Licensing Agreements in Biotechnology: Legal and Tax Considerations for SMEs

The Deal Moment: Opportunities and Underestimated Complexity

For research-based biotech and pharmaceutical companies, a licensing or partnering deal is often the decisive step from the lab to the market. Out-licensing, co-development agreements, or exclusive distribution partnerships open the door to capital, infrastructure, and global reach. At the same time, it is precisely these deals that often present opportunities for long-term legal and tax risks to creep in—unnoticed, because the focus is on the scientific asset, not the contractual structure.

Especially for SMEs and scale-ups entering into such a deal for the first time, internal structures for legal and tax support are often lacking. The result: contracts that become a problem during the next funding round, an acquisition, or a tax audit.

Milestone Payments and Royalties: Tax Structuring from the Start

License agreements in the pharmaceutical and biotech sectors are rarely simple one-time payments. Typical structures include:

• Upfront payments (a one-time payment upon signing the agreement)
• Milestone payments (performance-based payments upon reaching defined development milestones)
• Royalties (ongoing revenue sharing)

This distinction has significant implications for tax treatment: Upfront payments are generally taxable immediately, while milestone payments and royalties may be treated differently depending on the contract structure and classification. In cross-border deals—such as those with a U.S. or U.K. licensing partner—withholding tax issues and double taxation treaties also come into play.

In cross-border deals between affiliated companies, the transfer pricing component must also be taken into account, i.e., ensuring that the agreed-upon payments comply with the arm’s length principle.

A common mistake: Tax implications are not considered until after the contract has been signed. By that point, the key parameters have already been set—and subsequent optimization or risk minimization from a tax perspective is often only possible to a limited extent.

IP Location and Transfer Pricing: The Underestimated Lever

The legal location of a patent or license has a direct impact on the tax efficiency of the entire deal. Many biotech SMEs hold their IP in a German GmbH—without ever having verified whether this is the optimal structure from a tax perspective for international licensing transactions.

In addition to considerations regarding tax rate optimization, substance requirements and other aspects aimed at minimizing tax risks play a particularly important role here.

As soon as royalty payments flow between affiliated companies—such as between a German parent company and a foreign subsidiary—the issue of transfer pricing also comes into play. The requirements of the German tax authorities and the OECD guidelines should not be underestimated: transfer prices must comply with the arm’s-length principle and be documented. If this documentation is missing or if the pricing is not in line with market conditions, there is a risk of back taxes—with interest and possible penalty surcharges.

For biotech companies with unique assets (patents, clinical data, know-how), the valuation of this IP is particularly complex. Involving tax advisors at an early stage is not an option here, but a necessity.

What’s Often Missing from Contracts: Three Critical Clauses

In addition to tax considerations, there are contractual provisions that are regularly omitted or inadequately addressed in SME deals:

• Change-of-Control Clauses: What happens to the license agreement if the company is acquired? Many contracts provide for the licensee’s right to terminate the agreement in the event of a change of control—a significant risk to the company’s value during the exit process.
• Reversion rights: Under what conditions does the license revert if the licensee fails to achieve the agreed-upon development milestones? Without clear provisions, the licensor loses control over its asset.
• Sublicensing rights: Is the licensee permitted to sublicense the rights? To whom, under what conditions, and does the licensor receive a share of sublicensing revenues? These questions significantly determine the commercial scope of the deal.

These clauses are not only legally relevant—they have a direct impact on the company’s valuation in future financing rounds or a sale process.

The Right Time to Seek External Advice

The most common comment experienced advisors hear in this context is: “We should have known that sooner.” External support is often sought only after the term sheet is already on the table or the letter of intent has been signed. By that point, the key commercial terms have been set—and there is little room for negotiation.

It makes more sense to involve an advisor as early as the negotiation preparation phase: Those who understand the tax and legal implications of various deal structures before entering negotiations can actively shape the deal rather than merely react to it.

Rödl supports research-based pharmaceutical and biotech companies in the legal and tax structuring of licensing and partnering deals—from deal preparation through contract and tax structuring to ongoing tax compliance. With our own international network, we provide support for cross-border transactions.