H E A LT H C A R E

The Funding Landscape for Small Biopharma Ventures, 2010-2015
Trends, strategies and priorities By Gaurav Misra

Gaurav Misra
Gaurav Misra specializes in pharmaceutical licensing, valuations and opportunity assessments as strategy consultant for biopharmaceutical companies. He has participated in and led projects on revenue forecasting, product pricing, sales resource allocation and investment due diligence over an eight year career in the sector. Gaurav has an undergraduate degree in Chemistry and an MBA from the Richard Ivey School of Business, where he specialized in Healthcare & Life Sciences.

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Table of Contents
The funding landscape for small biopharma ventures, 2010-2015

Executive Summary
Macroeconomic trends and implications Accelerating biopharma collaboration Valuing investment opportunities in small biopharma Priorities and preferences of private investors Top-line trends in venture financing Investment choices of most active firms in 2009

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10 11 12 13 14 14

Chapter 1
Summary Introduction Recent events

Macroeconomic trends and implications

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18 19 19 20 21 23 25 26 29 30 31 33 34

Supply side factors- higher cost of capital Demand side factors- Decreased earnings potential Provider-level constraints Patient-level implications Short and long term implications Non-dilutive funding in an era of excessive dilution Research grants and government contracts Incentives of non-profit foundations Government incentives and associated initiatives Issues surrounding NDF from non-profit agencies

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Chapter 2 Summary Accelerating biopharma collaboration 38 38 39 43 44 47 49 50 50 51 52 52 Accelerating biopharma collaboration Rapidly evolving deal structures De-risking R&D via options-based investing Due diligence in biopharma alliances Marketing agreement Licensing arrangement/Product acquisition Joint venture Alliance/Corporate partnering Outright acquisition of a company Conclusions Chapter 3 Summary Valuing investment opportunities in small biopharma 54 54 55 55 56 57 57 58 60 61 62 65 Introduction Valuation methods and usage Discounted cash flow Risk-adjusted net present value Real options Comparables Assessing commercial potential Sales potential Pricing and positioning Cost of commercialization Chapter 4 Summary Introduction Stages of investment Priorities and preferences of private investors 68 68 69 69 72 72 73 74 74 Investors: definition. overview Distinction between private equity and venture capital funds Angel investors Venture capital funds Mezzanine investors iv .

Venture investors versus buyout investors Process of getting new investment Term sheets Type of security Board representation Valuation Capital expenditure Single versus multiple investors Investor priorities in the new landscape Market attractiveness and product-market-focus The organization Financials Business plan Assessment of risks Intellectual property protection 75 77 78 79 80 82 83 84 85 86 87 87 88 88 89 Chapter 5 Summary Top-line trends in venture financing 92 92 93 94 94 94 94 95 95 95 96 96 96 96 97 98 99 100 101 103 105 How to use this chapter Definition of key terms Venture financing Seed Start-up Early stage Growth/expansion capital Later stage Mezzanine Bridge loan Private placement Other Countries attracting the most venture financing Recent trends Conclusions Distribution of venture financing rounds by investment stage Recent trends Further analysis of financing rounds by stage Conclusions v .

2009 Assessing the net earnings potential of a medical intervention Assessing revenue potential Pricing and positioning 22 24 28 32 39 41 42 44 46 47 48 59 60 61 63 vi .6: Figure 2. Denmark Independent venture capital funds SV Life Sciences Investment focus in 2009 Texas Coalition for Capital Chapter 7 Index Appendix 129 129 132 Research methodology List of Figures Figure 1.Chapter 6 Summary Investment choices of most active firms in 2009 108 108 109 110 110 113 114 115 116 116 117 119 121 125 125 125 127 Most active venture capital investors in 2009 Analysis of investment preferences Therapeutic areas of focus Investment destinations by geography Stage of investments Two types of venture investors Corporate Venture Capital (CVC) funds Emerging role of CVC in Life Sciences Strategic motivations Novartis Venture Fund Novo A/S.14: Figure 3.5: Figure 2.2: Figure 1.10: Figure 2.1: Figure 1.7: Figure 2. 2008 Market share of generic medicines in Europe.8: Figure 2.11: Figure 3.3: Figure 1.12: Figure 3. 2007 (by volume) IPOs have recently reappeared at a low level Grant-making focus of Bill & Melinda Gates Foundation How biotech entrepreneurs hope to deal with the financial crisis Reliance of big pharma on R&D externalization Trends in biotech-pharma deals by development stage Overview of partnering issues Option agreements by top 20 pharma companies (≤Phase I) Reliance on the option model varies by company Deal structures and responsibilities Primary valuation methodology by investor type.9: Figure 2.4: Figure 2.15: Components of government healthcare expenditure in US.13: Figure 3.

2009 Preferences of top 15 venture finance investors.5: Table 6.2: Table 2.29: Figure 5.6: Table 6.20: Figure 4.39: Figure 6.27: Figure 5.17: Figure 4. 2009 30 43 50 56 70 109 110 vii .25: Figure 5.28: Figure 5.19: Figure 4.30: Figure 6. 2004-2010 Distribution of financing rounds by stage.33: Figure 6.40: Impact of incoming therapies on payor budgets Development and commercialization costs Company growth stages and funding sources The deal “funnel” at a typical VC firm Sequence of documents Board size: advantages and limitations Geographic distribution of venture financing rounds Trends in geographic distribution of venture financing rounds US investments by region. 2009 R&D performance scorecard Novartis Venture Fund investments in 2009 Novo A/S ownership structure Novo A/S investments.24: Figure 5. 2000-2008 Novo A/S investments in 2009 SV Life Sciences investments in 2009 Texas Coalition for Capital investments in 2009 64 65 71 77 78 81 97 98 99 100 101 102 103 104 105 111 113 114 118 120 122 123 124 126 128 List of Tables Table 1.1: Table 2.4: Table 4.23: Figure 5. 2004-2010 Trends in financing rounds by stage. 2004-2010 Preferences of top 15 venture finance investors.32: Figure 6.26: Figure 5.31: Figure 6.35: Figure 6.34: Figure 6.Figure 3. 2008-2009 Total number of financing rounds by stage. 2009 Number of deals by investment stage.18: Figure 4.37: Figure 6. 2004-2010 Late-stage funding by type.22: Figure 5.3: Table 3.7: Non-dilutive sources of funding Established and evolving deal structures Incentives in a strategic licensing arrangement Overview of valuation methods Stages of equity investing Most active venture investors in 2009 R&D focus of top 15 venture investors. 2004-2010 Mid-stage funding by type.21: Figure 5.38: Figure 6.16: Figure 3. 2004-2019 Early-stage funding by type.36: Figure 6.

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Executive Summary 9 .

As government funds are locked up in bailing out national banks and averting a recession. By contrast. and new biomedical therapies cannot expect high levels of market access at premium prices unless they fundamentally improve the standard of care. an ageing population demands ever increasing healthcare spending. private equity funds and public markets seem wary of the life sciences sector and have been liquidating the positions they had taken in the boom years.Executive Summary Macroeconomic trends and implications The higher cost of raising capital has increased the hurdle rates of healthcare investors across the world. This has fundamentally altered the willingness of society to pay premium prices for drugs that provide marginal improvement over cheaper alternatives. 10 .hedge funds. The largest components of healthcare spending like physician salaries and hospital care are relatively difficult to control and require long-term initiatives. prescription drugs are a smaller component of total healthcare expenditure but offer more immediate opportunities for spending cuts. Small-mid cap biopharmaceutical companies are struggling to offer the risk profile and cash flows needed by investors in today’s recessive economic climate. Growth in healthcare costs in developed countries will continue to outpace GDP growth due to demographic trends and increasingly unhealthy lifestyles. Healthcare payors have become extremely price-sensitive in their quest to manage increasing healthcare needs. This is primarily because of the large number of expensive drugs facing patent expiry over the next five years. fundamentally reducing their capacity to invest in risky drug development assets. In particular.

large drug manufacturers are likely to become the primary source of funding for small-mid cap biopharma via a variety of established arrangements such a licensing/ marketing agreements. The few remaining investors are offering terms that are very dilutive for the original owners. Such a situation has improved the bargaining of big pharma companies. The intricacies and tiered structures of partnerships between these small and large companies have evolved rapidly over the past five years. disaggregated units working on exploratory ideas. particularly between large pharmaceutical companies and smaller biotechnology companies. Big pharma’s drive to externalize early stage R&D stems from this realization. So has the fluidity with which one type of transaction changes into another via an options-based deal structure. In the absence of public market participation and with a much reduced private equity investment pool. and they are best positioned to understand the risks associated with early stage drug discovery.Thus not only have investors become more selective about risky biopharma investments. jointventures or M&A. the earnings projections of the assets they have already invested in have had to be scaled back. co-development. The risks of drug development can be better mitigated by having smaller. Accelerating biopharma collaboration An increased focus on collaboration between large and small stakeholders of the biopharma value chain will be among the most important consequence of the financial crisis. 11 . Small biotech companies are struggling to maintain working capital reserves as private equity investments have been scaled back and the IPO is no longer a feasible source of funds.

Almost every start-up has already conceded some level of ownership to VCs that provided their earliest funding, and hence option alliances that often represent nondilutive financing offer an attractive alternative to traditional equity investments.

Valuing investment opportunities in small biopharma
This chapter deals with the process of assessing the commercial viability of an R&D asset. The ‘asset’ in question can be a particular project within a biopharma company, a related portfolio of projects, or the entire company itself. All valuations are based on a set of projections such as revenues, costs, profits and cash flows. Even though valuation techniques differ in the way they evaluate the cost of capital and risk, the concept of free cash flows and earnings potential are applicable across the all methodologies. Choosing a valuation method or discount rate is a hot topic when making financial valuations and has been the subject of much theorizing. Business development and M&A teams in large pharmaceutical companies tend to rely on methods such as DCF and risk-adjusted NPV. Venture capitalists and private equity firms prefer estimating enterprise value by comparing it to what other investors are willing to pay for similar opportunities. Deals based on an options-based valuation structure are better able to offer fairvalue to both parties because financial and strategic commitment can be deferred to the point in time when new information becomes available. The pricing-positioning trade-off has become a critical component of the due diligence involved in assessing the commercial potential of a medical intervention. The impact of a certain pricing-positioning strategy on the budgetary dynamics of healthcare providers is now a key input in forecasting the real-world uptake of the product/ technology asset.

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Priorities and preferences of private investors
In the context of this chapter, all firms investing in non-publicly traded equity are classified as private equity investors. These include angel investors, venture capitalists, private equity funds, mezzanine funds, funds-of-funds, and others. Although each operates along different stages of a company’s lifecycle, traditional operating niches have been greatly stretched as the -funding model evolves to keep pace with the changing landscape. Private equity firms are willing to consider earlier stage companies and VC firms are willing to lower yield requirements in securing later stage opportunities. Unlike earlier years, the term sheets for biotech funding are no longer investor friendly, and include multiple clauses that limit the risks to the investor. With less venture funding available, small biopharma companies have to sacrifice more to raise funds. To maximize the chances of raising funds, the seller must anticipate the preferred exit strategy of the target investor and build the valuation with this end in mind. Biotechs that require high levels of capital expenditure are out of favor with private equity investors, who prefer to invest in leaner organizations with a greater ability to adapt to changing priorities. Even venture funds are wary of investing in companies that have committed large resources towards fixed assets that may or may not be required as their R&D strategy evolves. There is a limit to the extent of managerial/strategic input that investors can provide, hence communicating a sound business plan goes a long way in reassuring investors of the safety of their capital. The entrepreneur must make it easy for the investor to assess the people behind the business, specifically in terms of their ability to prudently manage an organization with a high burn rate. Since many aspects of the job are intangible, the seller must think of ways to communicate their ability.

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Top-line trends in venture financing
US companies attract the most venture financing, followed by companies in mainstream European countries like the UK, Germany, France, Italy and Spain. The financial crisis has not changed the geographic distribution of venture financing in any discernable manner. The US and Canada will continue to remain the hubs of biopharma innovation in the next five years. Certain states within the US are clearly the hotbeds of private equity investment in the biopharma sector. Among the top 10 regions, the ‘triangle’ comprising the areas of Boston, New York and New Jersey is clearly the leader, followed by parts of California. In terms of stage of investment, the number of deals involving drugs in Ph II and Ph III trials has increased substantially. Based on the number of venture rounds financed since 2004, late-stage financing rounds constituted 2% of the total between 2004 and 2006. In the following three-year period (2007 to 2009), this number has increased to 14%. Existing investors are reinvesting in assets they have already committed funds to because newer investors are demanding excessively dilutive investment structures that do not favor the existing owners. Private equity investors will prefer to invest in companies with late-stage clinical assets over companies with early stage assets in the next five years.

Investment choices of most active firms in 2009
The MedTRACK Venture Finance database was used to identify the investors that participated in the maximum number of financing rounds in 2009. The investments of these top investors were segmented on the basis of their therapeutic area of focus, industry segment, stage of investment and investment destination.

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Over 50% of total financing by value and over 50% of the rounds of financing fall under these three categories.6% share in terms of investment value. many CVCs are set up as evergreen funds that aim to combine financial motivations with the overarching strategic motivations of their parent organizations. European firms invest in a greater range of countries. Corporate Venture Capital arms of large pharmaceutical companies are becoming increasingly active and visible members of the VC community. This highlights the fact that clinical development of oncology products involves large scale and expensive clinical trials. Deals in Europe tend to be fewer in number but greater in scope of financing. A large proportion of companies that successfully raised VC funding in 2009 have a focus on biotechnology-based approaches to medicine. This reflects their local investment mandates and the greater ease of dealing with companies located close by. Unlike traditional VCs. oncology therapies and medical devices. 9. Nearly a fifth of all money invested was targeted at oncology therapies.Most of the top 15 investors are from the US and hence invest primarily in USbased companies. but oncology’s share in terms of number of deals is comparatively lower (<10%). which commanded a 12. not only within Europe but in other Asian and North American destinations.2% of financing rounds were in companies located in Europe. 15 .

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CHAPTER 1 Macroeconomic trends and implications 17 .

and new biomedical therapies cannot expect high levels of market access at premium prices unless they fundamentally improve the standard of care. an ageing population demands ever increasing healthcare spending. Healthcare payors have become extremely price-sensitive in their quest to manage increasing healthcare needs. Thus not only have investors become more selective about risky biopharma investments. private equity funds and public markets seem wary of the life sciences sector and have been liquidating the positions they had taken in the boom years. Growth in healthcare costs in developed countries will continue to outpace GDP growth due to demographic trends and increasingly unhealthy lifestyles.hedge funds. This has fundamentally altered the willingness of society to pay premium prices for drugs that provide marginal improvement over cheaper alternatives. the earnings projections of the assets they have already invested in have had to be scaled back. This is primarily because of the large number of expensive drugs facing patent expiry over the next five years. In particular. Small-mid cap biopharmaceutical companies are struggling to offer the risk profile and cash flows needed by investors in today’s recessive economic climate. The largest components of healthcare spending like physician salaries and hospital care are relatively difficult to control and require long-term initiatives.Chapter 1 Macroeconomic trends and implications Summary The higher cost of raising capital has increased the hurdle rates of healthcare investors across the world. As government funds are locked up in bailing out national banks and averting a recession. By contrast. prescription drugs are a smaller component of total healthcare expenditure but offer more immediate opportunities for spending cuts. 18 . fundamentally reducing their capacity to invest in risky drug development assets.

