Punctuated Equilibrium: Is a Meteor Heading Towards the BioPharma Ecosystem?

It is impossible to ignore the impact of social media in recent years and its powerful ability to connect people, ideas, and information across time and space. For relatively minimal time and effort, commercial websites can be created with tremendous social value (e.g. use of social media in Egypt's youth revolution). Contrast this to the aging drug development industry, which many pundits claim is facing a crisis due to a “broken business model”. Cash burn is too high, development timelines too long, approvals too infrequent, and reimbursement too low. Perhaps this is true, but pharmaceuticals are far too important to humanity for the industry to simply dissolve. Inevitably some set of phenomena will cause a rapid and dramatic change in the BioPharma ecosystem - a punctuated equilibrium of sorts. Could social media be this meteor? Could the IT world ironically give BioPharma the dose of medicine it so desperately needs?

                The striking aspect of the social media site Twitter is its openness and ability to index and communicate massive amounts of information. Similar to the invisible hand of capitalism, Twitter’s collective platform has a greater power than the sum of its individual contributors. In contrast, the BioPharma industry operates mainly in shadows and silos. At the research level, the patent system, while necessary to compensate investors for taking large and lengthy risks, clearly can stymy communication and the public’s ability to freely innovate in already staked areas. At the patient level, confidentiality and the historical difficulty of obtaining and sharing consistent digitalized clinical data are barriers to identifying large-scale trends through applying population statistics. When these barriers are overcome, the subsequent increase in the efficiency and effectiveness of drug discovery could return the industry to its boom years.

            Signs of the social media meteor can already be seen. Sage Bionetworks, a nonprofit research organization, is trying to “create an open access, integrative bionetwork evolved by contributor scientists working to eliminate human disease (http://sagebase.org/sage/index.php)”. According to their website, “The Sage Commons . . . an accessible information platform . . . will be used to integrate diverse molecular mega-datasets, to build predictive bionetworks and to offer advanced tools proven to provide unique new insights into human disease biology. Users will also be contributors that advance the knowledge base and tools through their cumulative participation. The public access goal of the Sage Commons requires the development of a new strategic and legal framework to protect the rights of contributors while providing widespread access to fundamentally non-commercial assets (http://sagebase.org/commons/index.php).”

                “Open-Source” sharing of discoveries seems anti-capitalistic. Patents should certainly continue to exist for downstream commercial developments that require millions of dollars of investment. However, many academic, corporate, and clinical datasets and scientific results will never be relevant for commercialization. A lot of information is sitting stale in a lot of labs and doctor’s offices across the globe. Like individual pieces of a large jigsaw puzzle, a clear picture of human biology only emerges when they are combined. BioPharma stakeholders will have to adjust to freely sharing basic research, datasets, and perhaps bioinformatics tools. In return, the resulting improvement in the fundamental understanding of biology will dramatically improve the success rates of patented drugs and lower costs of development. Although there will be a lot of cultural resistance at first, the social media meteor may be just what it takes to keep the struggling BioPharma ecosystem alive.

Relevant Links:

http://www.economist.com/node/2724420?story_id=2724420

http://p2pfoundation.net/Open_Source_Biotechnology

http://www.nature.com/nbt/journal/v28/n7/full/nbt0710-631.html

http://www.patentlens.net/daisy/cambia/home.html

http://mjlst.umn.edu/uploads/CS/bW/CSbWvh00RsLS5YM4raBkYg/feldman_a2.pdf

Subtle Barriers to Seemingly Win-Win BioPharma Spin-outs

Many of the R&D programs housed within big BioPharma may be developed faster, cheaper and better in the hands of a more nimble and focused start-up. These programs are often delayed or cancelled due to short term budget issues or changes in commercial strategy. Meanwhile, the IP clock runs out, researchers become demoralized, and past effort and capital is wasted. Why then, do we not see more spin-outs as part of a ritualistic spring cleaning on the part of big BioPharmas? There are six subtle reasons why seemingly win-win BioPharma spin-outs never happen.

