It is a known fact within the private company biopharma universe that the days of certainty for public exits, subsequent private financings, and even pharma licensing deals are over. IPOs have been out of favor for five years, venture firms are turning away from the sector, and fewer licensing deals are being cut. What is less understood about this uncertain environment is how it has forced management and their venture backers, to not only rethink their strategy, but to multi-task like never before. The view from the current crossroads of biotech and where all this may lead was discussed with a highly experienced group of experts last Wednesday at the 2012 BIO Investor Forum in San Francisco.
In the good old days, small biotechs could follow a straight path: Series A, B, C, IPO, then on to the FIPCO model through sizable follow-on financing rounds and partnerships. Because this is now the exception, and far from the norm in biotech, companies need to find other paths. More importantly, they need to find multiple paths and assess them continuously. Enticing potential acquirers, filing an S-1, identifying more venture backers, and running diligence for licensing deals is now a simultaneous preparedness. In the past, a single route might have been pursued with full attention and resources.
Option 1 – Testing the IPO waters
One of the biggest issues for late-stage private companies has been the breakdown in the model for IPO exits. The moderator of the session, Peter Reikes, Vice Chairman of Healthcare Investment Banking at Stifel Nicolaus Weisel, says investors these days only want to invest if someone else has already funded through the next milestone. He says the public equity investors see anything else as “taking a 3 foot jump across a 6 foot trench…the buy-side will not put down dollar one unless they see the other 100 dollars already on the table.”
When preparing for late stage financings, Dennis Purcell of Aisling Capital says that VCs are keeping extra dollars on hand for the public exit, for what he refers to as the “pay to play” IPO environment. Venture firms used to hold an extra dollar for potential later private rounds when they invested, and now they are being asked to step up for a percent of the initial offering. This illustrates the difficulty in pulling together demand to price at the higher range of initial public offerings.
Can new rules for pre-IPO marketing help? Panelists agreed that at the end of the day it is about building relationships that will make or break the transaction. The more that pre-IPO marketing allows for this the better. Some investors may believe in the company from the start, others need a lot of hand holding and need to build into the story and even grow with the company a little to gain familiarity. To this end, you never know (and can be surprised by) who will actually be your biggest investor, so the attention to a range of investors is important.
Rib-X Pharmaceuticals CEO, Mark Leuchtenberger sees the current issue as a matter of “value capture”, i.e. how and when value is being realized by investors. This in turn, he argues, has a lot more to do with externalities these days than it did in the past. If an election in Europe can scare off would be IPO buyers, then the issues we are facing are not just sector specific and CEOs need to be ready for anything at any time. Additionally, raising money when the story or product thesis is of high interest to investors may precede company milestones, so executives need to be flexible. For example, having compelling data for a cancer vaccine today is not the same as it was prior to Dendreon’s Provenge commercialization issues. Waiting for the right amount of data instead of acting when there is buy-in can be costly.
Todd Smith, Executive Vice President & Chief Commercial Officer of Horizon Pharma (HZNP) submits that companies need to do more than define corporate objectives and multiple pathways – they need to understand what it will take financially and structurally to meet those objectives. Furthermore, companies need to differentiate between development milestones and objectives that allow value to be realized. Horizon was in a unique situation for its 2011 IPO in that two product approvals were near term events and the IPO investors were quite focused on supporting these development milestones. Post-IPO, the two products were approved and those objectives were met. However, the full value for the company could not be realized unless the commercial side was built out further, thus more capital was needed. Subsequent offerings in the public market meant a dilution of existing shareholders.
Option 2 –Pharma to the Rescue?
Looking back at the 2009 acquisition of Targanta Therapeutics to The Medicines Company, Leuchtenberger says that prior to M&A discussions they had several financial plans in place so when the offer came they could quickly assess it and compare it with other options as these were already developed internally. Taking this approach is necessary these days, and has minimal downside impact when weighed against the upside. Purcell’s advice to management is to advise venture backers as to what options you are entertaining and not pull surprises. This saves the board, investors, and management time allowing for more efficient due diligence.
Will a big pharma deal help a company get the attention and valuation from investors? Purcell does not think they are as validating and important as in years past. There are many examples of pharma R&D partnerships leading to little realization of value, and plenty of examples of deal terminations due to portfolio restructuring. What is key more than ever, according to Purcell, is company management. This is because the asset and objectives, even those born from partnerships, will likely change but good management will navigate through the changes. Certainly, large pharma companies have a lot of experience and financial support to offer, but that has not lifted productivity. (A good argument for betting on management goes back to the beginning of biotech – Amgen management did not know if they would be making drugs or selling industrial enzymes when they went public in 1983, but management was able to adapt as data from research read through in subsequent years.)
It is hard to predict if and when a pharma alliance could turn into an acquisition. Balancing partnerships and other pharma relationships into something more requires careful attention. Even so, the reality is that the lines have blurred recently and the M&A route may not be as attractive. Acquisitions are not full exits anymore as the majority now contain substantial CVR components. Purcell argues that the pharma folks are not willing to pay as much up front at the same time that LPs are shortening their timelines. This has created a difficult environment for the venture community.
Option 3 – Back to Private Financing
What about the later round financings? Tim Trost, CFO of Chimerix, says there is a big dichotomy in board rooms as to whether to continue to find an exit or go back for another round of private financing. Some investors are constrained by external factors and are interested in the short term. On the other hand, being faced with yet another financing upon exit, as may be the case with assisting a portfolio company IPO, has made the decision more complex.
Rib-X filed an S-1 to go public, but now Leuchtenberger is stopping those plans and going back to private financing. These days, elections in Europe can dramatically impact what investors are willing to support in terms of IPO pricing. Going back to the private base may provide the capital to get to the value inflection point, which will strengthen the conviction of public investors. There are IPO windows and there are windows for certain biotech stories, and the timing of these can’t be underestimated. Had Leuchtenberger delayed the Targanta Therapeutics IPO in late 2007 by just weeks, they would not have made it public as they were the last biotech for almost 2 years to make it out.
Is the JOBS act support of crowdfunding going to help biotech? On one end, the panel agreed that opening up to more generalists and alternative funding sources is a positive. The power in numbers can add value, just as numerous angel investors have contributed to start-ups. However, the reality of biotech is that it is a specialist market place and investors would need to survive the giant ups and downs. Although it can have an impact for certain companies, it might be harder to see crowdfunding transforming the way the entire industry structures its early financing. For value realization, biotechs can require over $100M in financing to get to proof of concept. That is certainly not the case for developing a smartphone app, where crowdfunding could have a substantial impact.
The other place that private biotechs can turn to that has not been mentioned yet, is high net worth individual investors. They are not as limited by time constraints. As entrepreneurs and investors, they often understand when additional money is needed, albeit when the milestones and strategy are explained. Purcell said this route can be favorable to traditional LPs. His experience with one billionaire took less than a day to raise funds, whereas working with a big pension fund, and the gatekeeper consultants in between, took a year.
Everyone agrees that the pathway for company formation and continued financial support is in great flux. New models are being called for; some new financing vehicles, partnerships, policies, and asset centric models are being developed for the first time this year. A lot is riding on the success of these new models as longer term questions are looming for the future of biotech innovation.