Their financial positions were severely damaged when the mortgage market collapsed forcing them to stop investing in the biotechnology sector and liquidate their positions. Simultaneously. All of a sudden. Until as late as 2008. Investment decisions are driven by supply-side factors such as the cost and availability of capital. growth in healthcare-related expenditures is fast outpacing GDP growth for most developed countries. The cost of raising money from public and private markets was artificially held down at unrealistic levels. Investors came to expect a level of economic growth that was inherently unsustainable. highly leveraged investors such as hedge funds and investment banks were a key source of capital for the small-mid cap biopharma sector. which ultimately led to the collapse of mortgage backed securities.Introduction This chapter recaps the macroeconomic trends shaping the funding environment and discusses their implications over the next five years.a trend that is certain to gather momentum in the next decade. and is unlikely to return in the near future. Recent events Aggressive risk taking by highly leveraged financial institutions led to the financial crisis we have today. These two macroeconomic trends collectively dictate the constraints within which biopharmaceutical companies seek to attract investment over the next five years. 19 . and demand-side factors like economic growth and earnings potential. The financial crisis has raised the cost of capital for investors and made them more selective about the type of companies they invest in. a sizeable component of the total money going into the small-mid cap biopharma sector was withdrawn.

the creditworthiness of borrowers.higher cost of capital Most of the money invested in small-mid cap biopharma companies is financed via traditional private equity investors and big biopharmaceutical firms. This time around. The very definition of ‘normal’ will have to evolve and this will be neither quick nor easy.Once the reasons behind the financial crisis unraveled. Thus the global financial crisis has fundamentally altered the market landscape for small-mid cap biopharma companies. The big pharma companies usually provide such investment via licensing arrangements. the larger pharmaceutical companies. private equity investors rely on highly leveraged capital raised from institutions like pension funds and insurance companies. Market conditions are far from what was considered normal and this is not going to change anytime soon. royalty monetization. they have a fundamentally diminished capacity to invest. private equity investors are not just disenchanted with the high risk and long lead times in drug development. But this is not another down cycle of investor sentiment that the industry can wait out. Supply side factors. with their AAA credit ratings and stable cash flows are among the least affected stakeholders. the sophistication of investors and the distribution of credit risk were widely questioned. Although the cost of raising capital has increased for all parties. By contrast. joint-ventures or outright M&A. The reaction has lead to a liquidity crisis in which companies across all sectors (not just biopharmaceuticals) have struggled to raise capital at what they consider acceptable rates. This group is more able to fund such transactions from their internal cash reserves. Their cost of raising capital has gone up to level at which smaller biopharma companies are no longer able to offer 20 .

Decreased earnings potential The fundamental drivers of growth for biopharmaceutical companies are relatively independent of the wider economy. Other industries offer much shorter lead times.a viable investment opportunity. They also have greater freedom to branch out into unrelated industries. A renewed focus on positive cash-flow generating businesses. Demand side factors. Epidemiological trends that stem from an ageing population and disease prevalence are not influenced by economic conditions. even if the eventual cash generation is smaller in its scope. some well-known historical reasons for the dearth of private equity capital for small-mid biopharma companies include: Long lead times between identification of promising compounds and ultimate regulatory approval/ market launch. the performance expectations of private investors have risen sharply in the past three years. Aside from the higher cost of capital. However. This implies that the demand for healthcare will continue to grow over time and remain relatively inelastic over time. tougher economic conditions directly impact the willingness of society to pay for expensive therapies. Private investors are not as well positioned as mature pharma companies to understand the inherent development risks of immature biotechnology companies. which can be as long as 8-10 years. This makes potential investors wary of investing in good ideas that may never be approved at a commercially viable level. High levels of project attrition at the research and development stage. and hence influence the 21 . A decline in the number of therapies approved for broadly defined patient populations by the FDA and other mainstream regulators. therefore a shift away from companies that do not have significant marketed drugs. In effect.

2008 800 700 600 $ 731 $ 718 US$ billion 500 400 300 200 100 0 10% of total expenditure was on Rx drugs $ 234 $ 160 $ 138 $ 114 $ 69 $ 66 $ 65 $ 44 Prof essional services Prescription drugs Public health activities Medical products Administration Hospital care Nursing homes Home care Source: Centers for Medicare and Medicaid Services. Increased healthcare spending was already a critical area of concern for policymakers and regulators long before the credit crisis. The largest components of healthcare spending such as physician salaries and hospital care offer limited scope for spending cuts. The non-availability of finances has only served to exacerbate budgetary pressures. 22 Research investments Other investments . Nat’l Health Statistics Business Insights Ltd The demand for cuts in healthcare spending will increase as the gap between growth in healthcare spending and GDP widens. This is because they involve public health worker’s wage expectations in an inflationary macroeconomic environment.1: Components of government healthcare expenditure in US. which restricts the room to maneuver within overall healthcare budgets.commercial potential of upcoming biopharmaceutical drugs. It is a question of inelastic demand versus inelastic budgets. Short-term cuts can only be made in certain areas. Figure 1.

As a direct consequence.1). Healthcare providers control reimbursement policies for biopharmaceutical therapies. and the manner in which the drug influences the economics of healthcare provision. hospitals. Some of these are recapped below. the impending patent cliffs in the biopharmaceutical sector have drawn the world’s attention to the cost containment opportunity they present. Increasing demand for ‘proof of added value’. specific “schemes” within larger government bodies. As the entities that ‘pay’ for biopharmaceutical therapies on behalf of patients. Regardless of the market. depending on the nature and extent of cost containment measures used by healthcare providers. Although expenditure on prescription drugs only constitutes a relatively small component of overall healthcare costs (Figure 1. etc. it is more visible to the public eye. healthcare providers across the world are using similar strategies to lower the costs of healthcare delivery. the economic component has become as important in the 23 . This is perhaps the most important factor in assessing the commercial potential of biopharmaceutical companies. it will encounter few obstacles in being accepted within the treatment paradigm by healthcare providers. While a superior clinical profile may have been sufficient for a drug to be competitively successful in the past. The pressure on drug revenues will vary by market. If a drug provides a clear medical benefit over incumbent competitors and also lowers the cost of treatment. Provider-level constraints In the context of this chapter. Added value has two components. and manage the costs in a manner most suitable to their needs. Examples include health plans sponsored by insurance schemes.In such an environment. government sponsored institutions like the NHS. biopharmaceutical therapies are always one of the first items under scrutiny when there are discussions on healthcare cost control. the clinical unmet need fulfilled by the drug. They are also under enormous pressure to lower healthcare delivery costs. “providers” or “payors” include all health plans that have the responsibility to provide healthcare services to a population under their purview. their importance as stakeholders in the healthcare value chain has risen tremendously over the past five years.

Increased generic usage.current/ future context. Figure 1. such as prescription guidelines. In many of the key markets for biopharmaceuticals. drug-substitution at the pharmacist level.2: Market share of generic medicines in Europe. regulators in these countries are expected to replicate tried and tested means of increasing generic usage.2 below shows how nearly half the markets in Europe still use less than 20% generics in terms of volume of drugs consumed. leading to more restrictive reimbursement policies for new products. Other markets have put in place specific policies to encourage generic usage. There will definitely be greater use of recommendations by bodies such as NICE (National Institute of Health and Clinical Excellence) in the UK. electronic prescribing systems. 2007 (by volume) 80% 60% 40% 20% 0% Spain Germany Netherlands Denmark Belgium Austria France Portugal Sweden Italy UK Source: EGA Market Review. To reduce healthcare spending. usage of generic drugs is still low. and these recommendations will be carefully studied by payors in other countries as well. and incentives/ disincentives for pharmacists and physicians. Figure 1. 2007 Business Insights Ltd 24 .

it is obvious that cost-containment policies will take centre-stage. it is extremely difficult to forecast the consequences on the earnings power of new biopharma therapies seeking to launch in the US market. even as demand increases. In the meantime. or even 2030. bulk purchasing. This is a direct addition to what was already the world’s largest and most lucrative patient pool for biopharma companies. consumer spending is a key component of biopharmaceutical earnings projections. The willingness of governments and purchasers to pay premium prices for new drugs has clearly decreased over the past two years. In spite of the uncertainty. creative deals that are based on specific budgetary and clinical goals will become the norm over the next five years and beyond. On the plus side. Patient-level implications The impact of the recession is also felt at the patient level. Even though most healthcare costs are covered by government schemes such as the NHS in six of the seven major markets. Examples include volume based discounts. Policy changes in the US. New.Measurable health outcomes and changes in pharmaceutical purchasing. the ability to fund such medical expenses is severely restricted and this deficit will continue to increase in the coming years. the removal of the Medicare non-negotiation clause in Medicare Part D could decrease revenues of biopharmaceutical drugs by between $10bn and $30bn annually. This is especially for the case for the more ‘discretionary’ elements of pharmaceutical/ healthcare spending. measurable health outcomes. Now that the landmark healthcare bill has been signed into a law in the US. However. there will be wide-ranging implications for biopharmaceutical companies. As an example. 25 . The inherent strategy underlying the law is that savings will eventually cover the deficit. the new law will eventually extend health insurance cover to about 32 million Americans. but this is not likely to happen before 2020. greater demand for rebates in the tendering process and reimbursement based achievement on short-term. such as cosmetic-related therapies and surgery.

Inflationary pressures and decreased spending power will alter these projections. The biggest pharmaceutical companies have tremendous cash reserves and starved pipelines. and focus on relatively unorthodox/ less used means to secure funding. This figure can be contrasted with 95% for a typical financial institution. mid-sized and large companies. Such predictions were built into the revenue projections of analysts. The need of the hour is to effectively utilize the asymmetric access to capital by stakeholders in the biopharma spectrum. It is estimated that that the average net debt as a percentage of capital employed for the top 20 pharmaceutical companies is as low as 6%i. 2008 26 . only people in the highest income brackets (‘rich’ and the ‘super-rich’) contributed anything substantial to the earnings of branded drugs in these markets. The recent wave of mergers and acquisitions among big pharma companies is evidence of the opportunities they possess in these times of contrasting fortunes. While the cost-of-capital has gone up for everyone. Short and long term implications The impact of the financial crisis has been asymmetrical across the spectrum of biopharmaceutical companies. emerging markets have started to become a key component of biopharma revenue projections. The government plays a relatively smaller role in healthcare provision in such markets and 60-70% of the value of drug spending comes from out-of-pocket expenses. Small biotechnology companies i Boston Consulting Group. Historically. Large. mature big pharma companies are relatively underleveraged. the reliance on external capital varies tremendously between small.Aside from the major markets and other developed countries. This was widely expected to change as the ‘mass-affluent’ segments of these societies became increasingly willing to pay premium prices. leading to a decrease in revenue potential.

‘pharmaceutical company’ and ‘biotechnology company’ are no longer particularly relevant in today’s market environment because a biotechnology-based approach is a critical component of the pharmaceutical industry at multiple dimensions. cash rich pharmaceutical companies. This highlights the fact that the relationship between biotechnology and pharma companies is co-evolutionary in nature. Public offerings will not be the primary exit strategy for life sciences investors. The very terms. In the long term such strategic partnerships will not only increase in number but evolve into better and more creative collaborations that tackle the specific incentives of the two parties. the most likely exit 27 .3 below illustrates the sharp drop in IPO activity over the past two years. This situation has already improved the bargaining position of the large.are starved for cash but have promising pipelines. Instead. Figure 1. In the medium-to-long term. which have capitalized on the opportunity in various different ways: Acquiring small R&D-centric biopharma companies to plug gaps in their pipeline portfolios In-licensing compounds/ platforms via deals and alliances Out-licensing non-core R&D assets Leveraging corporate venture funds to scope out early stage/ potential product opportunities The Initial Public Offering (IPO) route as an exit strategy for investors is currently unrealistic and will continue to remain so in the next five years. The real long-term effect of the credit crisis will be to accelerate this mutual evolution. This asymmetry has been recognized and capitalized upon by both parties even before the credit crunch. the ability of the private equity community to finance risky biopharma ventures will remain diminished due to which a large proportion of small-mid cap biopharma companies will find it harder to raise capital. nor will they be a realistic source of funds for entrepreneurs in the foreseeable future.

Companies that wish to avoid a big-pharma alliance or those that are yet to reach the crucial milestone when their value is best perceived will have to find a way to keep working capital coming in. VCs are tailoring their funding and development plans accordingly. Industry analysts have already advised investors to stay away from biotech companies in urgent need of capital. Such a trend is already apparent in the investment preferences of Venture Capitalists who have been proactively approaching big pharma and big biotech firms to understand the type of assets they might want to buy.strategy promises to be collaborations/ deals with the big pharmaceutical firms. Although costly. bank loans and some form of royalty monetization. Armed with such information. an increase in such alliances is already apparent and will remain so in the next 12-24 months. There appear to be three types of alternative: The first includes expensive short-term financing approaches such as venture debt. 28 . Figure 1.3: IPOs have recently reappeared at a low level 35 30 30 Number of IPOs 25 20 15 10 5 0 2007 * Year-to-date Source: MedTRACK Business Insights Ltd 2008 2009 2010* 2 3 1 In the short-term. small-cap biopharma companies will continue to find it difficult to raise funds.

Such moves can increase the overall enterprise value and reduce the short- 29 . with limited financial resources. Within these two categories. the necessity of experimentation is clearly perceived from the bench to boardroom by entrepreneurs and investors alike. will need to conserve cash by closing/delaying a large part of their pipeline. Other biotech companies. In the post credit-crisis era. the equity interests of pre-deal shareholders are progressively diluted. The third category constitutes sale to traditional private investors (specifically those not affiliated to the big pharmaceutical companies). To reach their optimal value inflection point. In each successive round. Non-dilutive funding in an era of excessive dilution A biotech company has to pass several fund raising rounds before it can launch a drug and generate revenues. a wide variety of creative strategies are being adopted and the next 1224 months will reveal which of these are the most successful. Biotech companies having to raise capital via such private channels in the next 12 months will either be forced do so at the expense of shareholder value. partnerships with academia or mergers with similar biopharma companies. or will not be able to raise capital at all. Consequently.The second includes the relatively (if not entirely) non-dilutive sources of funding such as research grants via foundations and government bodies. existing investors have to give up more of their ownership to raise the same amount of funds and feel that the new investors have excessively diluted their positions. Even in the short term. A large number of biotech companies are already adopting such strategies and others will follow suit in the months to come. start-up biotechs have to make many risk diversifying moves such as raising enterprise costs or delaying advancement of a program. such dilution has reached enormous proportions with new investors being more cautious and attributing a lower value to the asset than existing shareholders and entrepreneurs.

A research grant is a sum of money used to fund a specific project or purpose. This may create tension with the company’s existing VCs.to cater to their internal healthcare needs and also to develop an internationally competitive industry. The foundation funds work that meets specific grant-making priorities and supports the foundation’s guiding principles. They may be the 30 . Many such non-dilutive sources are discussed in the following chapter on collaboration between small and large biopharma companies. Biopharma ventures with research mandates that connect with the social incentives of governments and non-profit foundations may be able to raise funds (directly or indirectly) by tapping into the research grants and government contracts. secondary sources Business Insights Ltd Research grants and government contracts The government and society as a whole is acutely aware of the looming healthcare crisis we see today. Most such grants come from non-profit organizations committed towards a specific disease area or healthcare initiative. who do not like to see shares devalued. Table 1. This section focuses on government assistance and grants from disease-area foundations. At a broad level governments are keen to encourage skills and infrastructure development in the life sciences sector.1: Non-dilutive sources of funding Investment vehicle Debt Venture debt Convertible debt Royalty monetization Licensing Dilution No No No No No Tax No No No Yes Yes Transaction Costs High Hidden fees High Low Low Capital costs Low Medium Medium Medium Varies Source: author’s analysis. Thus R&D-based biopharma ventures seek to blend traditional VC funding with nondilutive financing—money from third parties that can be obtained without giving up stock.term price of the company’s shares.

