Navigating Regulatory and Legal Risks in Biotech Investing: A Framework for Investor Due Diligence and Corporate Governance

The biotechnology sector, once a frontier of innovation, has become a high-stakes arena for investors. From 2020 to 2025, regulatory and legal risks have intensified, reshaping the landscape for biotech firms and their backers. For investors, understanding these risks-and how corporate governance practices either mitigate or exacerbate them-is critical to avoiding costly missteps.

Regulatory Shifts: A Double-Edged Sword

The U.S. regulatory environment has grown increasingly complex. The Biosecure Act, enacted to restrict federal funding for biotech services linked to Chinese entities, has forced companies to reevaluate supply chains and compliance protocols, according to a PwC analysis. Simultaneously, the Trump administration's push for streamlined drug approvals and "most-favored-nation" pricing policies threatens to erode profit margins for biotech firms, particularly those reliant on Medicare reimbursements, the PwC analysis notes.

The FDA's evolving stance on AI in drug development further complicates matters. While the agency's January 2025 guidance on AI-driven regulatory decision-making aims to foster innovation, it imposes stringent credibility assessments for AI models used in clinical trials and manufacturing, as noted in the FDA draft guidance. This creates a paradox: AI could accelerate drug discovery, but the draft guidance makes clear that its adoption requires navigating a labyrinth of risk-based evaluations and transparency requirements.

Legal challenges have also disrupted regulatory stability. A federal court's invalidation of the FDA's attempt to regulate laboratory-developed tests (LDTs) underscores the vulnerability of regulatory actions to judicial review, as described in a DealStream guide. Such rulings highlight the need for investors to anticipate regulatory reversals and build flexibility into their strategies.

Corporate Governance: A Litmus Test for Resilience

Poor governance practices have repeatedly exposed biotech firms to litigation and reputational damage. Praxis Precision Medicines (PRAX), for instance, has drawn investor ire for its opacity in clinical trial data, raising questions about its accountability, according to an EdgarIndex analysis. Similarly, governance failures at major firms-such as GSK's chairman holding multiple directorships under synthetic identities-reveal systemic compliance gaps, as noted in the DealStream guide. These cases demonstrate that weak governance not only invites legal scrutiny but also erodes stakeholder trust.

Conversely, firms adopting precautionary governance frameworks-which emphasize foresight and stakeholder engagement-have fared better. For example, companies proactively addressing ethical, legal, and social implications (ELSI) of their technologies early in development cycles avoid public backlash and regulatory delays, according to a PMC article. Such strategies are particularly vital in contentious areas like gene editing and GMOs, where public perception can sway policy outcomes.

Investor Due Diligence: A Checklist for Risk Mitigation

To navigate these challenges, investors must adopt rigorous due diligence frameworks. Key metrics include:
1. Regulatory Compliance: Assess adherence to GLP, GMP, and GCP standards, and evaluate the feasibility of navigating AI-related FDA requirements, per the DealStream guide.
2. Intellectual Property (IP) Defensibility: Scrutinize IP portfolios for freedom-to-operate and infringement risks, as outlined in the DealStream guide.
3. Clinical Data Quality: Verify the statistical validity of trial designs and the maturity of product pipelines, consistent with the DealStream guide's recommendations.
4. Cybersecurity Protocols: Ensure compliance with GDPR, HIPAA, and other data protection laws to safeguard sensitive information, a point emphasized by PwC.
5. Governance Transparency: Audit leadership track records, directorship disclosures, and conflict-of-interest policies, as highlighted by the EdgarIndex analysis.

A 2025 report by DealStream emphasizes that investors must also evaluate a company's burn rate and capital allocation discipline, as regulatory delays or litigation can rapidly deplete resources.

Conclusion: Balancing Innovation and Prudence

The biotech sector's promise is undeniable, but its risks demand a nuanced approach. Investors must balance optimism for breakthrough therapies with vigilance against regulatory headwinds and governance pitfalls. As the FDA and EMA continue refining AI frameworks and pricing policies, firms that prioritize transparency, proactive compliance, and stakeholder engagement will emerge as long-term winners. For investors, the lesson is clear: due diligence is not just a checkbox-it is a strategic imperative.