1.       Precedent

For many BioPharma companies, there is little institutional precedent for such spin-outs (although there are admittedly notable examples, see links below). Business Development, Legal, R&D, and Commercial professionals often have scant experience preparing their own early-stage programs for someone else’s due diligence. Scientists may not have Know-how, Trade Secrets and physical materials organized and ready for transfer. Accountants may be uncomfortable with reporting requirements in light of Fin 46. Bus Dev folks may have never completed an out-license or structured a start-up. Commercial groups may lack analysis or projections for early-stage programs. This all adds up to a BioPharma deal machine whose wheels are not greased for spin-outs.

2.       Glamour

The Business Development groups of most BioPharmas are focused on M&A or in-licensing products to fill near-term holes in their parent’s income statements. Spinning-out early-stage R&D programs that the parent can no longer develop is considered neither glamorous nor the best means of career advancement. Spin-outs are also a psychological acknowledgement that someone else may be able to do a better job, a fact that can be uncomfortable to swallow.

3.       Fear

This point is perhaps the most obvious. BioPharma companies fear licensing out a potential blockbuster. After all, if they keep the R&D programs in-house, they maintain their (often valuable) option to resume developmet efforts if conditions change. Thus, BioPharma may want to include “strategic rights” or “clawback provisions” in an out-license or asset sale in addition to equity, milestone payments and royalties. These can include Right of First Refusal, Right of First Negotiation, Hard and Soft Call Options, etc. However, VCs/Angels and the management of start-ups are loath to agree to such provisions and their inclusion often halts spin-out discussions in their tracks.

4.       Entanglement

Whereas start-ups are often “project” companies focused on discrete technology bundles to be sold in five or so years, “perpetual” BioPharma companies are much more complex. Their R&D programs are often entangled with one another and may each step on some broad core set of IP or Know-how (e.g. a class of compounds or targets or manufacturing know-how). The BioPharma may not be able to effectively license out or assign IP to one program without endangering or affecting another program or restricting future activities. In addition, the BioPharma may have itself sub-licensed relevant IP without the ability to sub-sub license it. Furthermore, whereas start-ups have limited assets to worry about outside of their lead program, BioPharmas have much more cause for fear from lawsuits and other liabilities.

5.       Valuation

BioPharmas often have poured more money into a program than the VCs are willing to value in a financing round. As stated in a previous post, BioPharmas usually want to stay under 20% share ownership. With say a $10M cash Series A raise from investors, the BioPharma’s stake is equivalent to $3M (assume post of 65% investors, 20% biopharma, 15% option pool). If the BioPharma has spent $8M on the program so far, that is a hard pill to swallow even factoring in milestones and royalties. (However, it raises an interesting accounting question as the R&D has most likely already been expensed.)

6.       Management

Many of the better known BioPharma spin-outs are the result of M&A where the acquired start-up’s management team decides to spin-out remaining peripheral assets (e.g. Relypsa/Ilypsa/Amgen). In this case, the assets are unentangled and a management team is both ready, willing and able to spin them out and backed by the momentum of a recent success. It is a lot less clear who would manage the spin-outs of BioPharma’s organically grown programs.

Despite the challenges, BioPharma spin-outs can still be worthwhile endeavors. Besides preserving value and R&D momentum, they can also provide jobs during periods of corporate downsizing and give some drug programs a greater probability of success. There have been many other articles/blogs written on this topic, a few of which are linked below.

Useful Links:

http://www.nature.com/bioent/2003/030401/full/bioent727.html

http://www.signalsmag.com/signalsmag.nsf/657b06742b5748e888256570005cba01/cf05408f18adda9d8825679b0052d533?OpenDocument

http://www.fiercebiotechresearch.com/story/gsk-bets-hungry-spinouts-can-upstage-fat-pharma/2010-10-05

http://venturebeat.com/2007/10/29/amgen-relypsa-and-the-art-of-the-biotech-spinout-startup-restart/

http://www.fiercebiotech.com/story/alkermes-spinout-nabs-20m-fuel-parkinsons-program/2011-01-10

Apples v Oranges: Don’t Use BioBucks for Deal Comps

Press releases often grossly overstate the dollar value of life science license agreements. The stated “BioBucks” are adjusted for neither probability of occurring (often slim) nor the time value of money. However, many industry participants refer to these press releases for deal comps when structuring agreements. Upfronts, regulatory milestones, and single or double digit royalties are all teased apart for signs of what is “fair market value”. Below is an explanation of why this is a common yet faulty approach.