The Bill and Melinda Gates foundation is another important foundation that funds research in various disease areas including: Diarrhea and Enteric Diseases HIV/AIDS 31 . Its grants are designed to find innovative ways to develop new drugs. which is among the most-high-profile therapeutic areas. UNDP. novel approaches to treatment or on the unmet needs not served by the large biopharmaceutical manufacturers. Other foundations have funding initiatives that marry a medical and social motive. they are judged on the basis of the unmet needs they are able to serve within a healthcare niche. WHO and World Bank) funds specific projects in diseases of poverty. which cover infectious diseases and the culture and environment that contribute to these problems. the American Heart Association (AHA) represents patients suffering from cardiovascular ailments in the US. For example. As such. Although each disease area is likely to have its representative foundations. Hence the scale of their funding activities will be proportionately higher than that of foundations representing an orphan or ultra-orphan disease. government initiatives or a combination of the two. Their emphasis varies by therapy area but always focuses on either break-though. barriers to the insects and worms that carry the parasites. TDR (supported by UNICEF. For example. Incentives of non-profit foundations Disease area foundations have the goal of finding therapies that solve the problems of the patients they support. diagnostics and other tools against infectious diseases in developing countries. the funds available to such foundations vary enormously.philanthropic efforts of wealthy individuals or corporations.

Malaria Maternal.4: Grant-making focus of Bill & Melinda Gates Foundation The foundation begins by asking: What affects the most people? They look for projects that: Produce measurable results What has been neglected? Use preventive approaches Where can we make the greatest change? Promise significant and long-lasting change How can we harness innovative solutions and technologies? How can we work in partnership with experts. Figure 1. governments. Newborn. & Child Health Neglected Diseases Nutrition Pneumonia & Flu Polio Tuberculosis Vaccine-Preventable Diseases Its grant making focus is outlined in the figure below. and businesses? Leverage support from other sources Accelerate work the foundation already supports Source: Bill & Melinda Gates Foundation Business Insights Ltd 32 .

Government incentives and associated initiatives Government also supports early-stage research for areas with significant unmet need. clean-tech and academic research. The program is largely a grants program disguised as a tax credit which covers up to half of the R&D expense for qualifying projects and is targeted at vulnerable young businesses with fewer than 250 employees. It is a US$73. It involves a tax credit worth up to $5 million per company and totaling $1 billion overall. Such nascent companies do not earn a profit in their early years and owe no taxes. and high-risk biopharmaceutical companies. Paris. Earlier in 2009 the Kurma Biofund was launched as a joint partnership between the public financing body Caisse des Depots et Consignations (CDC) Enterprises and venture capital group Natexis Private Equity.a provision to aid small companies doing R&D in biotechnology. so the program allows those firms to convert the credits into grants. epidemics. Anxious investors in the private and public markets have shifted money to low-risk investments.9 billion flowing into the life sciences.7 billion economic stimulus package to fund French industry and infrastructure. Most countries also have various initiatives to fund research in the life sciences sector. It is the biggest government-driven plan to benefit the biotech sector in the country. etc. the national ‘Grand Emprunt’ (Big Loan) was launched in 2010. especially those engaged in early-stage development have been left scrambling for cash. In France. As part of health-care law signed by the US senate is the Therapeutic Discovery Project Program. many of which have gained impetus in the past year as the full extent of private equity withdrawal from the life sciences sector has become apparent. biotech. It is open to newly-created biotech companies spinning off European academic centers. threats related to bioterrorism. 33 . They do this via many initiatives. with at least US$7. That the national CDC deposit fund is part of these financial investment instruments demonstrates the French government’s resolve to push biotech onto its agenda.

Issues typically audited include time-based activity reporting. quotes from sub-contractors. Expensive to apply: Preparation of proposals for grant applications is time consuming and expensive. often taking up senior management time. Start-ups can also apply for several grants in each cycle. Such support also externally validates the unmet need of the clinical goals and also validates the rigor of the scientific approach and caliber of individuals responsible for the program. specific work plans. Support infrastructure: If successful. there are many takers and not enough grants. IP reporting and submission of periodical technical reports. it is not easy to abandon the program and reorient the clinical strategy. and provision of abundant data in a non-confidential setting. So even after months have gone into the preparation of an application. there is no guarantee that the effort will yield results. Once a grant has been awarded. Preparation of an application may take months. the negotiations on the ‘statement of work’ and funding amounts can also take many months. 34 . It requires detailed budgets. as does the selection of winning applications by the foundation or charity. Loss of focus: The mandate a start-up has to adhere to on winning a grant must tally closely with other commercial projects so that focus is not diluted and resources spread too thin. While such help is invaluable to early-stage R&D. Time and availability: However the process of applying for and receiving funding takes a lot of time. equal opportunity employment reporting. Once accepted.Issues surrounding NDF from non-profit agencies Best thing about grants and government contracts is the money raised is non-dilutive. Hence a long term view needs to be maintained. a good deal of support infrastructure is needed to manage the administrative needs of auditing and communication with the granting agency. it does not require the company to issue more stock.

Clauses related to IP also need to be checked carefully.Conflict of interest: There may be conflicts of interest between the mandate of the non-profit granting agency and those of VCs/ for-profit investors who have a stake in the company. the non-dilutive nature often compensates for this. ownership of the assets in developing countries and approvals over potential acquisition candidates. Lack of commercial expertise: Unlike VC funding. and the extra credibility gained makes VCs more receptive about investing in unrelated for-profit programs that the company may pursue. there is greater need to study the implications of the granting agency’s preferences related to eventual commercialization. non-dilutive financing via grants and contracts does not bring in business expertise and networks that a traditional forprofit investor can bring. leaving the developer free to pursue other commercial applications for the IP. they will usually want to retain a license for any eventual IP in their area of interest. The entrepreneur needs to assess the ‘hooks’ in agreements like diligence requirements. In cases where the grant was made by a government agency. In other cases. 35 . However.

36 .

CHAPTER 2

Accelerating biopharma collaboration

37

Chapter 2

Accelerating biopharma collaboration

Summary
An increased focus on collaboration between large and small stakeholders of the biopharma value chain, particularly large pharma companies and smaller biotech companies will be among the most important consequence of the financial crisis, The risks of drug development can be better mitigated by having smaller, disaggregated units working on exploratory ideas. Big pharma’s drive to externalize early stage R&D stems from this realization, and they are best positioned to understand the risks associated with early stage drug discovery. Small biotech companies are struggling to maintain working capital reserves as private equity investments have been scaled back and the IPO is no longer a feasible source of funds. The few remaining investors are offering terms that are very dilutive for the original owners. Such a situation has improved the bargaining of big pharma companies. In the absence of public market participation and with a much reduced private equity investment pool, large drug manufacturers are likely to become the primary source of funding for small-mid cap biopharma via a variety of established arrangements such a licensing/ marketing agreements, codevelopment, joint-ventures or M&A. The tiered structures of partnerships between these small and large companies have evolved rapidly over the past five years. So has the fluidity with which one type of transaction changes into another via an options-based deal structure. Almost every start-up has conceded some level of ownership to VCs that provided their earliest funding, and option alliances that often represent nondilutive financing offer an attractive alternative to traditional equity investments. To best communicate their value propositions, entrepreneurs need to familiarize themselves with the due diligence process followed by the licensing, business development and M&A teams at big pharma corporations.

38

Accelerating biopharma collaboration
For the biopharma industry as a whole, the most important consequence of the financial crisis will be to accelerate the cooperation between large and small stakeholders along the industry’s value chain. This means an effort to find creative deal structures that align the incentives of small and large biopharma companies, CROs and academic institutions. From a big pharma perspective, impending patent cliffs over the next five years have forced them to initiate or import innovation of all types. Thus drug discovery externalization was already an established area of focus for large pharma companies even before the financial crisis. This process has been accelerated by their superior bargaining position in the current funding environment. Figure 2.5: How biotech entrepreneurs hope to deal with the financial crisis

Will try to be acquired Take over undervalued companies Will inlicense earlier Will in-license more Will out-license earlier Will out-license more 0 5 10 15 20 25

Number of respondents

Source: Avance (Corp Finance in Life Sciences) survey, 2008

Business Insights Ltd

Figure 2.5 above shows the result of a survey conducted by Avance, a Switzerland based life sciences consultancy. It illustrates that managers at smaller biopharma companies hope to gain funding by focusing on out-licensing as a means of revenue

39

via which to collaborate with a large pharmaceutical company. and also intend to out-license at an earlier stage of drug development. Product licensing. Although these transactions can still be grouped together. Corporate Venture Capital funds (discussed further in Chapter 6) are generally employed to scout for early stage product opportunities that are beyond the parent company’s core focus areas. So has the fluidity with which one type of transaction changes into another via an options-based deal structure. The large pharmaceutical and biotechnology companies import R&D assets from smaller. their intricacies and tiered structures have evolved rapidly. Restrictive venture capital and IPO activity has forced small biopharma companies to partner earlier.generation. Joint-ventures and acquisitions can bring in new capabilities/ technologies quickly. 40 . etc are employed to plug specific gaps in product portfolios. such alliances are becoming the most significant source of biotech funding. more focused companies in various ways. Creative deal making that seeks to limit cash outlays and motivate small company partners is gaining popularity as entrepreneurs and large corporations find new ways of working together. The entrepreneur has a choice of arrangements. The traditional ‘sweet-spot’ for licensing and partnering deals was generally the proof-ofconcept stage (typically on completion of Phase II trials). co-development agreements. marketing agreements. changing as the R&D lifecycle advances. In the absence of public market participation and with a much reduced private equity investment pool.

especially so in the early stage of development (Pre-clinical and Phase I). March 2010 Business Insights Ltd The process of ‘asset acquisition’ by big pharma has accelerated rapidly since 1995. Figure 2.7 41 Number of assets (line) 80 4000 .6: Reliance of big pharma on R&D externalization 100 90 5000 4500 Proportion of assets (bar. a process that entails the in-licensing or acquisition of an externally owned asset by a big pharma player. Figure 2. An example of such a situation is one in which a diagnostic platform is developed in conjunction with the drug to develop a composite product. The line charts represent the number of assets at each stage and the stacked bar charts represent the proportion of assets within top-20 pharmaceutical companies Source: Pharmaprojects. Drug Discovery. It is also possible that more than one preclinical asset is aggregated together to form a late-stage asset. Nature Reviews. %) 70 60 50 40 30 20 10 0 Pre-clinical Other Other Phase I Phase II Phase III 3500 3000 2500 2000 1500 1000 500 0 Top 20 companies Top 20 companies Active preclinical and clinical assets owned by or under exclusive license to large pharmaceutical companies.6 illustrates that most of the early stage assets are owned by smaller. As the R&D process advances. R&D driven organizations.Figure 2. This is because big pharma companies selectively import R&D assets at the early stages and complete the work in-house to exploit economies of scale. big pharmaceutical companies own a higher share of the pipeline.

Figure 2.shows the increase in early-stage deal activity between biotechnology and pharmaceutical companies. Thus the major drug makers are cutting back on their internal discovery and early stage clinical programs. March 2010 Business Insights Ltd 42 . Nature Reviews. disaggregated teams working on exploratory ideas. Drug Discovery.7: Trends in biotech-pharma deals by development stage 140 120 Number of deals 100 80 60 40 20 0 1995-1999 Pre-clinical 2000-2004 Phase I Phase II 2004-2009 Phase III Number of deals reported between biotechnology and top-20pharmaceutical companies classified by development stage Source: Pharmaprojects. This drive to externalize early stage development has come from the realization that the risks can be better managed by having smaller. but not at the same pace. The number of Phase II and Phase III deals have also increased.

or even acquiring a whole company. The legal/financial analysis is inherently very similar in all these levels.Rapidly evolving deal structures Pharmaceutical companies. acquiring or licensing technology rights. This is regardless of the type of deal being assessed.2: Established and evolving deal structures R&D stage Feasibility studies Sponsored research Technology access Collaborative R&D Licensing rights Product licensing agreements Simple license Option-to-license Option-to-purchase Co-development Co-marketing Product swaps Product sale & purchase Single products Portfolios Alternate agreements structures Combined deals Equity investments Royalty monetization Source: PharmaVentures Business Insights The analytical processes followed by business development managers and investors in assessing many types of investment opportunities in small biopharma companies are very similar. in their quest to shorten the developmental pipeline and increase profitability have long been participating in many types of collaborative agreements with small drug discovery firms. and this whole analytic process is an integral part of the due diligence. Table 2.2 lists out some of these deal structures. acquiring a division within a company. Table 2. which can encompass buying a product. 43 . in-licensing a product.

) need to be funded? • What’s the opportunity cost to putting money in this partnership compared with other potential product opportunities? Source: author’s research & analysis Business Insights Ltd De-risking R&D via options-based investing Big pharma companies use the real-options based investment approach to explore the drug discovery and development landscape externally. Such an “option” gives the investor the right. If clinical proof of concept is established. to continue investing in the asset if predetermined clinical milestones are achieved. partnering later • this program in spite of partnering now? • What is the cost of capital in today’s equity/debt markets? Partnership vs. The only commitment is to pay for the goals. sales. or will new resources (manufacturing. The down payment on the option is used by the developer to fund certain specified clinical projects. but not the obligation. usually as an upfront down payment. etc.Figure 2. the bigger partner can choose to exercise its option to take a 44 . The big pharmaceutical companies purchase an “option-to-invest” in a promising company/ R&D asset. The goal is to identify companies with innovative platform technologies/ therapies and good management teams that might push out three or four programs into the clinic over a 3-6 year period. fund raising • What is the long-term cost of partnering-away a potential revenue stream? • Are there sufficient data to build a reasonable risk/reward valuation model? • What are the chances of getting this product approved? Product considerations • What pricing flexibility will this product have? • How can potential reimbursement issues be factored into the valuation model? • Does this product fill a gap in the pipeline? • Can existing development and commercialization infrastructure be Corporate considerations (Licensee) leveraged to support the product. typically at the end of Phase II studies.8: Overview of partnering issues ISSUE SUB-ISSUE • How do licensors balance the near-term need for capital with opportunity for increased valuation if programs are partnered at later stages of development? Partnering now vs.

From the perspective of a small biopharma company. the up-front payments of which typically represent non-dilutive financing. The model enables them to unlock the real value of their target discovery platform in many more diseases than they would be able to do otherwise. and hence the start-ups cannot help but favorably consider option alliances. Options also give pharma companies a form of non-debt leverage due to the fact that upfront payments for option agreements are typically lower than taking an outright full license or ownership of an R&D asset. Almost every start-up has already conceded some level of ownership to VCs that provided their earliest funding.product forward by itself. options can be seen as a way to keep a stream of revenue flowing into the company. Such an approach distributes and shares the risk associated with drug development. once new information regarding the success of the initiative emerges. 45 . The big pharma partner does not directly provide research funding but rather buys options which can be exercised at pre-determined prices at the predetermined stages of development.

Not only have the number of such deals gone up. Figure 2. PharmaDeals Business Insights Ltd The use of options-based investing varies from company to company. it is certain that the use of options-based investment approaches will increase across the board in years to come. Other companies also employ similar strategies to a greater or lesser extent. for example GSK’s Centers for Excellence in Drug Discovery (CEDD). One of the CEDD units. Figure 2.Figure 2. 46 US$ million 15 30 . Some companies use specialist business units. the Centre of Excellence for External Drug Discovery does not discover and develop drugs internally for GSK like its sister CEDDs but rather explores the drug discovery and development landscape externally to find innovative companies and then form option alliances with them.9: Option agreements by top 20 pharma companies (≤Phase I) 20 40 Number of deals 10 20 5 10 2004 2005 2006 2007 2008 Number of deals 2009 Average upfront payment Source: PharmaVentures.9 shows how the use of such options-based alliances has increased over the past five years in pre-clinical and Phase I stages. so has the amount of money invested via options-based approaches.10 below represents the number of deals and money invested using this approach across some of the top biopharma companies. However.

