The New Normal for Biotech Startups


Xconomy Seattle — 

The structural changes roiling the pharmaceutical sector are driving innovation of biotech business models. With shrinking operating margins, patent expirations, a paucity of new product launches, significant reimbursement pressure, and an unpredictable regulatory environment—Big Pharma’s high risk bets on early stage biotechs of the past decade look cavalier through the lens of the current market environment.

The days of multi hundred million dollar upfront payments to acquire early stage biotech companies are likely gone for good, creating an exit trap for early stage private company investors. This trend is proving challenging to the sustainability of the venture capital model of the past. Various prognostications are that one quarter to one half of venture capital firms will disappear in the coming few years. The old biotech model of building early stage companies with loads of venture capital in the hope of a rapid Big Pharma acquisition at a large multiple to the invested capital, now seem oddly prosaic. Risk-sharing, earnouts, and contingent value right (CVR) agreements are the order of the day. The strategy of going public looks even more remote in today’s market. So, with that gloomy backdrop what does the future hold for those of us not ready to hang it up and head to the golf course?

Amidst all this turmoil a couple of things remain constant. The pace of innovative research and discoveries by our talented scientists in the public sector has not slowed; and pharma’s need for promising compounds is more dire than ever. However, the way in which one reaches the other is in flux at the present time, presenting a challenge but also an opportunity. In its latest efforts, pharma seems to be trying to sidestep the richly priced acquisitions and licensing deals of previous years by cutting out the middle market and going directly to the source – with a recent trend for generously funded research collaborations being doled out to top tier universities. Whether pharma has the agility to stock its pipeline through this mechanism without relying on biotech companies seems unlikely.

In the meantime, one biotech model gaining traction is the single asset, infrastructure-lite, development model, which deploys modest amounts of capital to develop a single compound to an early clinical data package which can be partnered with pharma. The asset resides within an LLC, and following the license transaction, the LLC is wound down and distributes the upfront, milestone and royalty payments to the LLC members on a pro rata basis. The key to success in this model is choosing the appropriate asset/indication – one where it is possible to get to a clinical data package on limited capital. This approach excludes many molecules and indications often favored by biotech, and tends to drive towards clinical studies using biomarkers – directly in line with one of pharma’s favored strategies.

The model seems to be gaining popularity in large part due to the fact that the probability of an M&A exit for any given private early stage biotech company is approximately 2 percent, and the probability of a licensing transaction on an attractive asset with early clinical data may be 30 to 50 percent. So on a risk-adjusted basis, the return profile of the single asset LLC model makes good sense for a growing number of investors with the flexibility to invest in these structures. The structure is also very motivating to founders and development teams since there is a real possibility of retaining undiluted equity ownership and reaching membership distributions of licensing revenue in the near term. That is something that has proven elusive for the scientific founders of more typically capitalized venture-backed companies.

With these principles in mind, we have recently founded Resolve Therapeutics, LLC and have begun work on a compound sourced from the University of Washington, discovered by researchers and scientific co-founders Keith Elkon and Jeff Ledbetter. In addition to the scientific founders, Resolve has built a highly experienced development team to advance the asset from preclinical research to an early biomarker phase IIa study in lupus patients, with the goal of partnering upon the successful completion of the study. As the team hones the model and strategic relationships are formed with key vendors, the next assets are coming into focus.

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6 responses to “The New Normal for Biotech Startups”

  1. James, thanks for posting a description of this new model of biotech financing. I wish you the best of luck at Resolve Therapeutics with moving forward with your lupus program. However, it is disturbing to think that potential drugs that don’t fit into this model now have little chance of receiving funding. Many drugs already on the market would not fit this model and could not have been developed if this was the only system in place in the past. The drug development financing system clearly needs to be rebuilt so that developing novel medicines for unmet medical needs becomes the paramount driver for selecting which drugs innovators work on. New incentives (e.g. tax breaks for lengthy investments and novel first-in-class drugs) are required to entice investors into putting their money into companies that won’t generate a return for many years. Hopefully your article will help to catalyze discussions along that line.

  2. Raghu Pandurangi says:

    Dear all:

    With big pharmas layng off in a big way, opening a smlal biotech company may be on the chord for all senior scientists. There is a platform to submit SBIR grants to jump start the company. Any other suggestios will be helpful since I am planning to do it after 23 yeras of R & D both in academics and industries.

    The main logo of our company is Sci-Engi-Medco which means Engineering basic science concepts to translational medicine and back to basic science for reverse translational medicine in a kind of loop.

    In other words, bench to clinic and from clinic back to bench for validity of real findings in patients.

    It is a good discussion to hop on!!.

    Raghu Pandurangi, M.Sc.Ed; Ph.D.

  3. I’ve been a big fan of the “lite” biotech LLC for a long time. I think it’s a great way to identify and develop promising candidates. Savvy investors can invest in a portfolio of these assets and even provide some back office functions, such as accounting and finance. The issue we have run into is that an individual investor may not want to invest in a single asset, but a portfolio of assets. This is why a “real” company with a technology that can crank out multiple assets are more attractive. Thus, we need a bunch of “lite” LLCs so that investors can build a portfolio and diversify their risk. This is where University tech transfer offices can play a big role. They can take the lead in LLC formation and outsourcing of initial experiments for their LLCs. External consultancies can be engaged on an as-needed basis to handle the outsourcing and out-licensing. For example, we’re looking to help a “lite” LLC + university tech transfer office access low-cost preclinical and clinical development capabilities. University tech transfer offices that develop long-term strategic relationships with companies offering low-cost development capabilities can ease the process from LLC concept to data generation. By keeping both management and infrastructure costs low, then more LLCs can be formed, creating multiple investment/exit opportunities for all investors.