Non-disclosure

The detailed financial terms and structure of drug development and commercialization agreements are rarely made public. Private companies don’t disclose them and public companies only do so if they are “material”. License agreements disclosed as Exhibits to regulatory filings often redact key items. It is small wonder that people rely on what is available – carefully tailored press releases.

Complex and Customized Deal Structures

Drug development and commercialization agreements are highly complex and customized. Trying to condense their key terms into one or two sentences is unrealistic.  Some subtle variables that are manipulated to structure a license agreement include:

·         R&D – Some deals require the licensee to pay for near term clinical trials which can easily match or surpass the size of any Upfront.

·         Indications – Some agreements “split indications” and only license a few of a drug’s many potential therapeutic uses or pay indication-specific milestones. The same may apply to a particular route of administration.

·         Geography – While some licenses are worldwide, there has been a recent trend towards ex-US or country-specific deals.

A worldwide deal where the licensee pays for all future clinical trials and the licensor accesses all uses of the drug will have much higher “headline” deal terms than an ex-US deal where the licensor pays all future expenses and only accesses the lead indication.

Drugs Are Not Fungible

Even if two agreements have identical structures, are at the same stage of development and are for the same specific indication (e.g. front-line for stage III lung cancer), their financial terms can and should diverge. The value of a drug depends on many factors including existing and projected safety & efficacy data, route of administration, reimbursement setting, IP life, manufacturing requirements and COGS estimates, etc.  

Because each deal is custom and terms are kept mostly private, the life science partnership market is extremely opaque.  Relying on surface-level press releases is bad practice. Every deal should be properly financially modeled to include all key variables and identify the optimal structure and financial terms that can withstand a variety of future scenarios.  Otherwise, you are just comparing apples to oranges.

When to Partner a Biotech R&D Program

When early-stage life science companies are deciding when to partner a program, they must weigh their ability to convince a third-party of its value against their ability to successfully continue to the next stage of development. Both require a bit of guesswork. The time sensitivity of the VCs on their board may tip the scale.

Convince a partner of your worth

Many big Pharma’s operate their development pipeline using portfolio theory. Every stage of development has an average attrition rate, which Pharma’s apply across a bucket of projects. If your drug truly has an above average probability of success in future stages, you must convince a partner of this fact or face an unfair valuation haircut. You know your drug better than anyone and are in the best position to judge its chances. The Pharma knows there is an information asymmetry and will rely on the empirical preclinical and clinical data you provide. It is up to you whether you can and should stick to your guns and raise another round of funding. Remember that the process of finding and courting potential partners, preparing for diligence, and engaging in term negotiations is itself a distraction and significant use of limited management time and focus.

Going it alone

While big Pharma’s have the resources, experience and horsepower to execute later stage clinical trials, many biotech companies are essentially focused on completing research projects vs building traditional stand-alone companies. They often hire only those needed for the immediate task at hand and make liberal use of consultants. This approach, while efficient, can limit a company’s options if it cannot find a partner and/or chooses to go forward alone. Besides finding and adding appropriate full-time personnel for the next stage of development, a company’s most difficult challenge these days is raising enough capital to reach an inflection point years away. Earlier stage projects in the pipeline may have to be postponed or cancelled. The impact on corporate morale (both good and bad) of such a decision is not insignificant. On the bright side, going it alone allows a biotech to maintain full control and avoid the possibility of watching their lead program get short-shrift within a big Pharma.

VCs and Time Sensitivity

VC funds face pressure to monetize their investments in roughly five years. They may balk at doubling down again on an investment and claim to prefer “non-dilutive financing” via a partnership. This is a misnomer, however, as the top-line (revenues, cash flow, control) does get diluted in a partnership, if not the shares outstanding. The partner is not jumping in for free and will demand a significant portion of the project NPV. These days direct secondary PE funds may play a small role in preserving corporate value while allowing investor liquidity.