The assessments are based on publicly available information to answer fundamental questions regarding the product opportunity before any more resources are expended in a more detailed investigation.10: Reliance on the option model varies by company 15.0 $3000 Number of deals 11. Thus the predeal due diligence forms the foundation for post-deal due diligence and is critical for a successful transaction. For example. perhaps the product/ company in question should not be considered for licensing/ acquisition because its target market is too small.5 $1500 3. as further investigation reveals opportunities and problems that were not originally contemplated.Figure 2.8 $750 Number of deals Sum of deal values Source: PharmaVentures. or it cannot successfully compete with incumbent therapeutic options in terms of added value. or because payors are unlikely to offer reimbursement. etc. There is a tendency for deals to start in one category and migrate naturally towards another.3 2250 7. 47 US$ million . PharmaDeals Business Insights Ltd Due diligence in biopharma alliances Determining the most suitable type of deal for the partnering opportunity is among the first steps in the due diligence process. Due diligence starts at the pre-deal stage and is conducted from outside the precincts of the target company.

48 . A joint venture or a corporate alliance/partnering deal is even more complex because joint-ventures involve issues of control whereas corporate partnering frequently has an equity investment element. label and indications.Once the basic deal terms have been agreed upon. especially those conducted prior to Phase III trials. All parties involved must keep an open mind and continuously ask questions to test the merits of the contemplated transaction. Such information frequently throws up new questions and negotiating points that were not raised in the preliminary deal analysis and are the subject of post-deal due diligence. there is a formal process of information exchange that takes place between the buyer and the seller. This section reviews the rationale for each deal type and allows readers to establish the type of deal that best fits their needs.11: Deal structures and responsibilities Simplest Most complex Type of deal MARKETING ARRANGEMENT OR LICENSING DEAL CORPORATE PARTNERING OR JOINT-VENTURE OUTRIGHT ACQUISITION OF A DIVISION OF PART OF A COMPANY Responsibility Licensing department of pharma company Licensing Department or Business Development Unit Business Development Unit or M&A group Source: author’s research & analysis Business Insights Ltd Marketing agreements require the least intensive due diligence effort because the product’s characteristics are well laid out in terms of its therapeutic profile. Licensing agreements are more complicated. because vital parameters of the product’s profile need to be anticipated and this involves more probability-based calculations. Figure 2.

A marketing agreement can be expanded to cover a family of products or a therapeutic field to make use of the commercialization capabilities of the licensor and utilize economies of scale. the due diligence requirement is comparatively less demanding.Marketing agreement A marketing agreement confers no technology access to the licensor and usually involves a launched or soon-to-be launched product. 49 . Therefore. paid on a per unit basis or on sales values. It can be replicated easily in different countries or regions. For the drug developer it can involve a stream of product-sale revenues or else just the receipt of royalties. It allows great flexibility for both parties and its risks and its rewards to both sides are relatively limited.

A partner with commercialization expertise. The logic for a JV is to provide two companies that have complementary assets with a chance to pool resources and achieve benefits of scale and scope. such benefits can include: Access to new markets via sales or distribution networks 50 . These types of transactions are typically handled by a pharma company’s licensing department. In a big pharma-biotech context. Table 2.3: Incentives in a strategic licensing arrangement Licensee Access to new product candidates. It involves a greater level of commitment and confers technology rights to the licensor for a defined period of time in defined geographies. Upfront and near-term funding can help build a pipeline and advance development of proprietary programs. Licensor Access to additional R&D and commercialization resources. “Validation” of technology or approach. Royalties / co-promotion opportunities provide long-term returns. Since pharmaceutical products have a bell-curve shaped sales pattern over a 10-20 year period after which generic incursion reduces the commercial opportunity. Leap-frog into new therapeutic class or indication without building additional research infrastructure. It involves the creation of a new and free-standing enterprise and is generally taxed as a partnership. An outright acquisition is more like a full-payout for all commercialization rights. Replenished pipeline in the target market /indication. Source: author’s analysis Business Insights Ltd Joint venture A joint venture or JV is a way for companies to partner together without having to merge with each other. Diversify development risk across multiple programs. although this is not always the case.Licensing arrangement/Product acquisition A licensing agreement or product acquisition typically starts at an earlier stage of the product lifecycle when compared to a marketing agreement.

and royalties. technology and finance The main problems with a JV are related to control and consolidation. Despite these human and accounting problems. For the larger partner. 51 . underfunded but highly creative company. Therefore the due diligence requirements may be similar to those for M&A transactions.Sharing of risks and costs of drug development Access to greater resources. especially in terms of accounting and management rights. If the economies of scale and scope are promising. including specialized staff. However a corporate partnering arrangement gives a more flexibility to adapt. The first point of investigation for the big pharmaceutical company is to assess whether or not it would be better off acquiring the smaller company outright. Such details vary depending on the deal’s particulars. The smaller company usually does not have the necessary business skills. Often such alliances build in the possibility of an acquisition by including some sort of right of first refusal provision. financial muscle. after paying costs such as clinical development expenses. a surprising number of JVs exist and some have worked satisfactorily over long periods of time. R&D funding. an outright acquisition may make more sense. Corporate partnering deals often include an equity component wherein the larger partner purchases equity in the smaller partner with the hope of capital appreciation of its investment. financial and product development assistance to a smaller. a corporate partnering arrangement achieves a stream of net incremental revenues from eventual product sales. Alliance/Corporate partnering This format is basically a means whereby a cash rich big pharmaceutical company (with full manufacturing and sales capabilities) extends its operating. and an acquisition still remains an option that can be pursued later. operational capacity or geographic market presence to fully commercialize its product or technology. milestones for technical/clinical/regulatory achievements.

they need to develop arguments that convince the bigger of the same. entrepreneurs need to familiarize themselves with the due diligence process followed by the licensing. business development and M&A teams at big pharma corporations. Conclusions To best communicate their value propositions. The size of the team involved in such a transaction is larger and includes teams of corporate managers. etc. Such transactions are usually handled by the M&A department of the big pharma partner. Once entrepreneurs have identified the type of deal that best suits them. 52 .Outright acquisition of a company Mergers and Acquisitions require the heaviest and best orchestrated due diligence effort and involve advisory services from investment banks and strategy consultancies. industry experts. accountants. intellectual property experts. lawyers.

CHAPTER 3 Valuing investment opportunities in small biopharma companies 53 .

Business development and M&A teams in large pharmaceutical companies tend to rely on methods such as DCF and risk-adjusted NPV. Venture capitalists and private equity firms prefer estimating enterprise value by comparing it to what other investors are willing to pay for similar opportunities. Deals based on an options-based valuation structure are better able to offer fairvalue to both parties because financial and strategic commitment can be deferred to the point in time when new information becomes available. All valuations are based on a set of projections such as revenues.Chapter 3 Valuing investment opportunities in small biopharma Summary This chapter deals with the process of assessing the commercial viability of an R&D asset. or the entire company itself. Even though valuation techniques differ in the way they evaluate the cost of capital and risk. the concept of free cash flows and earnings potential are applicable across the all methodologies. The impact of a certain pricing-positioning strategy on the budgetary dynamics of healthcare providers is now a key input in forecasting the real-world uptake of the product/ technology asset. costs. Choosing a valuation method or discount rate is a hot topic when making financial valuations and has been the subject of much theorizing. The pricing-positioning trade-off has become a critical component of the due diligence involved in assessing the commercial potential of a medical intervention. 54 . profits and cash flows. a related portfolio of projects. The ‘asset’ in question can be a particular project within a biopharma company.

entrepreneurs and advisors. Entrepreneurs who have to communicate the above-average value proposition of their companies have to rely on the more fundamental. Thus choosing a valuation method or discount rate is a hot topic when making financial valuations and has been the subject of much theorizing. The ‘asset’ in question can be a particular project within a biopharma company. the concept of free cash flows and earnings potential is applicable across the nearly all methodologies. There are many different opinions regarding what is the “correct” method and discount rate to use. The first part of this chapter discusses the valuation methods typically used by investors. The methods most known to industry professionals 55 . a diagnostic test or medical device. a typical pharmaceutical small molecule. Private equity/ venture capital investors tend to value biopharma assets based on what others are paying for similar transactions. The purpose is to make the parties aware of each others’ preferences and thus facilitate communication. This section discusses the different valuation methods preferred by different types of industry professionals.Introduction This chapter deals with the process of assessing the commercial viability of an R&D asset. a related portfolio of projects. future cash flow-based valuation techniques. The second part discusses the fundamentals of assessing the commercial potential of an R&D asset. and biotechnology assets are not on the radar of non-specialized investment firms. Even though valuation techniques differ in the way they evaluate the cost of capital and risk. Valuation methods and usage Different types of investors prefer to use different methodologies. This methodology suits them best because the overall economic climate is currently recessive. or the entire company itself. regardless of whether the asset in question is a biologic drug.

DCF is considered a strong tool because it focuses on the cash generation potential of a business. The Net Present Value (NPV) of an asset is the sum of all future cash flows. Step by step valuation enables managers to wait for information to emerge and uncertainty to decrease. Table 3. Usage Widely accepted across a range of industries. Widely used. Pragmatic but simplistic approach.4: Overview of valuation methods Method Discounted Cash Flow (DCF) Description Future free cash flows are totaled.4 provides an overview of the different viewpoints on and approaches to biotechnology valuation A more detailed description follows. The total is discounted using the WACC* plus a component for risk. Includes valuation of management flexibility. * WACC – Weighted Average Cost of Capital Source: author’s analysis Business Insights Ltd Discounted cash flow This classic valuation method based on free cash flow analysis is widely used across a broad range of industries. Risk-adjusted Net Present Value (rNPV) Real options Clearly accepted as more relevant to the biopharma sector. Not widely used. Comparables Widely used in early stage investments when future cash flows are difficult to predict. Real Options and Comparables.the 56 . but considered appropriate for the biopharma sector due to its ability to tackle high-level of risk/ uncertainty. All future cash flows are estimated and discounted to give their present values. Cost of capital and probability of success are calculated separately. Opportunity is compared to what others paid in a similar transaction. both incoming and outgoing. Modification of DCF. discounted to the present using an appropriate discount rate. Risk-adjusted Net Present Value (rNPV). This discount rate has two components. Table 3.include the Discounted Cash Flow (DCF).

e. the rNPV allows to risk to be assigned to each component separately. since the risk factor has already been considered in assigning the probability of occurrence for each cash flow. They assume that the strategy deemed appropriate at the present moment (when an investment opportunity is 57 . even VCs must use the DCF methodology to assess how much strategic buyers like big pharma corporations will pay for the particular asset in future. Unlike the DCF method. The discount rate used should therefore be equal to the company’s WACC. this discount rate does not include an additional component for risk. Only VCs tend to avoid this methodology as they invest in earlier stages of the pipeline and their paths to exit are normally based on sale of the asset to a strategic investor. Real options Both the DCF and rNPV methodologies suffer from the disadvantage of not being able to incorporate management flexibility into their valuations. These adjusted values are discounted back to the present moment using the investor’s Weighted Average Cost of Capital (WACC). The rNPV method is now the defacto standard in the valuation of biotechnology companies/assets. Risk-adjusted net present value The rNPV or Expected Net Present Value (eNPV) method is a modification of the standard DCF calculation. While the DCF method clubs all components of project risk into a single quantifiable discount factor. and then the value of each is adjusted based on its probability of occurrence. the payments investors have to make to leverage such a transaction) and a component representing the risk of failure of the project. The overall discount rate is therefore higher than just the company’s Weighted Average Cost of Capital (WACC). Thus the two “discount factors” – the average cost of capital and the success rate of the project – are calculated separately. The rNPV method allows valuation professionals further granularity in incorporating the probability of success of a project. Each future cash flow is first identified. However.investor’s cost of capital (i.

It is common for an asset to be valued via the traditional DCF/ rNPV approaches. and hence increase its value. it can be said with certainty that use of this approach will continue to gain ground. Although the use of an options-based approach to investment is gaining ground. Therefore comparables are widely used by VCs and other private investors to target the early stages of drug development. The Real Options approach addresses these objections by providing management with the ability to actively modify the project after the initial investment decision is taken should the need arise. and the need to speak a common language is restricting the usage of real options as a valuation tool.being assessed) will remain the most suitable in future. 58 . publicly traded companies where earnings ratios and cash flows are well defined and easily compared. This makes sense for valuing well established. starting with biotech-pharma alliances and moving into the broader investment community. It is argued that the comparables method best reflects market value and that market value is real value. Such a method is also applicable at the early stages of drug development when future cash flows are difficult to predict.which are the norm with most biotech investments. Such a strategy seems appropriate for long-term. multi phase investment decisions . and then juxtaposed using the comparables approach to adjudge a fair value. The bulk of industry professionals still use DCF and rNPV based methodologies. Comparables Many investors believe that the best way to value an investment opportunity is to compare it what others are willing to pay for a similar opportunity. such as biopharma drug development. However. In this sense. This is a pragmatic argument. they are static valuations of assets that evolve rapidly in earnings potential. Thus it has been argued that the DCF and rNPV valuation methods are not sufficiently robust when valuing high risk projects. This flexibility can reduce the risk associated with a project. it is used by only a minority among biotechnology valuation specialists.

2009 Valuation experts 60% 50% 40% 30% 20% 10% 10% 60% 50% 40% 30% 20% Biotech/ Pharma professionals 0% DCF rNPV Real-options Comparables other 0% DCF rNPV Real-options Comparables other 60% 50% 40% 30% 20% 10% 0% Venture Capital investors DCF rNPV Real-options Comparables other Source: “Financial valuation methods for biotechnology”. Denmark Business Insights Ltd 59 .12 below compares the usage of financial valuation methods by different stakeholders in the biopharma investment value chain.12: Primary valuation methodology by investor type. Figure 3. Biostrat.Figure 3.

Assessing commercial potential
Biopharmaceutical companies are typically valued on the basis of the cash flows their R&D asset is likely to generate. The whole process is based on a set of projections such as revenues, costs, profits and cash flow. This is a complex exercise that varies enormously, depending on the type of asset and the eventual goal of the investor.

For example, if the investor is a pharmaceutical company that intends to commercialize the product by itself, the entire sequence of due-diligence activities is relevant to the eventual valuation. If the investor is a financial institution (like a private equity firm or venture capitalist) that intends to sell the assets to another strategic investor, only components of the sequence are relevant. Figure 3.13: Assessing the net earnings potential of a medical intervention

Present value of future cash flows

Revenues

Costs

Volume potential

Pricing and market access

R&D, Regulatory, etc

Sales & Marketing

Manufacturing & miscellaneous

Source: author’s research & analysis

Business Insights Ltd

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Sales potential The first step in judging sales potential is to estimate the number of patients that are in need of a therapy to address their therapeutic concerns. Data on the epidemiology of a disease, such as incidence, prevalence and demographic trends are available from a variety of sources. Such data is gathered, verified and forecast for each individual market in which the R&D asset is to be commercialized. Treatment algorithms are studied to assess how the physician community typically treats the disease. Therapeutic guidelines issued by representative bodies (for example the American Heart Association in the case of cardiology diseases, or prescribing guidelines for specific health plans) provide the best reference points. On the basis of such information, the number of patients that are eligible for pharmacological therapy is estimated. Figure 3.14: Assessing revenue potential

Disease prevalence, epidemiology, demographics

• How many patients suffer from the disease? • How many patients are eligible for pharmacological treatment? • How is this number likely to change over the product lifecycle?

Patient populations
Treatment algorithms

Volume potential
Competitive landscape

• Which therapies are currently employed to serve this patient population? • Will market/ scientific developments alter this scenario during the life cycle?

Ability to gain market share

Fulfilment of unmet medical need

• Does the drug add value to the evolving treatment landscape? Is the value established via good clinical trial data?

• What level of market access can be expected if the price was comparable to main competitors? Ability to commercialize • Does the company possess the necessary sales infrastructure to reach physicians in this therapeutic area?

Source: author’s research & analysis

Business Insights Ltd

The next step is to assess the competitive strengths of the drug vis-à-vis other therapies

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that address the same patient populations. It is best to clearly define the unmet needs within the disease spectrum, which the current therapeutic options do not adequately address. Clinical pipelines and scientific literature can reveal other drugs or technologies under development that can potentially alter the spectrum of unmet needs.

