opportunities to acquire and to be acquired. Indeed, three companies out of four were involved in at least one M&A transaction during the sampling period (190/254 firms). Compared to independent firms, university-based were targets of M&As more often (2.5 times compared to 1.5 of independent firms), especially cross-border M&As (60 per cent of M&As of university-based firms are cross-border, vs. 44 per cent of independent firms). Nevertheless, university-based firms were involved more frequently in intra-industry deals with respect to independent firms, but the difference

Notes: All variables were measured at the time of the IPO, as declared in the IPO prospectuses. In the regressions, the sales, age (years + 1), patents and upper echelon size are expressed as natural logarithms.

Table 9.3 Descriptive statistics

Notes: Unless otherwise noted, the data represent averages. Statistics on deals are relative only to firms with at least one deal (190/254 firms). Statistical tests compare affiliated groups and independent IPOs. Significance levels are based on t-statistics (mean), Mann–Whitney U-test (median) and Z-tests of equal proportions, as required. Significance level at 1% (***), 5% (**) and 10% (*).

is not statistically significant. On average, research-affiliated firms were valued more than independent firms at the time of their IPO (Tobin's Q 4.3 vs. 3.6). University-based and corporate-affiliated firms were typically smaller and younger than independent firms (median 6 years vs. 9 years old). The size of universitybased firms was smaller than that of the rest of the sample (on average, sales for €5.7m vs. €51.9m for independent firms). Independent companies were already profitable at the moment of the IPO, whereas most of the affiliated (any affiliation) companies exhibited negative operating margins. This evidence corroborates and extends in time the results of previous studies on this typology of firms (Ensley and Hmieleski, 2005; Zahra et al., 2007). Original shareholders of the university-based firms did not typically divest at the time of the IPO, as can be deduced from their much lower participation ratios. The percentage of shares sold at IPO by existing shareholders of these firms was on average 7 per cent, whereas it was 24 per cent in independent firms.

The figures on innovative activity describe affiliated firms as more innovative in terms of output (number of patents), whereas there was no clear difference in R&D investments displayed in the balance sheets. The backgrounds of upper echelons were considerably different between affiliated and nonaffiliated firms. The leaders of the former companies had higher educational achievements (PhDs and MBAs). University or corporate-affiliated firms had more non-executive directors and upper echelons with more industry experience.

Methodology

The probability of being a target in M&As after the IPO was investigated in our study by using survival models. This approach can add further knowledge by showing how university affiliated firms could be targeted in M&A deals before firms that are independent or with different affiliations. In addition, this analysis indeed provides further information on acquirers' preferences, such as the time elapsed on average before receiving a takeover bid. In particular, we used Cox proportional hazard regressions. This model does not need any assumption on the underlying distribution of survival times. However, if the distribution of survival times can be well-approximated, then parametric failure-time analyses can be useful, which allow a wider set of inferences to be made. We investigate the M&A phenomenon, considering as survival time the time elapsed from the IPO day to the first M&A deal as target, and the acquisition represents the failure event. Positive/ negative and significant coefficients of explanatory variables mean that the measured factors shorten/extend the time elapsed on average before receiving a takeover bid.

Because not all firms go public, studying only IPO firms may introduce a ‘success’ bias that could influence our results. To address this possibility, we included a selectivity instrument as a control. Consistent with prior research on IPOs (e.g. Pollock et al., 2010), we employed the Heckman procedure to create the instrument. First, we obtained from the Bureau van Dijk's Amadeus database a list of biotech firms that did not go public between 1995 and 2009. To match treatment units (IPO firms) with control units (private firms), we first estimated the propensity scores, or fitted values, using the nearest-neighbour propensity scores (Dehejia and Wahba, 2002). Then, we estimated a logistic regression, where the predictive variables were firm size (revenues) and age (year of foundation) and country dummies. This regression was used to create the selectivity instrument that was included among the baseline regressors in our models (Van de Ven and Van Praag, 1981).

Notes: Standard errors are in parentheses. Significance level at 1% (***), 5% (**) and 10% (*). Country and industry dummies are included.

Figure 9.1 Kaplan Meyer Survival estimates by affiliation.

Econometric results

In this section, we report the results of our empirical validation of the hypothesis introduced above.

