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.
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