Given the target product profile of the R&D asset, discussions with industry experts can elucidate whether or not the asset fulfills these needs, and if so, to what extent. Based on such reactions and other clues from the marketplace, analysts estimate the market share the R&D asset is likely to gain. Based on such information, probability based scenarios can be developed and further investigated. In such a way, the R&D asset’s ability to penetrate the market is assessed by juxtaposing its profile with those of current/ future competitors.

The final piece is to assess the ability of the investor (or, strategic buyer if the investor intends to further divest the asset) to capitalize on the strengths and weaknesses of the asset, given their internal resources and capabilities. Now that the market potential has been identified, what will it take to successfully commercialize the asset via sales and marketing? The issue of price can be layered on top of this estimate to develop a more representative picture of the incoming cash-flows.

Pricing and positioning So far we have ascertained the number of patients likely to be given the drug if price were not a key consideration in a physician and/or patient’s choice. However, given the restrictive budgetary environment facing healthcare providers, pricing is a very critical issue. Not only does it directly impact the revenues generated from a given patient population, it determines the number of patients the drug is likely to be indicated for by payors and regulators. This is why drug positioning and pricing are inextricably interlinked. If the proposed price of a drug is too high, payors are likely to restrict its usage to relatively smaller patient populations via prescribing guidelines, step-therapy or outright removal from the formulary. Conversely if the price is considered affordable, payors are more likely to grant access to a wider patient population. Hence,

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based on health technology assessments.pricing-positioning impacts strategic planning. and assessing the willingness of payors to reimburse those levels of costs. If the R&D asset clearly adds value over and above the incumbent 63 . economic evaluations. By investigating the cost of treatment of established competitors. if the drug is granted access to the proposed patient population at the proposed price? • Is the payer likely to tolerate such changes in expenditure? Source: author’s research & analysis Business Insights Ltd The underlying principle in drug pricing is the balance between the incremental economic and medical value added by the drug in comparison to its comparators. For example. if the R&D asset under investigation is likely to be indicated for patients who have not responded adequately to currently established first line therapeutic options. etc. based on their therapeutic profile and place in the treatment algorithm? • How does the proposed price of the drug compare to its comparators? • What level of clinical value does the drug add over its comparators? • Are payers likely to pay extra for this level of improvement? Proof of value Clinical value Pricing & positioning • What market share is the drug likely to gain over its comparators? Budget impact • From which brands will the incoming drug cannibalize market share? Ability to pay Prevailing sentiment • How will the economics of the payers change.15: Pricing and positioning Economic value • Which drugs can be considered adequate comparators. Individual markets follow their own systems of pricing. Figure 3. analysts can gauge an approximate price band for the R&D asset in each individual market. reference pricing. the comparators are likely to be the incumbent second line drugs. due-diligence and strategic marketing on multiple dimensions.

a clear improvement in safety and/or efficacy is likely to command a price premium over incumbent therapies. and is priced at a premium. may be less likely to warrant the same. Although the specific research can be very complicated. the following general rules apply: If a drug is therapeutically superior to its comparators and is priced at the same level. Figure 3. analysts need to identify the specific ways in which the value is added.comparators. it is likely to be granted access to a similar/ greater number of patients If the drug is clinically superior to its comparators. the next step is to assess the impact on the budget of healthcare providers. such as compliance advantages. For example. it is likely to be granted access to the same patient population 64 . the level of access will depend on the magnitude of therapeutic improvement If a drug is therapeutically equivalent to its comparators and is priced at the same level.16: STATUS QUO (no coverage) Impact of incoming therapies on payor budgets FULL COVERAGE Overall market forecast Segmentation by products Additional market growth due to incoming drug Market forecast by product (under status quo) Incumbent market shares/ dynamics Source of business for incoming therapy Market forecast by product (under full coverage COST UNDER STATUS QUO BUDGET IMPACT COST UNDER FULL COVERAGE Source: author’s research & analysis Business Insights Ltd Given a proposed price and specified health outcomes. whereas a smaller improvement.

17: Development and commercialization costs • What will be the scale and scope of the clinical trials required to get the drug approved? • Can the R&D be conducted in-house. as shown in Figure 3. can APIs be easily sourced? • Is it a biologic that will require special facilities? If so. will other technologies need to be in-licensed/ developed for cost-effective manufacturing? Source: author’s research & analysis Business Insights Ltd Biopharma entrepreneurs have traditionally divested their drug assets once Phase II trials have been completed and a proof-of-principle established. the various means of achieving these landmarks are assessed. or does the company have partners that can conduct the trials cost-effectively? • Will other technology platforms/ intellectual property need to purchased/ licensed in order to fulfil R&D requirements? R&D • How loyal are physicians to competitor drugs? • What size of a sales force will be required to market the drug? • What levels of reach/ frequency of sales calls will the team have to implement? • Which other activities will have to be conducted to spread the brand message? Costs Sales & marketing Manufacturing • Is the drug a small molecule that can be easily manufactured and stored? If so.17. Once this has been established. and is priced higher. The critical assessment is the scale and scope of further preclinical research/ clinical development that will be needed to get the R&D asset approved by healthcare regulators. The first components are the costs related to research and development. Figure 3. it is not likely to be granted access/ reimbursed.If the drug is not therapeutically superior. Cost of commercialization The costs of drug development and commercialization can be grouped into three broad categories. But this is not a 65 .

These are fairly straightforward for typical small molecules. Sales and marketing costs are typically dominated by the expenditure on sales personnel in reaching out to the physician universe. or if the R&D asset belongs to a relatively new and unknown category. but can be murky for new biologics and protein-based therapies. 66 . Other marketing expenditures such as conferences and information support do not require the same magnitude of financial resources as a well-motivated sales team. The final component is manufacturing and cost-of-goods sold. This is a costly process. the sales team will have to spend time and resources in educating physicians about its relative advantages.general rule. and investors/ drug developers usually try to attract investment at the most appropriate ‘point of value inflection’ for that particular therapy/ technology. If physicians are extremely comfortable with their incumbent therapeutic options.

CHAPTER 4 Priorities and preferences of private investors 67 .

all firms investing in non-publicly traded equity are classified as private equity investors. venture capitalists. Private equity firms are willing to consider earlier stage companies and VC firms are willing to lower yield requirements in securing later stage opportunities. specifically in terms of their ability to prudently manage an organization with a high burn rate. who prefer to invest in leaner organizations with a greater ability to adapt to changing priorities. Even venture funds are wary of investing in companies that have committed large resources towards fixed assets that may or may not be required as their R&D strategy evolves. private equity funds.Chapter 4 Priorities and preferences of private investors Summary In the context of this chapter. Biotechs that require high levels of capital expenditure are out of favour with private equity investors. There is a limit to the extent of managerial/ strategic input that investors can provide. funds-of-funds. 68 . small biotechs have to sacrifice more to raise funds. Unlike earlier years. These include angel investors. To maximize the chances of raising funds. mezzanine funds. the term sheets for biotech funding are no longer investor friendly. hence communicating a sound business plan goes a long way in reassuring investors of the safety of their capital. the seller must think of ways to communicate their ability. The entrepreneur must make it easy for the investor to assess the people behind the business. and include multiple clauses that limit the risks to the investor. Although each operates along different stages of a company’s lifecycle. the seller must anticipate the preferred exit strategy of the target investor and build the valuation with this end in mind. Since many aspects of the job are intangible. With less venture funding available. and others. traditional operating niches have been greatly stretched as the -funding model evolves to keep pace with the changing landscape.

Their primary exit strategy over the next five years will be to divest the asset to another strategic buyer that operates along later stages of product development. The most common priorities for the founders include completion of the prototype and business plan. increasingly. The primary driver of change is the increased need to collaborate following the collapse of IPOs as an exit strategy. and simultaneous IP protection. wherein the company has just been formed or incorporated and is busy developing its core product or service. Thus private investors are looking towards expanding beyond their historical operating niches or stage of investment. This chapter describes their historical stance and comments on how it has changed over the past five years. all types of firms investing in non-publicly traded equity are classified as private equity investors. traditional operating niches have been greatly stretched as the biotech-funding model has evolved to keep pace with changing landscape.most often a big pharma company. and facility/funding needs identified. This has been labeled the seed stage. 69 . Private investors like VCs and private equity firms do not have the patience and appetite to hold ownership of R&D assets until the commercialization stage or. Such a definition includes a wide variety of players. from angel investors to venture capitalists to private equity firms.Introduction In the context of this chapter. Additional collaborators/partners in academia may be sourced. Although each type operates along different stages of a company’s lifecycle. until Phase III clinical development. Stages of investment The first growth stage of the company is when an idea is generated and the intention to pursue it as a commercial business is formalized.

also be appropriate for companies further along the development/ commercialization pathway. but no positive cash flow.5: Stages of equity investing Stage Seed Start-up Early stage Mid-stage Late stage Established Investor type Founders. However.Table 4. slower growth in maturing markets Business Insights Ltd Source: author’s analysis Once this has been accomplished. A roadmap for pre-clinical research. profitable Recapitalization. Angel investors VC. clinical trials and regulatory approval is laid out. under certain circumstances. not yet profitable Expansion. Buyout Activity Proves a concept Product development Continued product development Expansion. early revenues. Angel investors VC. Private Equity firms VC. Additional senior management may be recruited and VC/angel investor relationships developed. venture investing may. Seed funds. relatively stable revenues. Private Equity firms Seed funds VC. and the workforce is expanded. Private Equity.5 summarizes the stages of equity investing and shows that VCs focus on startup and early stage companies. Mezzanine Private Equity. the company typically enters the early stage of its lifecycle. It has a core management team and a possibly a proven concept/ technology. Table 4. 70 .

the management has to plan for further development. new market development. the senior management focus typically shifts towards expanding the market. product portfolio and workforce. global market expansion. The senior management focus now shifts to other issues such as their next-generation strategy. development of the pipeline. Perhaps the company has gone public or has plans to do so.Figure 4. The main concerns at this stage include follow-on funding. Once these challenges have been overcome and the company is mature and profitable. 71 . facilities expansion/relocation and management/workforce expansion. Seed funds ROLL-OUT Venture Capital/ Private Equity TIME Source: author’s research & analysis Business Insights Ltd After the company has received one or more rounds of financing and is generating revenue (or is in a position to generate revenue in the short to midterm). Acquisition REVENUE GROWTH Banks. and management/workforce expansion. VC/ Private Equity IDEA START-UP PILOT Founders Angel investors.18: Company growth stages and funding sources INCUBATION PERIOD COMMERCIALIZATION MATURITY EXPANSION IPO.

usually not secured by assets. On the other hand. Again. Private equity capital comes from many types of investors such as Venture Capital firms. Distinction between private equity and venture capital funds Historically. Their avenues for mitigating risk include diversifying their funding sources or broadening their R&D mandates by branching out into related therapeutic areas.Investors: definition. This reflects the historic trend when VC firms invested at more risky stage of the company’s development. Most such entities are institutional investors and accredited investors who can commit large sums of money for long periods of time. traditionally speaking. drug developers typically place a more focused bet on a single technology or therapeutic area. The scope of such investing covers diverse stages of investment and a range of industries (typically excluded are real estate. VC funds have provided high-risk equity capital to start-up and early stage companies whereas private equity funds have provided secondary sources of equity to companies that are more mature in their corporate lifecycle. It is typically defined as capital invested in private companies by way of equity. Such investors make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Mezzanine funds and Secondaries / Funds of Funds. Their investments are more long-term because the companies they invest in tend to be young and rapidly 72 . Such investors target multiple companies. Leveraged Buyout (LBO) firms. overview Private equity is capital that is not quoted on a public exchange. technologies and therapeutic areas. VC firms have higher hurdle rate expectations and can be more mercenary with their valuations. natural resource extraction and retail). The companies gaining the investment usually require long holding periods before the investors can exit their investment via a liquidity event such as an IPO or sale to another strategic investor. thereby distributing their risk by putting smaller amounts of capital in play among a variety of companies.

There is also an implicit expectation that their investments are relatively more liquid than those of VC funds. the company will often require several rounds of venture financing before the angel investors are able to exit their investment through an initial public offering (IPO) or. that makes small investments of his or her own personal capital in early stage companies. If the seed round is successful. 73 . the lines between VC and private equity investments have been blurred by increased competition over the last few years.growing businesses that require time to develop into profitable organizations. a sale to a strategic investor. These days private equity firms are willing to consider earlier stage companies and VC firms are willing to lower yield requirements to be more competitive in securing later stage opportunities. Such finding is often obtained from an “angel investor”. more commonly. In the context of the small-mid cap biopharma sector and hence in this report. This has forced both VC and private equity firms to expand their respective investment horizons. both private equity firms and venture capital firms have been clubbed into a single category. acting alone or in a group. While the above descriptions are technically correct from a historical perspective. Private equity funds tend to invest in more mature companies where there is greater potential to increase company value via restructuring and exploiting economies of scale. An angel investor is a wealthy individual. This is because the potential for capitalizing on operational efficiencies is greater in more mature companies. Angel investors A pure startup company often obtains its first round of funding via a “seed round” which typically involves small investment amounts.

Mezzanine investors A mezzanine investor provides later stage investment to companies that already have incoming cash flows via sales of a product or service. non-controlling stake in the company and may often syndicate the risk of the investment among a number of firms. VC funds usually structure their investments as preferred stocks. All VCs strive to add value. it does not imply forever. It is important to recognize that venture capital represents an active rather than a passive form of financing. and requires active involvement by investors in the companies which they finance until they are sufficiently developed for disposition.Venture capital funds A venture capital fund invests in early stage companies in need of capital for growth. want a seat on the board of directors. The companies they invest in usually do not have stable cash inflows and the investment is made on the premise that such inflows will occur in future. A good VC will be considering potential exit strategies from the time the investment is first considered. although this is not always the case. Doing this requires active involvement and almost all VCs will. beyond capital. or having the right to convert other financial instruments into common shares) in a private company. Such an investment is invariably 74 . It is also important to recognize that although a VC fund invests for the long haul. Is expected to be a long-term investment (generally from three to eight years). to their investments in an effort to help them grow and to achieve a superior return. A VC investment typically: Involves minority equity or quasi-equity participation (owning common shares outright. at a minimum. There are two key criteria that differentiate venture capital from more conventional sources of capital. They will usually take a minority. The primary objective of VC investors is to achieve a superior rate of return through the eventual and timely disposition of investments.

The people participating in venture investing can be broadly classified as either business builders and idea investors. Such contacts are part of the value they bring to the table when investing in a new venture. Buyout investors are not especially relevant to the funding landscape of small. the mezzanine investor typically receives a lower return than other private equity investors. Venture investors versus buyout investors Private equity investors can also be classified as venture investors and buyout investors. emerging biopharma companies. 75 . In the course of their careers. Due to its lower risk tolerance and investment in less risky securities. The former are typically serial entrepreneurs or industry veterans who have a thorough understanding of the operations of the businesses they invest in. while a buyout investor is concerned about worst-case outcomes and tries to mitigate risks through deal structures. Such transactions are usually financed via purchase of debt-like securities. such individuals develop an extensive network of industry contacts from their previous industry and investing experience. Venture investing is about understanding the impact of products and technologies on markets while buyout is about control and deal structure. with the purpose of helping a company achieve some critical objective such as an initial public offering or achieving a critical clinical milestone. and have been excluded from the following analysis. which have greater seniority than equity in a company’s capital structure (typically at the subordinated debt level).short-term in its focus. A venture investor is by nature an optimist who looks for ways to exploit a commercial of a business idea. depending on their strategic motivation. The securities may feature an accumulating or current pay dividend and will often include equity warrants. This gives them the ability to provide direct assistance to the management teams of their portfolio companies.

