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Public Exits and Virtual Biotechs - Dreams or Reality?

October 26, 2011
Here at the 10th Annual BIO Investor Forum, investors and CEOs are debating “all the options” for private companies. The first panel of the conference explored the backdoor entrance into public markets as chilly winds continue to blow through the latest IPO window. For the lunch plenary, panelists examined the option to go virtual and make capital efficiency a reality.

Reverse Mergers

It is no secret that the IPO market for biotechs has been tough. What is less known is that reverse mergers in biotech continue to gain momentum, with eight transactions in the last year alone, and 19 over the last few years. Alan Auerbach, President & CEO of Puma Biotechnology has been part of two of these transactions, the latest being Puma’s merger with Innovative Acquisitions. In his view, reverse mergers offer a cheap route to the public markets that can open a company up to investors seeking the increasingly popular PIPEs, or Private Investments in Public Equity. PIPEs have been rewarding for savvy, specialized investors over the last three years. When comparing reverse mergers to IPOs, Alan sees little difference after the first few weeks of going public as trading settles into a fundamental valuation range, accented by broader capital market forces. The real differences are found in the legal formalization of the shell on one side and gaining board consent and intent on the other. Jonathan MacQuitty, a Partner with Abingworth, notes that reverse mergers have a place in markets where most equity investors and underwriters are only willing to support high valuation, highly liquid companies.

Paul Hastings, CEO of the privately held OncoMed, adds that private companies need to have all options available so a move can be made when the time is right. For some companies, remaining private is the best option, for others it might be filing the S-1 or seeking the shell route. He added that for all options to be available we need to see regulatory certainty return to the sector. Only then will investors on both sides of the market widen their allocation to risk capital.

Marc Beer, CEO of the recent IPO company Aegerion (AEGR), argues that if venture investors and management view the IPO as a fundraising event, as opposed to a final exit point, more companies would be able to take advantage of the IPO option. Otherwise, companies risk taking the next financing round with just enough capital for the next milestone, and not the next three. The unpredictable nature of this business and the funding environment we are in, makes the step by step approach inefficient. Marc adds that public investment is out there if you have the right data. Fortunately for him, he has a late stage asset in a rare disease, essentially the hottest place to be in biotech these days.

One of the tough realities of the public market today is the myopic valuation models for development stage biotechs. Companies with a late stage asset are being valued on their lead program, with the rest of the pipeline valued at such a deep discount that it is essentially irrelevant. For a company with multiple early stage assets today, it makes the IPO or reverse merger prospect not as inviting as a deal from pharma that may offer a premium. The counter to that argument is all the CVR activity we are seeing today as the buyer’s market continues its trend.

The barriers to going public also include the stage of an asset and its perceived risk. We see this in the fact that most IPOs these days are late stage asset companies, as opposed to a decade ago when many IPOs were actually pre-IND. Those days are gone, but companies with earlier pipelines can knock down their risk by running careful designed studies addressing issues identified by regulators, investors, physicians and payers. Marc cited the example of Aegerion, where extensive communication with outside entities helped identify safety and regulatory hurdles. One by one they addressed these issues, cutting safety and regulatory risk through trial data such that investors were willing to accept the remaining risk in the program.

Virtual Companies

Start-up biotechs are also working on ways to appeal to investors in ways that bring costs well below traditional levels and bring exits years earler. Venture capitalists are turning to the capital efficient, virtual approach to drug development. In essence, the old biotech model of building a fully staffed company around IP and then seeking to bring a molecule through the clinic is morphing into building a molecule through the clinic first, then building the staff. With success rates so low in the industry, perhaps the industry had the cart before the horse when launching last decade’s start-ups.

The panel today exemplified this potential sea change for early stage biotech structures, with working examples illustrated in Versartis and Diartis Pharmaceuticals. Jeffrey Cleland, CEO of both companies, explains that each of these companies has just one drug, spun out from a parent innovator company. If the drug fails, the company fails, but there won’t be any layoffs. The reason is that the company is run by clinical and regulatory experts that oversee outsourced development. No human resource department, no cleaning crews, no bench scientists, no accounting department, no press team, no IR department, no bricks and mortar. Even the CEO, wearing many hats, will just rotate his focus to another portfolio company if one compound dies in the clinic.

The idea for most of these models is to advance the drug from IND to POC, then explore options for acquisition by larger pharma or biotech. David Collier, Managing Director at CMEA Capital explains that it is much harder to exit at POC today if the company burn rate is burdened by non-development expenditures. He believes the old model burn rates were 60-70% unrelated to a drug’s actual clinical development. The CEO’s salary and peripheral corporate staff salaries heavily weighed on this figure.  The new model is attractive to suitors as the excess fat has been trimmed and capital is laser-focused on execution. We are in a buyer’s market and the cost of clinical drug development is soaring, so anything that cut costs and adds value through data generation is where biotech start-ups need to be.

David Collier is also the CEO of Velocity Pharmaceutical Development. Velocity’s motto is “We build drugs, not companies.” The company seeks drugs that will make it to POC in ~3 years for just $15M, with no bias toward modality. The experience behind the three Chief Medical Officers that will oversee the external development is extensive and diverse, one of the essential ingredients to setting up such a virtual shop.

The panelists all agree that even a new model will not fix the industry’s productivity problems unless all attention is focused on the details of trial design and execution. The new model attempts to focus on the core clinical activity, much more so than traditional biotechs with many broad interests. Sanjay Shukla, CEO of RxMD knows this first hand, as his company has played “clinical trial quarterback” for many firms over the years. RxMD’s expertise is clinical trial design and execution for biotech clients. Their advantage is that not only are they deep in the trenches of running trials, they can also offer objective analysis of outcomes. This objectivity is key to killing drug programs after negative results. Without the objectivity, many management teams in biotech allow failing drugs to linger in development as they are wedded to the compounds they have discovered and fear how failure will affect their job stability.

Sanjay, Jeffrey, and David all agree that having trial design input from all constituents is critical to make the final package attractive to future acquiring entities. In addition to bringing regulators to the table at an early stage, key physicians and potential acquiring firms should be surveyed to establish all endpoints and comparator arms that might be needed to show ample evidence of efficacy, superiority, physician adoption, and reimbursement.

The biggest risk for start-ups today? Being successful with POC in man, yet finding no suitor. At this point a virtual company would have done all they set out to do, and faces closing down or switching gears to actually go beyond PII and into PIII, or even breaking the virtual model and actually creating a salesforce and fully integrated company. This would break from the original concept forcing management to spend a lot of their time seeking funding for the expensive inflection points and hiring staff.