As the universe of potential big Pharma partners will likely continue to contract in the near future, more and more biotechs are going to have to derisk their programs themselves. For this to be sustainable and realistic, proof of concept trials will have to be shorter, smaller, and cheaper. Perhaps the answer lies in the discovery and use of surrogate biomarkers as endpoints. Perhaps next-gen sequencing and computing power will discover new easy-to-drug targets and restore us to a time when biotechs pursued low-hanging fruit. For the dreamers out there, perhaps the IPO market will return and early-stage biotechs will evolve into the very FIBCOs (fully integrated biotech companies) that are now an endangered species.  

The Impact of Time on the Drug Development Industry

The lengthy timeframe for drug development serves as a strong and subtle influence on the biotech industry.  Certainly its relatively slower pace has caused traditional biotech to adopt a unique culture distinct from its Med Device, Diagnostic, & Tools cousins. Below are three ways time causes the biotech model to diverge from most other industries.

1)      IRR (Time-weighted return)

Many VCs and the biotech media will measure multiple return on cash investment as an indication of success (e.g. 5X return). However, this ignores an important variable in finance, time. IRR, a time-weighted return, is the more important measure. A 10X return achieved over 100 years is not so impressive. Because biotech takes so long before a product is cash flow positive (10+ years), returns on an IRR basis take a hit. Even if an early-stage biotech sells to big Pharma after say Phase IIa proof-of-concept, its purchase price will be heavily influenced by the Pharma’s timeframe to cash flow breakeven. Cost of capital becomes a real issue over ten years, as does any loss in patent life. Contrast this to the faster paced Med Device or Diagnostic world, and you can see why a lot of Healthcare VC dollars are migrating in those directions. Furthermore, the pressure for a biotech to partner or sell after five years to satisfy VC’s timeframe puts unnatural pressures on a program that is meant to take much longer. When a biotech rushes development to partner early, when the focus is not on a successful product launch but solely Phase II exit, shortcuts are taken, know-how, focus and momentum are lost, and drugs often fail as a result.

2)      Crystal Ball

In many ways running a biotech is like steering an ocean-liner. It is hard to be nimble and you have to predict what macro and microeconomic conditions will look like ten years from now. Will regulatory rules and reimbursement mechanisms have changed? Will there be an IPO market or interested acquirers? Will a new diagnostic tool identify more patients to treat? Will the emerging markets have a sustainable health care system and honor IP? What about competition? It is very difficult for biotech companies to predict any of these variables. Unlike most industries, the long R&D time-cycle means you can’t necessarily tailor your business model to the fluctuations of the marketplace.

3)      Personalities

The relatively slower pace of drug development and its focus on major innovations vs incremental improvements attracts a different personality than most other industries. Many start-up biotech companies are at least initially run by MDs or PhDs, not traditional business people. These individuals are intellectually curious, passionate about their field, and interested in advancing science and medicine. However, many were raised in academia and have little inclination to focus on the end market. They often base their companies around innovative capital-intensive solutions looking for problems to solve. This “hammer-looking-for-a-nail approach” can create a challenging dynamic for a for-profit, VC-backed start-up with little cash or time to spare and high demands for exits.

Because the healthcare commercial marketplace is constantly evolving, biotech companies should avoid relying on stale business model heuristics that were only relevant to the healthcare landscape of the past. No one has a crystal ball, so the best you can do is research current market conditions, take a reasonable and thoughtful guess as to the future, narrow your focus on a specific set of product opportunities, and generate a tactical game plan. Then do it all over again in six months.

Issues To Consider When Adding A Corporate VC To Your Fundraising Syndicate

Since 2008, cash has been king, and as the traditional VC market constricts, Corporate VCs have become an appealing source of capital and expertise for young biotech companies. Below I discuss issues to keep in mind when considering adding a Corporate VC to your syndicate.

Disclaimer: Please consult an accountant expert for more information as these rules are complex and change frequently. I am not an accountant.