Most private equity investors exist somewhere between these two extremes. They usually understand the commercial dynamics of an opportunity before others. 76 . They may have less domain expertise than business builders and hence invest across a broader range of companies. and seek to capitalize on this understanding before the broader investor community is aware of then. Such individuals seek to identify gaps in an industry or areas of need that have not been fully serviced.Idea investors exist at the other end of the spectrum.

Term sheet Closed deals Source: author’s research & analysis Business Insights Ltd If. Hundreds of incoming offers and interesting prospects are funnelled down to perhaps 5-10 closed deals. and checking management references. The investment opportunity is formally communicated to private equity firms via a concise overview or executive summary of the business plan. scientists or technologists.19: The deal “funnel” at a typical VC firm Incoming deals and “interesting” prospects First meetings and basic due diligence Extensive due diligence The ever contracting funnel. Figure 4. The introduction might come from other entrepreneurs. If this appeals to the investor. Activities include discussions with physicians/market experts. the investor begin the due diligence exercise. This involves assessing the market opportunity and the management’s capabilities. the 77 . Following successful completion of this review. industry leaders.Process of getting new investment The process of new investment begins with the introduction of an entrepreneur's idea. it is followed up with an initial meeting with the entrepreneurs to better evaluate the team and the opportunity. or through the investor’s website. mutual contacts. service providers. the opportunity remains attractive after this meeting. completing detailed market research.

If the final go-ahead is given. the investor might agree to invest immediately.entrepreneurs are usually invited for an in-depth discussion. a relatively standard sequence of paperwork commences. It outlines the most important details of the transaction like the valuation. preferred shares. This is described in more detail in Figure 4. keeping in mind the current/future investment climate and priorities of both parties (the entrepreneur and investor). often involving additional members of the team. 78 . etc). type of security (common shares. At this point. Term sheets Figure 4.20 below. various issues mentioned above are discussed in further detail. or may decide to follow up with more questions before making a decision. The onus is always on the investor to complete this process as quickly as possible and to give opinions and feedback to the entrepreneur along the way.20: Sequence of documents • Key financial amounts and other terms • Amount of money • Financial instruments • Valuation TERM SHEET SUBSCRIPTION AGREEMENT • Details of the investment round • Number/ class of shares • Payment terms • Milestones INVESTORS’ RIGHTS AGREEMENT • Investor protections • Consent rights • Board representation • Non-compete clause ARTICLES OF ASSOCIATION • Rights attached to various share classes • Procedures for issue and transfer of shares • Procedures for holding of shareholder/ board meetings Source: author’s research & analysis Business Insights Ltd The term sheet is perhaps the most critical element of the investment process once the decision to invest has been made. In the following section of this report.

small biopharma companies have to sacrifice more to gain investment. reflecting the bullish economic climate. These may include a liquidation preference. Since early stage biopharma assets are inherently risky. Type of security The type of security/ financial instrument that investors purchase tends to reflect the exit strategy and associated risks that they foresee when making the investment. For example. the investor’s investment or a multiple thereof is paid back in full before any funds are paid to other stockholders. redemption of the securities purchased by the investor and registration rights.liabilities and other terms. With less venture funding available. 79 . VC funding for risky biopharma assets has decreased substantially. In the restrictive economic climate we have today. if investors are worried that the company will be sold at a discount or dissolved before its value inflection point. which are specified in the term sheet and further elucidated in the investor rights agreement. In the late 1990s and early 2000s. they may use a promissory note to try to protect their investment by having a ‘liquidation preference’. a great deal of thought if given to such details. it may even be easier to manage the concerns of different investors via convertible promissory note structure rather than negotiating a series of individual stock purchase agreements. it is better not expect much negotiating power at the term sheet stage. Today’s term sheets are anything but investor friendly. For the entrepreneur. Unless the entrepreneur presents an unusually attractive investment opportunity. Investors tend to include multiple provisions focused on the exit strategy. such terms sheets tended to be very investor friendly. Investors were more worried about losing out on a promising investment opportunity than the repercussions of investing in a failed venture. turning it into a buyer’s market. and include multiple clauses and terms that limit the risk of the investor. Such clauses protect the investor by stipulating that that if the company is sold or dissolved.

As the venture grows and becomes more complex. the first board of directors consists of a minimum of three people including the owner/founder or the first president. Preferred stock is the most frequently used investment vehicle for private equity investments. Preferred stock. through a specified series of payments. Ideally each brings a special background that adds value to the total board.e. It identifies the parties. Convertible promissory note deals are common in very early stage investing or in so-called ‘bridge’ financings (short-term loans made in anticipation of subsequent equity financings). In the event of liquidation. A promissory note is a written promise to repay a loan or debt under specific terms . preferred shareholders and other debt holders have been paid in full. or upon demand. Promissory note. The main types fall into three categories: Common stock (also called ‘ordinary’ stock) is the normal type of shares that companies issue. common shareholders have rights to a company's assets only after bondholders. Similarly. The specific terms of the preferred stock are heavily negotiated and detailed in the term sheet. in the event of a sale or liquidation of a company. Common stockholders are on the bottom of the seniority ladder within the ownership structure. preferred share holders will receive dividends before common share holders). It may also include an "acceleration clause" which will make the entire amount of the note due if a payment is missed. The upside is that common shares usually outperform bonds and preferred shares in the long run. Preferred shares are senior to common shares during the disbursement of dividends (i. Board representation Typically. Given the varied challenges faced by 80 .usually at a stated time. additional board members are brought in.All types of stock are not equal. the amount of the obligation. the preferred share holders are paid before common share holders. and usually includes the terms of repayment and interest rate which will apply. It is created by amending the company’s certificate of incorporation to include the type and amount of preferred stock issuable and the rights and privileges of the preferred stockholders.

feeling of satisfaction from the work • Fewer administrative staff are required • Limited opportunities for diversity and inclusiveness • Fewer skills. which can lead to apathy and loss of interest • Meetings are more difficult to schedule. perspectives are represented • Heavy work load • Fewer people are available to serve on committees • Board has less continuity in times of leadership change • Members may feel less individual responsibility and • More opportunities for diversity and inclusiveness less ownership of the work • May hinder communication and interactive discussion • Cliques or core groups may form. creating unity • Better inter-personal relationships.. non-management) directors. the overall board should contain individuals skilled in the technical aspects of most such challenges. Toronto Business Insights Ltd When boards get too big. and to utilize there the independent (i. deteriorating board cohesion • May not be able to engage all members. Nevertheless. It would be common and expected that a large investor would be entitled to at least one board seat but uncommon to give the investor 81 . community leaders and funding area experts • More people are available to serve on committees • Fundraising may be easier because there are more people on the board with more connections • Helps maintain institutional memory in times of leadership change Source: Adapted from MaRS DD. members find it easier to miss meetings. Figure 4.early-stage biopharma assets.e. A pattern of backgrounds needs to be developed to ensure that the board is balanced and valuable. They also find it difficult to hold a reasonable discussion wherein everyone interacts. This is the usual reason for establishing an executive committee that includes a few key board members. more staff time is needed to coordinate board functions Large boards • More seats allow for inclusion of legal and financial advisors.21: Board size: advantages and limitations Advantages • Sense of ownership and responsibility for the work Limitations Small boards • Easier Communication and interaction • Board members know each other as individuals. It is easier to get this group together more often. subcommittees have the potential of lessening the effectiveness of the board. This situation can lead to the formation of subcommittees of the board where certain directors have greater expertise on a certain issue. So the general rule is to create few subcommittees. but to have them for at least audit and compensation.

Valuation The valuation of a biopharma asset is based on a thorough due diligence process that involves looking at the company and its prospects. a valuation depends on a set of projections and probabilities associated with anticipated revenues. It is also better to have an uneven number of board positions to avoid the problems that might arise from a tie vote. This section covers some practical concerns and general comments derived via interviews with venture capitalists and private equity firms. costs. The entrepreneur can mitigate much of this disagreement via good preparation and communication. These voting agreements usually contain provisions permitting the investor to designate board members and prohibiting the company from taking certain actions without the investor’s approval. The technical aspects of an asset’s valuation have been dealt with in Chapter 3. 82 . The bylaws of the venture should set a maximum number of directors and the board must endeavor to maintain this level. which leaves room for considerable disagreement between the negotiating parties. Based on such assessments. The actual valuation is a combination or art and science. At its core. net profits and most importantly. investors decide on what portion of the company’s total equity they will purchase.enough seats to control the board. It is necessary to check the appropriate governing legislation or accreditation guidelines to determine any regulations related to board size. the overall economic climate and cost of capital. cash flows related to a biomedical asset. the values for comparable assets. It is best to heavily negotiate these aspects at the term sheet stage of the transaction as they will restrict the entrepreneurs’ ability to run the company as they see fit. Investors normally require an agreement with the company and the other stockholders regarding the investors’ rights as a stockholder.

Hence in such a scenario. today’s existential realities dictate that the business strategy (and hence R&D mandate) must be kept fluid so that the firm can capitalize on 83 . For example. Most VC investors do not retain an asset till operational revenues via market launch start flowing in. if the investor is a venture capitalist who is unlikely to hold the asset until regulatory approval. but only by careful fiscal management and greatly reduced R&D goals.i.Most importantly for the seller. Pre-money valuation refers to the value of a company not including external funding or the latest round of funding. there were dire predictions on the fate of most small biotechnology companies because of their high burn rate and capital expenditure. Capital expenditure In early 2009. while post-money refers to its value after it gets outside funds or its latest capital injection. the pre-deal valuation must resonate with what the VC can realistically get for the asset at a certain point of time in the future. then. unless fresh funding was found. it is important to differentiate between the pre-money and post-money valuation. it would be cheaper to invest in fixed assets that are depreciated or amortized over a period of 4-10 years. most such biotechnology companies have weathered the storm. In the process of negotiations. Post-money valuation. both are valuation measures of companies. However. Pre-money refers to a company's value before it receives outside financing or the latest round of financing. In fact. this involves anticipating the preferred exit strategy of the target investor and building the valuation with this end in mind. includes outside financing or the latest injection. they would not be able to continue operations beyond 6-12 months. A barrage of research pointed to the fact that most small biotechnology companies had less than one year of working capital remaining. epidemiology-based revenue projections may be secondary to the perceived value as established by comparing the investor’s proposed exit transaction to similar transactions for assets with the same risk-reward profile.e. If business strategy was pre-determined and hence the R&D mandate kept unchanged.

The amount of funding required is directly proportional to the dilution of ownership existing investors will suffer. Single versus multiple investors Even in today’s recessive economic climate. a small biopharma company that offers a convincing value proposition will find many interested VCs and other private equity investors. Examples include the development of infrastructure and acquisition of equipment. Technically. “Capital expenditures (CapEx)” are expenditures that create future benefits. Thus investors are acutely sensitive to the capital expenditure requirements of the companies they invest in. Entrepreneurs must make it absolutely clear to potential investors that money will be carefully managed. especially for small biotechs for which acquisition is typically the ultimate objective. Such changing priorities have made it difficult for entrepreneurs to commit resources towards capital expenditure. In the currently recessive investment climate. and have made VCs wary of investing in companies that have committed resources towards fixed assets that may or may not be required as their R&D strategy evolves. much against the prevailing need of the hour. VCs prefer to invest in companies that minimize CapEx and carry out their activities via operational expenses. Therefore CapEx should be minimized and activities managed through operational expenditures. Fixed assets are ‘fixed’. The entrepreneur is left with a choice between sticking with one VC or 84 . Keeping a low CapEx to operational expenditure (OpEx) ratio is one way of being capital efficient. Thus strict control of ‘Capital expenditure’ has become a major part of the due diligence process of VC investors.new opportunities and extricate itself from failed projects. Such assets are typically ‘fixed’ and relatively illiquid. Companies requiring high levels of capital expenditure need to raise proportionately higher amounts of financing at each successive round of funding. leaving little room to maneuver and adapt business strategy to an ever-changing external climate.

Having a single investor often simplifies day to day management. the status of US FDA interaction and approval. the entrepreneur fate is more closely tied to that of the single VC. the agreements with employees and consultants such as contract research organizations. operational aspects of investor relations and communication can be more cumbersome for a thinly staffed biotechnology company. the status and estimated cost of upcoming clinical trials. Such issues are discussed in further detail in this next section of the report. contacts and strategic expertise that the investor can provide will be more limited in scope (as compared to a group of investors. Investor priorities in the new landscape During due diligence the investor will examine multiple aspects of the company such as the technical expertise of the founders and key scientific employees. the entrepreneur has to start from scratch once again. the in-license and outlicense agreements the company holds. if the single investor declines to participate in the next round of funding.gaining possibly larger funding via a conglomeration of investors. each with their own expertise and contacts). As always. With multiple investors.making it faster and less tedious. The overall transaction may even be more beneficial to the seller. On the downside. The industry networks. although this advantage is more than compensated by the greater availability of money and expertise. Moreover. although this is not necessarily the case. the patent and trademark/branding positions of the company and clearance over any third-party intellectual property (IP) in the space. and many other issues. the R&D pipeline and future patent protection. 85 . there are upsides and downsides of having a single versus multiple investors. the market conditions and competition. Such a possibility is greatly reduced if there are multiple investors in earlier rounds because there is a better chance that at least one investor familiar with the company and its technology will be able to participate in subsequent financings.

which depends on the nature of the product. The feasibility and probability of success of the product/technology. The investor will need clarity on the following issues to be convinced that the commercial focus of the venture is feasible. Identification of market segments. The level of differentiation again the current/ future standard-of-care and the product’s competitive advantage. The fundamental concepts behind these questions been covered in detail in Chapter 3. Market attractiveness and product-market-focus The first area of investigation is the target market and product-market focus.their size and rate of growth. 86 . Whether or not there is a genuine unmet need and the exact manner in which the product addresses the unmet need. The explicitness of the R&D plan and whether or not it can be executed. Likelihood of the company’s products being reimbursement by healthcare providers at the anticipated price points Likelihood of physician acceptance of the therapy. The company’s ability/strategy to establish a defensible market position based on the level of competition.There are certain standard questions that start-up biopharma/ medical device companies must ask themselves before seeking new investment. This is discussed in greater detail in Chapter 3. They all have the common goal of assessing the business opportunity. What follows below is a succinct recap of the key questions.whether it is a fast-follower to existing therapeutic options or a “brave new world” solution. Length of the sales cycle.

Experience of the founders and the respect they command within the industry. The problem is that evaluating management is difficult since many aspects of the job are intangible. but there are factors to which investors should pay attention. The company's capital needs in the current financing round. and whether or not it is in-depth. and success-oriented. the more additional capital a company requires. It is clear that investors cannot always be sure of a company by only poring over financial statements. the more the dilution of equity of the original investors. The ability of the team to build a large company. Ability of the company to attract new senior management/CEO. Before reaching out to the investment community. Financials As explained in the preceding sections. The team’s knowledge of the market. the entrepreneur must honestly address investor concerns related to the people behind the business. Most investors realize that it is important for a company to have a good management team. The track record of the CEO and other senior management leaders. There is no magic formula for evaluating management. Whether or not the team is passionate about the opportunity. entrepreneurs must put themselves in the investor’s position and answer questions that they would have concerns about. and over the life cycle of the company. The overall strengths and weaknesses of the founders. given a reversal in roles.The organization Since it is eventually the people that make or break a business opportunity. Some of these are discussed below. Whether or not the team is innovative. and the team’s open-mindedness. experienced. 87 . This is ever more important in the investment climate foreseen over the next five years.

