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BIO2010 Review: New approaches to early stage discovery dealmaking

Posted on 12 May 2010

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A recent study claims it costs in execss of $1.3 billion to get from discovery to market!

With increased R&D costs and declining R&D budgets, there is a desperate need for creative solutions to discovery dealmaking.

This article reviews the novel approaches being pursed within the industry to find funds to fill the gap between grant money and the first industry deal.

The new deal climate

In the past, bigpharma and VC's were willing to invest in discovery stage startup companies. Not anymore.

Now VC's are viewing discovery stage startups as not only very high risk but also very slow to provide a return on investment. Typically, a VC might expect a technology investment to provide a return and/or exit within 3-4 years. In biotech, this timeframe is likely to be more like 5-8 years. For a VC to invest in a company with similar risk but a much longer return on investment timeline does not make alot of sense, especially at a time of finite funds to invest.

Similarly, bigpharma has found to its cost that investing in numerous early stage discovery opportunities is an expensive and risky business. Where in the past it might have been willing to make substantial upfront payments to have a foot in the door, most compnanies are now waiting proof of principle and that often means phase II data.

So how are early stage discovery technologies going to get funded?

Company acquisition

One conventional approach adopted in recent years by bigpharma is to identify, partner and then acquire a discovery stage company, bringing the entire R&D capability inhouse.

However, this is a costly and time consuming activity. the comapny needs ot balance the benefit of acquisition with trying to retain personnel in the small company who may not wish to be part of a large organization. Company cultures are often radically different, as are processes and clarity of intent. Alot of talent in a small company can often be lost rapidly.

Creating new companies around technology

A novel approach being sought by Third Rock Ventures is to forget about the company. Instead they focus on finding the right technology assets, build a management team around the assets and establish a company with specific objectives to develop the technology assets.

Bigpharma are often invited to participate early on through option-based deals on the technology and/or company. Alternative route to involvement include equity investments, R&D funding for rights, staged buyouts linked to success milestones, first right of negotiation, and partner consortiums.

For example, a consortium of pharma partners make an initial non-dilutive investment in the newco. Upon achieving specified milestones, the companies make option payments providing continued participation in the consortium. The companies are then obliged to make a payment for a non-exclusive license to the technology at a specified development success milestone.

Bigpharma perspective

In the past, bigpharma would have shown alot of reluctance in external R&D. However, recent lack in internal success, pipeline attrition and declining budgets has forced a reconsideration of how R&D is funded and delivered to the organization.

Bigpharma is much more willing to consider:

  • independent R&D
  • external R&D
  • sharing of assets
  • open innovation structures

Several companies are now actively seeking models that allow investment in technology focussed companies with the participation of VC's, as outlined above.

From bigpharma's perspective paying a modest fee in exchange for access to a novel technology that would not otherwise have been developed is a risk worth taking. Paying an optional fee to obtain a non-exclusive license to that technology at a specified milestone, resulting in a fully paid and perpetual license is also a consideration. This allows for new business models where the asset needs to make its money in upfront, funding and option payments, but not ongoign royalties.

Providing access to assets for wider good

Researchers into neglected or rare diseases have long campaigned for access to compaound libraries and technologies of the bigpharma comapnies, often to no avail. The belief was that compounds might already exist on the shelves of bigpharma that would treat or cure rare diseases. Now bigpharma, is starting to listen and recognize that such efforts, often by charitable organizations are of little threat to their established business and may in fact unveil compounds previously thought of little potential.

If nothing else, bigpharma gets to share in incremental upside if a compound should be found to successfully treat a neglected disease, and perhaps a little good PR will also go along way where bigpharma is often maligned.

Reinvent research outsourcing

Several companies are working together with CROs to develop an open innovation model. In many cases, CROs are able to access government grants to fund such acitvities where bigpharma would not.

The partnership results in the CRO learning best practice in how to develop products whilst the pharma company gets access to technology and CRO services at lower cost. The result is a risk sharing model.

The VC perspective

Exits are limited or non-existent. Funds need to be reinvested in portfolio compainies. Little or no money to invest in new opportunities. VC's are spending much of their time managing existing portfolio to identify efficiencies and drive focus into the business. As result, less money available for new deals, a reluctance to invest in new opportunities, and very selective dealmaking.

M&A is the principle exit, many becoming milestone driven and option based. IPOs are rare, with the window still firmly shut.

Enter bigpharma option funds

Necessity is said to the mother of investion. This has never been truer than in the current financial climate. Bigpharma has either invested large sums in the form of upfront payments or relied upon VCs to fund early stage discovery startups. Both models have struggled to provide success and the current constraints on funds has made the situation worse.

Enter the new option-based funding model being implemented by bigpharma. Numerous companies have sought to make investments in companies and/or technologies in the form of option-based investments.

The proposition works as follows: In return for a modest option payment, the bigphamra company obtains an option to acquire or license the company/technology, respectively, at a defined milestone in the future.

The benefits for the small company include:

  • funding injection in the form of the option payment
  • validation of the technology by a major company
  • funds to allow contiuation of the work
  • clear direction and focus on a defined milestone
  • time limited option, so that is expires able to continue unhindered
  • market terms when option exercised

The benefits to existing investors:

  • does not limit upside of investor
  • allows company to continue partnering
  • provides funding to broaden company
  • normally non-dilutive
  • eases strain in onvestors funds
  • validates technology

Currentpartnering has published a detailed report on this topic: Option and Evaluation Partnering Terms and Agreements in Pharma and Biotech.

Summary

In summary, the current difficult financial climate has raised a number of challenges as to how early stage discovery stage startups and technologies are to be funded between grant money and proof of principle.

After a period of reflection, the industry is standing up to the challenge, with numerous approaches being implemented from option-based deals through to more open models of innovation where shared investments result in shared access to technology.

 

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