1.       Ownership constraints – Historically, many corporate VC’s could not own ≥ 20% of your post-financing fully diluted shares outstanding or their parent BioPharma would have to absorb a portion of your P&L expense onto their income statement. In recent years, the accounting rule FIN 46 has lowered the 20% ceiling further, especially if board seats or special voting rights are involved. The rule could potentially require the parent BioPharma to consolidate all of your financials onto their books every quarter and is a logistical nightmare for their finance group. The same may hold true if the Corporate VC contributes the majority of the cash in the round.

2.       Leading rounds – Many corporate VCs will not lead rounds despite their strong enthusiasm for your company.  The reason again has much to do with accounting. Parent BioPharma’s have to justify to their external accountants that they are paying fair market value for your stock. This is easier to do if a stand-alone third party VC sets the price. This is also one reason corporate VCs will be more hesitant to pay a premium for your stock (among other reasons) as they may have to immediately expense a portion of it. This same may hold true for all elements of the financing terms including liquidation preferences, anti-dilution provisions, conversion ratios, etc.

3.       Strategic relationship – There are both pros and cons to adding a Corporate VC to a syndicate. On the one hand, many Corporate VCs work closely with their parent Company to provide valuable expertise regarding clinical trial design, regulatory interactions, research tools, commercial assessment, etc. This expertise is often impossible to duplicate using external consultants. On the other hand, there are implicit signals sent to the world when you forge a formal relationship with a BioPharma company. These signals can provide validation and help you fill out your syndicate, but can also make other BioPharma’s feel that the invested Company will have the upper-hand when it comes time to partner.

4.       Motivation – Many Corporate VCs have different agendas then their Financial VC counterparts. Afterall, they are “strategic” investors who are using VC investing to ultimately help fill their parent’s product portfolio down the road. The people running the shops may have slightly different backgrounds and approaches to an investment. This can manifest in slightly different behavior than you are used to from a VC.

No two Corporate VCs are identical and they come in a variety of corporate structures and personnel flavors. Some are separate operating companies with their own balance sheet. Some are run off the parent Company’s books. That being said, in BioPharma there are less than a dozen major players, so getting a feel for each one does not take long. Overall, if done correctly, a Corporate VC can be a valuable addition to your syndicate.  

3 Tips for a Successful BioPharma Partnership Pitch

During my time in Corporate Development at a large BioPharma company, I observed hundreds of private biotechs make their case for partnership or a Corporate VC investment.  I noticed some constant themes for what works and what doesn’t. Below are three tips for a successful BioPharma partnership pitch.

1.       Know your audience – R&D vs BD meetings

Successful pitches are tailored to the concerns of a particular audience. R&D folks will care about data, data, data and how this program will fit into the existing R&D portfolio (and whose budget it will consume). They are by nature intellectually curious and will enjoy discussing the nitty-gritty details. BD folks care more about the big picture, synergies with the BioPharma’s existing commercial infrastructure, and tactical next steps. They are looking at hundreds of other companies and asking themselves whether they should spend their time on yours. Tailor your presentations wisely and know who will be in the room ahead of time.

2.       Don’t alienate your potential champion

Going around or over a BD person’s head often backfires. Very often, private life science companies will simultaneously try several different avenues to gain the attention of a particular BioPharma. I have seen this approach backfire VERY often because it ignores intra-Company dynamics. Remember, a BioPharma company is not its own living organism. It is made up of individuals with their own agendas. If a BD person who is supposed to “own” a particular space feels their autonomy or authority is being usurped, they will be less likely to champion your company when it eventually hits their desk. This is just human nature, and I have been guilty myself. Find the right person from the get-go even if it takes more time.

3.       Do think beyond Phase 2

Plan your program as though you were taking it through market launch. It shocks me how many companies pitch their Phase 2 program with no concept of the clinical, capital, and time requirements for Phase 3 and beyond. In my opinion, every Phase I biotech company should have financially and operationally modeled their program through ten years post launch. Not only will this guide their Phase 2 operating decisions but it will also heavily influence their partnership discussions and optimal deal structures. Claiming ignorance on the matter and deferring to their potential partner impairs the chances of any partnership at all. Don’t make your partner do all the heavy-lifting.

Welcome!

Welcome to the first of many biotech blogs!