The paths to liquidity and their timing. It must address issues such as: Whether or not the strategy is well conceived and clearly articulated. The eventual potential for growth of the company. early-stage biopharma investment is a buyer’s market. It is well known that the best scientists are not always the best businessmen. Hence. and clearly articulate how they will be addressed. investors need to be reassured that the people they are investing in are capable of making sound business judgments. Assessment of risks Both investors and entrepreneurs agree that nothing eventually goes as per plan. while continuing to manage daily activities that are essentially scientific in nature. The capital needs to achieve the eventual goal. in terms of size and scope. and communicates the astuteness of the entrepreneur as a businessman. there is a limit to the extent of managerial/ strategic input the investors can provide to a growing biopharma company. The explicitness of the company’s mission and roadmap to profitability. Business plan Although private investment is not passive by nature. the entrepreneur must be able to address the risks surrounding his or her proposal to the investor. An honest and upfront assessment of risks goes a long way in establishing trust. Therefore. Whether or not the numbers are realistic and achievable. Central to such reassurance is a sound business plan and strategy.The company’s ability to be financed in future. The company’s capital structure and ratios. In the current investment climate. The valuations for comparable companies. 88 .

and merger or acquisition agreements contain representations and warranties with respect to IP assets from the new business and often from founding entrepreneurs. In general. Such “freedom to operate” commercially is carefully assessed. often via lawyers familiar with IP Law. 89 . Therefore. At early-stage rounds of financing. Except as disclosed. an investor needs to make sure that a business owns the IP for its technology idea without any interference or encumbrance from any other party. Examples of typical representations include the following statements: The new business is the sole owner of the intellectual property. lease or other agreement to use the intellectual property. the new business does not interfere with intellectual property rights of a third party. It is usually the value of the intellectual property assets that the investor finances because the commercialization or divestment of the asset is dependent on the marketing exclusivity the patent protection provides. it is necessary to have “clean” ownership of any intellectual property (IP).What are the major risks? What is the magnitude of the risks? What is the risk/reward ratio? When will each of these risks be resolved? Intellectual property protection Intellectual property protection is the central theme of biopharma strategy. contracts for a strategic business partnership. suits or proceedings pending or threatened against the new business claiming that it is infringing any intellectual property rights of others. There are no actions. To the best knowledge of the new business. no person has infringed on the new business’ intellectual property rights. legal documents for an investment. To the best knowledge of the new business. the new business is not party to license.

90 .

CHAPTER 5 Top-line trends in venture financing 91 .

Chapter 5 Top-line trends in venture financing Summary US companies attract the most venture financing. The US and Canada will continue to remain the hubs of biopharma innovation in the next five years. followed by parts of California. France. the number of deals involving drugs in Ph II and Ph III trials has increased substantially. Private equity investors will prefer to invest in companies with late-stage clinical assets over companies with early stage assets in the next five years. 92 . Existing investors are reinvesting in assets they have already committed funds to because newer investors are demanding excessively dilutive investment structures that do not favor the existing owners. this number has increased to 14%. Italy and Spain. The financial crisis has not changed the geographic distribution of venture financing in any discernable manner. the ‘triangle’ comprising the areas of Boston. New York and New Jersey is clearly the leader. Among the top 10 regions. Certain states within the US are clearly the hotbeds of private equity investment in the biopharma sector. Based on the number of venture rounds financed since 2004. followed by companies in mainstream European countries like the UK. In terms of stage of investment. Germany. In the following three-year period (2007 to 2009). late-stage financing rounds constituted 2% of the total between 2004 and 2006.

000 Venture rounds and other details for more than 2. The details were taken from the MedTRACK Venture Finance database. 123.863 venture transactions. 516. mechanism-of-action. 636. 93 . or respond with educated agility to market news. The MedTRACK Venture Finance Database is the industry leader for breadth and depth of Venture Finance coverage. news. 653 indications. MedTRACK makes it easy to find the data you need. or clinical trial stage.008 biomedical companies worldwide. websites. a US-based biomedical data company that provides comprehensive pipeline. partnering. and announcements. Search functions reach into SEC filings. and patent information on 19. competitive product.008 companies. financial and venture information. find partnering opportunities. 57 countries. pipeline. The Venture Finance Database. The database contains 19.931 SEC filings and more. 93.000 biomedical companies covered in MedTRACK. 48. competitive products. 12.493 deals. The information can be sorted by parameters such as disease. provides comprehensive coverage of over 11. business and product descriptions.582 management contacts. It contains financial. which has been used in this chapter.681 drugs. sales. MedTRACK is the most comprehensive database of private and public biomedical companies. Users can drill down on company fundamentals to establish an opinion.253 drug delivery technologies. 1.How to use this chapter This chapter analyses 7347 venture financing rounds that have taken place over the past five years (January 2004 to April 2010). meeting abstracts. journals. MedTRACK is a product of Life Science Analytics.545 news pieces.

however. Venture financing The term “Venture financing” has been used if the company seeking investment is privately held and seeks private financing from a certain number of investors. 94 . they are likely to be relatively similar and can clearly be used to uncover insights based on top-line trends in venture financing. Seed ‘Seed financing’ or ‘seed money’ refers to the initial investment in a project or start-up company. a bank loan typically serves as a second level of funding. market research. whereas the VC funding is a source of longer-term equity capital that ultimately becomes the source of profit to the owners if the firm becomes successful. Banks tend to view entrepreneurial ventures cautiously and rarely make loans to newly organized businesses without taking collateral and if the business venture is a corporation. the bank loan becomes a source of working capital loan to finance conversion of inventory or receivables into cash receipts. If the entrepreneurs obtain VC financing.Definition of key terms To effectively utilize the information presented in this chapter. Start-up This refers to money used to start a business or purchase assets. A VC firm or private equity firm invests in a private company’s preferred. it is necessary to understand the manner in which the database has been structured. for proof-of-concept. personal guaranties of the starters. Venture subcategory terminology is explained below. The definitions used by MedTRACK may not be the same as those utilized by other companies. or initial product development.

but it is not ready to go to market. a company that receives early stage financing has been in business for less than three years. in relatively mature companies that are looking for capital to expand or restructure operations. enter new markets or finance a significant acquisition without a change of control of the business. production is underway and commercial activity is taking place. the investments made by late stage VC firms involve risks for those firms in order to gain profits. A detailed business plan is required to convince firms to offer late stage funding for business. financing has been referred to as ‘Early stage’ financing. Expansion funding is used to provide needed capital for the production process that can help generate profits. In some cases. the product may be commercially available in a limited manner but not yet generating revenue. Finding late stage venture investors can be a tricky process as certain criteria must be met for a company to be considered for late stage capital. VCs invest in firms that have a high potential for growth but are not ready to do an initial public offering of stock. Later stage Late stage capital (later stage) is business financing provided to established companies. 95 . In the expansion phase of development. Revenue growth is occurring and the enterprise typically is more than three years old. Growth/expansion capital Growth capital (also "expansion capital" and "growth equity") is a type of private equity investment. or seed. Vital to fund projects or support company growth. These investments tend to be both high risk and potentially high return.Early stage Financing provided by a VC firm to a company after it has received its initial. At this early stage the company has a product or service that it is in testing or development. most often a minority investment. Typically.

In the US. including a prohibition against general solicitation. Private placement Private placement is a term used specifically to denote a private investment in a company that is publicly held. or to establish a floor price for the public offer. They are normally structured to be repaid from proceeds of the IPO. The need for a bridge loan arises when a company runs out of cash before it can obtain more capital investment through longterm debt or equity. usually the final round of financing prior to an IPO. Other Financing which does fall under the above categories is classified as ‘other’.Mezzanine Mezzanine financing is a form of late-stage venture capital. Mezzanine financing is utilized by companies expecting to go public usually within 6 to 12 months. This exemption allows companies to avoid quarterly reporting requirements and many of the legal liabilities associated with the Sarbanes-Oxley Act. The SEC passed Regulation D (Reg D) in 1982 which clarifies how companies can be sure they are exempt from registration under the Securities Act. Such offerings exploit an exemption offered by the Securities Act of 1933 that comes with several restrictions. Private equity firms that invest in publicly traded companies sometimes use the acronym PIPEs to describe the activity. a private placement is an offering of securities that are not registered with the Securities and Exchange Commission (SEC). Bridge loan A bridge loan is a short-term loan that is used until a company can arrange a more comprehensive longer-term financing. Regulation D does include a notification requirement in Rule 503. 96 . Private placements do not have to be registered with organizations such as the SEC because no public offering is involved.

Italy. Spain. Switzerland and the Netherlands. Portugal. Italy. Sweden. Sweden. Korea. Spain. Hungary. Estonia.Countries attracting the most venture financing Figure 5. New Zealand. Taiwan. Belgium. Austria. Norway. Japan. Singapore. The same goes for investments in mainstream European countries. Israel 1 2 Year-to-date. Brazil. Finland 4 Includes: Australia.22 below presents the overall distribution of 97 . Malaysia. Scotland. Slovenia. France. They are followed by European companies in countries like the UK. Hong Kong. Iceland. Figure 5. Liechtenstein. Tunisia Business Insights Ltd Source: MedTRACK Venture Finance database. Germany.22: Geographic distribution of venture financing rounds 100% 80% % of financing rounds 60% 40% 20% 0% 2004 2005 2006 2007 2008 2009 2010 1 US/ Canada 3 Other European countries Mainstream European countries2 4 Other Asian countries India. Netherlands 3 Includes: Ireland. Switzerland. France. The proportion of investments in North American companies has remained relatively stable. 15-04-2010 Includes: UK. Germany. China. Denmark. Lithuania. Greece. author’s analysis US-based biopharma companies attract the maximum amount of investment and generate the maximum number of financing rounds.

Among the top 10 regions. Denmark. New York and New Jersey is clearly the leader. are marginal. Portugal. Estonia. Scotland. Lithuania. Italy. Brazil. As is apparent from the Figure 5. Figure 5. with Israel gaining the most from this shift. Belgium. Switzerland. 2008 and 2009. China and Israel have increased marginally. Finland 3 Includes: Australia. the specific country was either not mentioned or was ambiguous. China. Spain. Malaysia. 2005 and 2006.23 below. Norway.7347 rounds of venture financing by the geographic location of the company that was seeking investment. In 15 of the 7347 rounds. Israel 3% 3% US/ Canada 5% Mainstream European countries1 15% 1% 2007-09 5% 75% 74% 1 Includes: UK. Germany. These have been excluded from the analysis. France. if any. Slovenia. Japan. Recent trends The above data was segregated into two components: investments made in 2004. Hungary. and investments in 2007. Taiwan. Singapore. the ‘triangle’ comprising the areas of Boston. Korea. Netherlands 2 Includes: Ireland. Greece. It is interesting to note that investments in companies located in India. Iceland. Austria. author’s analysis Within the US. the trends. Sweden. Liechtenstein. certain regions are clearly the hotbeds of private equity investment in the biopharma sector. New Zealand. Tunisia Business Insights Ltd Source: MedTRACK Venture Finance database. Hong Kong. followed by parts of 98 .23: Trends in geographic distribution of venture financing rounds % of financing rounds 2004-06 3% 16% Other European countries2 Other Asian countries3 India.

2008-2009 12.000 Deal value (US$ million) 10. Full-year 2009 US Report Business Insights Ltd Conclusions It can safely be concluded that the US and Canada will continue to remain the hubs of biopharma innovation in the next five years.California.000 6. LA/Orange County reported the greatest drop in 2009 investment with a 53% drop followed by Texas with a 50% drop. The latter half of 2008 and all 12 months in 2009 experienced the financial crisis. Figure 5.24: US investments by region.000 2. Taken together. the top three regions—Silicon Valley. New England. PWC Money Tree.24 shows the distribution of investments (by value) across the US and also highlights the drop in 2009 versus 2008. However.000 0 Southeast LA/ Orange County San Diego Northwest DC/Metroplex Midwest New England Silicon Valley NY Metro 2009 2008 Source: Thomson Reuters. Figure 5. this has not changed the overall distribution of venture financing in any discernable manner.000 4.000 8. and New York Metro—accounted for 59% of VC backed funding and 52% of deals reported in 2009. 99 Others Texas .

Series H to Series Z.C. financing rounds have been grouped as follows: Early stage: includes rounds labeled ‘Start-up’. and Mezzanine rounds Figure 5. F and G Late stage: includes rounds labeled ‘growth/expansion capital’. ‘Series A’ and ‘Early stage’ Mid-stage: includes rounds labeled Series B. For statistical purposes.25: Total number of financing rounds by stage. 2004-2010 1400 1200 Number of rounds 1000 800 600 400 200 0 2004 2005 2006 Mid stage 2007 2008 2009 2010* Early stage Late stage Not-specified * Year to date (April 2010) Source: MedTRACK Venture Finance database. D.25 presents the distribution of venture financing rounds by stage type (as defined at the beginning of this chapter). E. author’s analysis Business Insights Ltd 100 .Distribution of venture financing rounds by investment stage Figure 5.

such as better reporting from the involved parties (the investor. or because it was ambiguous. author’s analysis Business Insights Ltd Recent trends The following points are clear from the data above: The number of investments in which the stage is not specified has decreased substantially. Figure 5. entrepreneur and business media). 2004-2010 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2004 2005 2006 Mid stage 2007 2008 2009 2010* % of financing rounds Early stage Late stage Not-specified * Year to date (April 2010) Source: MedTRACK Venture Finance database.A number of financing rounds did not have a clear stage associated with them. The data above is presented in Figure 5. and better data-gathering methodologies. 101 .26 below as a percentage instead of absolute numbers. In total. This is due to a combination of factors. the stage of investment was not specified in 2743 rounds of venture financing between 2004 and April 2010.26: Distribution of financing rounds by stage. This is either because the stage was not disclosed by the investors.

Closer analysis of financing rounds in Q1 of 2010 reveals that almost all investments were for growth-expansion capital. This is detailed further in the next section of this chapter.27: Trends in financing rounds by stage. The financial crises has decreased the ability of investors to hold-out for long. It clearly reflects investor preference for companies that offer exit-strategies in the near-term time horizon. This possibly implies that a select group of companies that are nearing their exit-strategy time horizons are being granted additional funding by existing investors. 2004-2019 2004-06 2% 46% Not. In the following three year period (2007 to 2009). this has increased to 14%. late-stage financing rounds constituted 2% of the total between 2004 and 2006.27 below. As can be gleaned from Figure 5. and those wanting investment exposure to the biopharma sector are clearly focusing on companies with late-stage clinical assets.specified Early stage Mid stage Late stage 2007-09 % of financing rounds 14% 31% 28% 31% 24% 24% Source: MedTRACK Venture Finance database. author’s analysis Business Insights Ltd 102 . Regardless of possible data gathering errors.The number of late-stage deals has increased substantially. Figure 5. this is a remarkable leap in magnitude.

They can be looked at chronologically. author’s analysis Business Insights Ltd It is apparent from the data above that most early stage rounds comprise Series A funding. 2004-2010 350 300 Number of rounds 250 200 150 100 50 0 2004 2005 2006 2007 Series A 2008 2009 Early Stage 2010 Start-up/ Seed Source: MedTRACK Venture Finance database. and the first round of formal venture backing (the Series A component). Mid and Late stages defined above. “Early Stage”. specifically to shed more light on the composition of Early. Figure 5.Further analysis of financing rounds by stage This section of the report delves deeper into the financing rounds by stage. ‘Early Stage’ and ‘Series A’.28: Early-stage funding by type. as the initial investment required to get a company off the ground. A possible reporting bias that needs to be highlighted here is that most startup/seed/early stage financing rounds are small in magnitude. as categorized in the preceding section comprised of investments that were labeled ‘Start-up/Seed’. and are hence not reported 103 .

It is also important to note that the time-horizon for an exit for the investors funding 104 . This may account for the greater share of Series A rounds in the analysis above. For this reason. Although two to three clinical milestones are commonly applied. 2004-2010 500 400 300 200 100 0 2004 Series B 2005 Series C 2006 Series D 2007 2008 2009 Series F 2010 Series G Number of rounds Series E Source: MedTRACK Venture Finance database. and these may translate into two to three rounds of financing. multi-step sequence of financing rounds. Not all companies go through a formal. Figure 5. reach beyond Series C financing. with much wider clinical scope. This reflects the poor potential of IPOs for biopharma companies in today’s climate. author’s analysis Business Insights Ltd A closer analysis of late-stage financing rounds reveals that the majority of investments are for growth/expansion capital.by the business media with as much diligence. Strong companies with solid future potential but without the ability to ‘go public’ are attractive candidates for venture financing. Only the larger companies. it is not a hard and fast rule. where the bulk of public offerings are not fully subscribed to or are heavily discounted. the majority of mid-stage investments comprise of Series B and Series C rounds.29: Mid-stage funding by type.