The typical university-based firm is attractive for potential acquirers. Our hypothesis is confirmed with reference to university-based firms, according to the results of the Cox survival models (see Table 9.4). In particular, in all regressions we performed, all forms of affiliation (regression 2) are positively correlated to a shorter time to be targeted in a M&A deal and this is also confirmed when we split for corporate and research affiliation (regression 3). However, the only positive and statistically significant coefficient is that referring to the affiliation with an academic institution (at a 5 per cent significance level). This result suggests that firms affiliated with universities make available some resources and services that investors could not find anywhere else when they expand. The survival analysis also shows a negative correlation between profitability and probability to be acquired, suggesting that less-efficient companies are more subject to being the target of acquisitions. The Kaplan Meyer Survival Functions estimated for each type of affiliation (see Figure 9.1) neatly show that an affiliation with a university increases the probability of a firm being acquired.

Conclusions

This chapter analyses the M&A dynamics of biotech firms that went public in Europe since the 1990s. The IPO and the contextual shift from the private to the public domain decreases information asymmetries, thereby increasing opportunities for equity deals. Moreover, IPOs are linked to M&As as they create public shares that may be used as currency in either acquiring other companies or in being acquired in a stock deal.

In this framework, this chapter addresses the role of institutional affiliation on the M&A dynamics of IPO firms. The main result is that the affiliation with a university appears to influence the evolution of the firms. The affiliation with a university is recognized as beneficial by investors that are willing to value the university-based firms going public more than independent or corporate-affiliated firms. From the descriptive statistics on the M&A deals, we additionally learn that these university-based firms are also more frequently targeted in subsequent M&A deals, and that the affiliation with a university enhances the internationalization of the firms; that is, more prone to take part in cross-border deals.

Our findings contribute to the existing literature showing that university affiliation is a source of legitimacy in the eyes of potential stakeholders. Moving forward from previous studies on post-IPO performance of university-based firms (e.g. Bonardo et al., 2011), we argue that the acquisition of successful research-based companies by incumbent firms can often be the most efficient mechanism to complete the technology transfer process and to exploit academic innovations effectively.

This study sheds new light on the relevance of scientific entrepreneurship in financial markets. With reference to the biotech sector, our research confirms that research-based firms show great promise, generating 40 per cent of biotech firms that went public in Europe since the 1990s. Results are of particular interest for specialized investment entities that could take an equity position in this typology of firms, envisioning a convenient exit through IPO or through M&As. The value-enhancing effect of university affiliation, combined with prior evidence on the likelihood of such firms to go public (Shane, 2004), explains the attractiveness of university-based firms to specialized pre-IPO investors, such as venture capitalists (Wright et al., 2006).

Finally, a shortcoming of this study centres on a signal – the affiliation with a research institute – that is not actually one that the entrepreneurs can actively choose. Future research could move forward by investigating individual scientists who were in the firm but left prior to the IPO, or joined afterward. Moreover, as a matter of fact, this study only focuses on successful research-based companies that completed their technology transfer mission via an IPO and subsequent acquisition, even if successful spin-offs may opt for a direct-trade sale. We acknowledge that, while this context offers a number of advantages for testing our arguments, it may limit the generalability of our results. Future research could also disentangle the single effects of each type of affiliation in improving the interests of external investors, even if this could be really challenging. For instance, the effect of the scientists' international mobility in enhancing the international exposure of a firm should be similar for both scientists working in the academia or in an external research institute. Finally, we suggest future studies to consider that the top management teams serve different purposes as the venture develops, as suggested by research on the life cycle of corporate governance (Filatotchev et al., 2006).

Notes

1 EURIPO (http://www.euripo.eu) is a database of European IPOs built and managed by Universoft, a spin-off company of the University of Bergamo. The industry classification is the official one adopted by the European stock exchanges, namely the Industry Classification Benchmark (ICB). To identify biotech companies, we refer to code 4573, which is Healthcare (45): Pharmaceuticals and Biotechnology (7): Biotechnology (3).

2 The data source on M&A deals was the Thomson One Banker Deals database, which relies on other sources such as stock exchange commissions, trade publications, law firms and investment bank surveys. In line with other authors (e.g. Bertrand and Zuniga 2006), we kept all deals of industrial restructuring. Thus, our sample firms could be targeted in several M&A transactions, because M&As do not refer exclusively to the combination of two companies to form a new company.

3 We considered the number of patents to which the firm had exclusive rights at the date of public offering, as published in the prospectus. Thus, the measure captures not only patents issued directly to the firm, but also patents acquired through arrangements with other firms. When missing, the patent variable was completed by measuring the number of patents as reported by the US and by the European Patent Office issued to the firm up to the date of the IPO.

4 The upper echelon consists of board members and top managers. The benefits of having prestigious members in both categories at the time of IPO registration are well known. Executives with lustrous credentials and experience may be more capable of leading a company through the IPO transition (Fischer and Pollock, 2004), and prestigious outside directors can reassure markets that the firm will be able to secure scarce resources (Lorsch and MacIver, 1989).

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