The Importance of Regulatory Due Diligence During the Acquisition Process

Darshan Kulkarni
Kulkarni Law Firm


ue diligence is the cornerstone of the acquisition process, particularly when considering the acquisition of companies regulated by the Food and Drug Administration (FDA) like pharmaceutical, medical device, food, pharmacy, or cosmetics companies. It determines not only the risks involved in the acquisition, but also the downstream impact of the risks.

Some companies, in the haste to close a deal, may overlook the depth and breadth of FDA-related due diligence. However, this oversight can lead to severe ramifications down the road, including overpaying for a transaction, increased risk, and even inadequacy of products the acquirer thought they purchased, which may be deemed adulterated or misbranded by the FDA due to inappropriate risk assessments. Accordingly, the due diligence process is much more than a procedural step; the assessment of a company’s interactions with the FDA and compliance with FDA regulations is a critical component in assessing the value, risks, and potential of an acquisition. The following is a list of factors to explain why FDA due diligence is critical.

Understanding the Landscape

FDA regulations are vast, complex, and continually evolving. A misstep in compliance can lead to significant operational hiccups, penalties, and even reputational damage. By meticulously examining a target company’s quality processes and regulatory compliance history, one can ascertain the robustness of its operations and evaluate its commitment to quality and safety. Furthermore, depending on the regulatory strategy in play, a company may even be working with a dubious understanding of the risks associated with the regulatory strategy being considered; this can result in missed deadlines, failed regulatory strategies, and personal and professional liability. For example, a company may unilaterally decide that a medical device should be considered to be a 510k device, or that a biologic should be deemed a 361 HCT/P and therefore proceed with that understanding, only to discover at the time of filing that the FDA disagrees with the assessment. This inaccurate risk assessment by the target company could result in the acquirer facing significant delays, much higher costs, and shareholder dissatisfaction. Depending on the acquirer, and their own risk tolerance, pressure testing products in development could help address or alleviate such risks.

Financial Implications

Undetected FDA-related compliance issues can result in substantial financial costs. Penalties, product recalls, or remediation actions can not only be expensive but also disrupt operations. Moreover, these issues can delay or even derail the acquisition itself. Proper due diligence can highlight such vulnerabilities, enabling an acquiring company to make informed financial projections and possibly renegotiate the acquisition’s terms if significant risks are discovered.

Assessing Cultural Fit

For an acquisition to be successful, especially in the long run, ensuring a harmonious cultural fit between the purchaser and target companies is crucial. Determining a cultural fit begins by determining your own company’s core values, decision-making processes, and communication styles. Then, the acquirer must evaluate the target company’s culture based on external and internal documentation, and evaluate gaps between the target and the acquirer. A key portion of the cultural fit determination process for an FDA-regulated company will include quality assessments.

The FDA expects that quality assessments be built into the development and sale of products to prevent them from being rendered adulterated or misbranded. Accordingly, the FDA sees quality as a critical component of the regulatory approval process. FDA regulatory due diligence is not merely about ticking boxes for compliance; it provides a window into the target company’s culture. A strong compliance culture often signals a well-run organization, while frequent regulatory hiccups might indicate deeper operational or cultural issues.

Future Growth and Expansion

An acquirer may determine the value of the proposed target not only based on its current product line, but also based on the target’s planned future offerings. The value of these future offerings may be determined not only based on the intellectual property, but also based on new markets, and new products they intend to introduce. In such a situation, an acquirer must understand not only the congruence of the markets of the current offerings and future proposed offerings, but also the risk of a new proposed regulatory strategy, the market size, and more. Companies must consider the use of FDA regulatory attorneys, market analysts, and strategists to connect the present to the future based on interviews, analysis, and more.

Intellectual Property and Licensing

In the pharma and medical device industries, intellectual property (IP) is often a significant asset. FDA-related regulatory due diligence can uncover issues related to IP, such as whether the target company has the necessary FDA approvals for the IP they claim or if there are potential future challenges related to proprietary technology or formulations. For example, a company may claim that it owns five patents. However, on due diligence it may become evident that the patents are unrelated to any product being sold, and these patents are therefore worthless in keeping potential competitors from entering the market. It is, however, uncommon to find companies who tie their regulatory and IP strategies together.

Ensuring Business Continuity

Any regulatory setbacks or compliance challenges faced post-acquisition can disrupt the continuity of the business. Such interruptions can affect supply chains, relationships with distributors, and the company’s standing with customers or patients. By identifying and addressing potential regulatory risks beforehand, acquiring companies can ensure smoother integration and continued business operations.

Potential Repercussions of FDA Noncompliance

One of the most pressing concerns that can arise in FDA due diligence is the uncovering of latent noncompliance issues that may lead to contractual violations, administrative penalties, civil fines, and even criminal violations. A target company’s breach of contractual obligations due to FDA noncompliance can have cascading effects on supplier agreements, customer contracts, and partnership deals. Administrative penalties often involve corrective actions that can be time-consuming and costly. Civil fines, often hefty, can significantly impact the bottom line and, in extreme cases, jeopardize the financial health of the acquired company. Furthermore, egregious violations of FDA regulations can lead to criminal charges against the company or its executives, resulting in imprisonment or substantial penalties. Such scenarios not only hurt the financial aspects of the business but can cause irreversible damage to its reputation and brand value. An acquisition that overlooks these potential pitfalls can quickly turn from a promising investment into a burdensome liability.

Potential Repercussions of FDA Noncompliance

Regulatory due diligence is an indispensable part of the acquisition process in FDA-regulated industries. It offers insights into the target company’s compliance history, its commitment to quality, and its operational robustness. By highlighting potential risks and vulnerabilities, regulatory due diligence empowers acquiring companies to make informed decisions, negotiate better terms, and ensure smoother integrations.

In an era where transparency is revered, stakeholders—from shareholders to customers—appreciate and expect proactive risk management. Demonstrating that comprehensive FDA due diligence has been undertaken can boost stakeholder confidence, signaling the acquirer’s commitment to upholding quality and regulatory standards.