Figure 5. author’s analysis Business Insights Ltd Conclusions Private equity investors will prefer to invest in companies with late-stage clinical assets over companies with early stage assets in the next five years.30: Late-stage funding by type. companies with early stage assets have two choices. This may possibly be the way forward over the next two to three years. The first is to seek investments from existing investors who already have a stake in the future of the company. Figure 5. The second option is to seek creative risk-sharing investment structures that are conditional upon successful completion of specific clinical milestones. although the risk may be higher. It is important to note that at the present moment. To counter such dilution. 2004-2010 300 Number of rounds 250 200 150 100 50 0 2004 2005 2006 2007 2008 2009 2010 Growth/ Expansion capital Other late-stage rounds/ Mezzanine Source: MedTRACK Venture Finance database. large pharmaceutical companies are better 105 . Companies that do attract investments at the early stage will do so at the cost of earlier investors because the transactions are likely to be excessively dilutive to their existing ownership structure.30 below details the distribution of late-stage financing rounds.growth/ expansion rounds is shorter than for those funding early stage rounds.

positioned to devise such risk-sharing structures. the sophistication of VCs and their understanding of the clinical development process is increasing rapidly. However. 106 .

CHAPTER 6 Investment choices of most active firms in 2009 107 .

Chapter 6 Investment choices of most active firms in 2009 Summary The MedTRACK Venture Finance database was used to identify the investors that participated in the maximum number of financing rounds in 2009. This reflects their local investment mandates and the greater ease of dealing with companies located close by. European firms invest in a greater range of countries. Over 50% of total financing by value and over 50% of the rounds of financing fall under these three categories. industry segment. oncology therapies and medical devices.6% share in terms of investment value. 108 . 9. The investments of these top investors were segmented on the basis of their therapeutic area of focus. Most of the top 15 investors are from the US and hence invest primarily in USbased companies. Nearly a fifth of all money invested was targeted at oncology therapies. Unlike traditional VCs. not only within Europe but in other Asian and North American destinations.2% of financing rounds were in companies located in Europe. but oncology’s share in terms of number of deals is comparatively lower (<10%). Deals in Europe tend to be fewer in number but greater in scope of financing. which commanded a 12. Corporate Venture Capital arms of large pharmaceutical companies are becoming increasingly active and visible members of the VC community. stage of investment and investment destination. A large proportion of companies that successfully raised VC funding in 2009 have a focus on biotechnology-based approaches to medicine. many CVCs are set up as evergreen funds that aim to combine financial motivations with the overarching strategic motivations of their parent organizations. This highlights the fact that clinical development of oncology products involves large scale and expensive clinical trials.

It does not address the size of the investments or their scope. J&J Development Corporation Pittsburgh Life Sciences Greenhouse Source: MedTRACK Venture Finance database Number of rounds 21 20 20 20 19 17 17 16 16 15 15 14 14 14 14 Country Switzerland USA USA USA USA USA USA Denmark USA USA USA UK Canada USA USA Type Corporate Independent Independent Independent Independent Independent Independent Corporate Independent Independent Independent Independent Independent Corporate Independent Business Insights Ltd 109 . Table 6. Polaris Venture Partners Versant Venture Management LLC Domain Associates.6: Most active venture investors in 2009 Firm Novartis Venture Funds Kleiner Perkins Caufield & Byers New Enterprise Associates. Inc. Please note that the activity is tabulated using number of rounds only. Ltd. LLC SV Life Sciences Novo A/S Texas Coalition for Capital (non-profit) InterWest Partners LLC MPM Capital Abingworth Management Limited GrowthWorks Capital.Most active venture capital investors in 2009 The MedTRACK database was used to highlight the firms that participated in the largest number of venture financing rounds in 2009.

The presence of three corporate funds of large pharmaceutical companies highlights the growing importance of such VCs. Table 6. 2009 Disease Area Autoimmune Diseases Biotechnology Cardiovascular Central Nervous System Disorders Diagnostic Drug Delivery Drug Discovery/ Development Infections Medical Device Metabolic Diseases Oncology Ophthalmology Other Pain Respiratory Diseases (General) Services Technology Source: MedTRACK Venture Finance database Number of investments 14 38 4 9 13 4 7 10 71 8 21 13 7 5 4 10 12 Business Insights Ltd 110 . given their strategic motivations.It is clear that most of the active investors are from the US. stage of investment and investment destination. Further discussion highlights the specific preferences of each firm. they provide an appropriate sample to investigate the investment preferences of the broader community. industry segment. The goal of this analysis is to seek patterns from the data and link it to the general economic climate prevalent in 2009.7 lists the number of venture financing rounds by the R&D focus of the company seeking funds. Therapeutic areas of focus Table 6. Even though the strategic motivation of the firms listed above varies from non-profit firms to purely profit driven investment firms to CVCs that combine financial goals with more strategic ones. Analysis of investment preferences The investments of these 15 firms in 2009 were first analyzed by segmenting them on the basis of their therapeutic area of focus.7: R&D focus of top 15 venture investors.

2009 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Size of investments Number of investments Biotechnology Ophthalmology Diagnostics Medical Device Autoimmune Diseases R&D platforms & Drug Discovery Oncology Central Nervous System Disorders Others Source: MedTRACK Venture Finance database. oncology therapies and medical devices.31: Preferences of top 15 venture finance investors. and are not static in nature. A large proportion of companies that successfully raised VC funding in 2009 have a focus on biotechnology-based approaches to medicine.31 above further compares the percentage of deals within a disease area to the overall amount invested in those disease areas by the top 15 venture investors of 2009. Figure 6.It is important to note that the disease area specified above does not have to be the only focus (or core competence) of the biotech company. The labels have been chosen after studying the press releases. Over 50% of total financing by value and over 50% of the rounds of financing 111 . corporate websites and reports on the companies gaining investment. They aim to reflect the primary focus of the company as of the date of investment. authors analysis Business Insights Ltd Figure 6.

VC investors are clearly taking on the responsibility to nurture the early stage medical device projects in the hope of successfully commercializing them via alliances with big pharma. Another area of focus for these companies is medical devices. Big pharmaceutical companies urgently need to bolster their product portfolios with successful drug-device combinations. 112 . It also highlights the fact that clinical development of oncology products involves large scale and expensive clinical trials. Nearly one-fifth of all money invested was targeted within oncology. but oncology’s share in terms of number of deals is comparatively lower in proportion (<10%).fall under these three categories. This reflects the commercial importance of oncology as a therapeutic area and the potential for biotechnology based approaches to tackle its major challenges. yet this is not their core competence.

This reflects their local investment mandates and the greater ease of dealing with companies located close by. 113 .2% 84. European firms invest in a greater range of countries.6% 1.20% 1. Figure 6.80% 9. 9. authors analysis It highlights the following trends: Most of the top 15 investors are from the US and hence invest primarily in USbased companies. not only within Europe but in other Asian and North American destinations.40% 85.6% share in terms of investment value. 2009 Investment destinations 4.Investment destinations by geography Figure 6.32 below captures the investment destinations of the 15 most active venture firms in 2009. which commanded a 12. Deals in Europe tend to be fewer in number but greater in scope of financing.2% of financing rounds were in companies located in Europe.8% 12.60% Investment amounts 0.4% Canada Europe Other USA Business Insights Ltd Source: MedTRACK Venture Finance database.32: Preferences of top 15 venture finance investors.

Stage of investments As is apparent from Figure 6. implying that the companies which gained investment had at least one established source of revenue. Business Insights Ltd In terms of actual money invested. only 2% of financing rounds that the top 15 investors participated in were for start-up and seed investments.33: Number of deals by investment stage.33 below. This reflects the highly evolved partnering mindset prevalent in the country but a lack of large scale capital injections. Figure 6. B and C investments have over 50% share in terms of money invested and number of rounds of financing. start-up and seed investments constituted 12% of 114 . 18% of the investments were meant for growth/ expansion activities. …. but mostly for small amounts of capital. Nature Biotechnology. Series A.Canada is witnessing significant deal activity. This reflects the current preference for companies with late-stage R&D assets.. 2009 Number of deals 2% 10% 12% 21% 10% 14% 15% 10% Amount invested 18% 23% 12% 12% 10% 31% Not Specified Series B StartUp & Seed Growth Capital/Expan Series C Series A Series D+ Source: Novartis venture Find portfolio analysis.

115 . CVCs invest it in entrepreneurial start-ups at all stages of development.6 also distinguishes the active VC firms by their strategic orientation. The profiles of these four VCs are meant to provide a snapshot of the broader community.the total. Two types of venture investors Table 6.” Such funds raise money not only from their parent corporation’s internally generated cash but also from external sources such as pension funds. to which it may also provide management and marketing expertise. etc. CVC is defined as the "practice where a large firm takes an equity stake in a small but innovative or specialist firm. As a group. SV Life Sciences and Texas Coalition for Capital are examples of two independent VC firms. Novo A/S and Novartis Venture Fund are two CVC firms highlighted in this chapter. fund of funds. Chapter 4 deals with independent venture capital firms which are primarily motivated by financial returns. the CVC sector mirrors the broader VC sector. Corporate venture capital firms combine financial motivations with strategic ones. It is important to distinguish between ‘corporate’ venture capital (CVC) and ‘independent’ venture capital. managed to raise a relatively large share of the total capital invested by this group of 15 investors. This implies that relatively few companies (2% in terms of rounds). The distribution of investments across industry sectors for both independent and corporate VC investors is markedly similar. with funds specializing by stage of development and industry. the objective is to gain a specific competitive advantage.

the funding of new internal ventures that. Firstly. Investments that fall under the more general rubric of "corporate venturing"—for example. On the one hand we have cash-starved biotechs which cannot generate money via IPOs and are faced with increasingly unattractive term sheets and highly dilutive investment structures from the few private investors that are still capable of investing. and perhaps most 116 . Finally. remain legally part of the company. The parent pharma/ biotech company is investing. The following exclusions are important in differentiating CVC from other strategic investment vehicles. even if the investment vehicle is funded by and specifically designed to meet the objectives of a single investing company. They have greater patience for the typically long lead times in biopharma R&D. their hurdle rates are lower. while distinct from a company's core business and granted some organizational autonomy. They clearly have a much reduced capacity to invest and are scaling back their operations. rather. without using a third party investment firm. in an external start-up that it does not own. Meanwhile CVCs backed by the low-leverage financial structures of big pharmaceutical companies do not suffer from many of the restrictions facing independent VCs. CVC excludes: Investments made through an external fund managed by a third party. it is a specific subset of venture capital. Emerging role of CVC in Life Sciences The asymmetric access to finances in the aftermath of the credit crisis has created the perfect environment for big pharmaceutical companies to extend their capabilities beyond their core R&D focus via CVCs. Other traditional investors such as hedge funds and VCs are hampered with high hurdle rates and long lead times to an exit.Corporate Venture Capital (CVC) funds Corporate venture capital is not synonymous with independent venture capital.

It has also been noticed that the most successful biotech-CVC deals are those that strengthen the parent company’s core portfolio. Similar results are claimed in terms of long-term valuations. rather than those that explore adjunct business areas. investment funds set up by big pharma companies are beginning to dominate early-stage financing of biotech firms CVC programs are clearly of interest to biotech entrepreneurs as a source of funding for start-up ventures. Some studies have revealed that the overall success rate of clinical programs is higher when a small biotech firm partners with a CVC fund (compared to deals with independent venture capital funds). clearly illustrating the higher rate of success at a lower cost (Figure 6. management focus and time. CVCs offer a more efficient opportunity to achieve the same ends. CVC has emerged as a very effective way to achieve the same objective. collaborations. in the hope that they hit upon the ‘next big therapy’.34) 117 . Strategic motivations The reasons behind a large pharmaceutical company’s intentions to utilize CVC are numerous and are clearly illustrated by looking at similar venture funds in the IT/ Telecom space. their big pharma lineage gives them a better understanding of the challenges facing nascent biopharma companies. As high hurdle rates temper the appetite of traditional VC for startup investments. While the large pharmaceutical firms are ‘externalizing’ their drug discovery and development in many ways (in/out licensing. Internal R&D initiatives geared towards such an end require financial resources. Big pharmaceutical companies are especially keen in hedging their bets across multiple lines of clinical investigation.importantly. etc). A portfolio analysis of the Novartis Venture Fund compares the success of developing the R&D pipeline using the traditional internal approaches and a CVC fund. M&A.

The motivation of the CVC typically involves leveraging and/or upgrading the core competencies of its parent pharmaceutical company. the parent company has less interest in short-term financial returns. 118 . Ostensibly.400 million Ph III / Registration Phase I / II Preclinical 2 29 42 Source: Novartis Venture Find portfolio analysis. where investments are recycled into the fund and not transferred to the parent company’s bottom line. indicating a primarily strategic rather than financial focus. reserving its right to play in alternative markets/technologies and finally building a networked ecosystem.Figure 6. Nature Biotechnology 2008 Business Insights Ltd Many CVC funds were organized as evergreen funds.34: R&D performance scorecard TYPICAL MID-CAP PHARMA COMPANY R&D spend: US$ 1800 million Ph III / Registration Phase I / II Preclinical 6 16 19 EARLY STAGE VC (Novartis Option Fund) R&D spend: US$ 300 .

The fund was initially allocated a limited amount of financing in the belief that sources for entrepreneurship were situated both within the existing company and within local academic institutions. or supplier networks. indicating a primarily strategic rather than financial motive. Novartis Venture Fund The Novartis Venture Fund (NVF) was organized as an evergreen fund. 119 . Both of these groups possessed limited expertise in starting a business and welcomed the NVF’s guidance in addressing key business issues. CVC programs may not only realize value through leveraging and upgrading core competencies and reserving the right to play in alternative technologies or markets. where investments would be recycled into the fund and not transferred to Novartis’ bottom line. Academic researchers and former Novartis scientists founded most of the portfolio companies. Resource upgrade: new complementary technologies that could be used in corporations’ business units. but also through the network the company develops from the portfolio of investments. gaining access to product development expertise. CVCs can also provide “strategic feelers” to identify early substitute technologies/markets and to co-opt them through minority investments. Resource combination: co-development of R&D assets or joint task forces. brand names.Leveraging and/or upgrading the core may come from the transfer of resources from the corporation to the venture (leveraging) or from resource combinations or the transfer of resources from the venture to the corporation (upgrading). transfer of key staff. Resource transfer: of the venture leveraging the corporation’s existing distribution channels. The minority investment (rather than a full scale acquisition or full scale development program) can be seen as a learning option/probe/hedge into a new technology or market that the parent company has not pursued internally but considers worthy of interest.

The initial equity investment is coupled with an option to a specific project.Figure 6.35: Novartis Venture Fund investments in 2009 30% 25% Product/ technology focus 20% 15% 10% 5% 0% 3% 6% 22% Stage of investment 39% 30% Not specified Series A Series C Source MedTRACK Venture Finance database. the scope/ duration of the option is limited and the subject of the option is not necessarily even an active program for the start-up at the time of investment. author’s analysis Growth Capital/Expan Series B Business Insights Ltd Currently NVF operates two funds. the ‘Venture Fund’ and the ‘Options fund’. In 120 . The Options Fund seeds innovative start-up companies during their earliest stages. The option’s structure is meant to remain consistent with the new company’s corporate development plans.

Its primary focus is on the development of novel therapeutics and platforms. NVF invests in areas of therapeutics. and drug delivery.addition to the non dilutive cash payment to secure an option to a specific program. This unique funding structure allows Novo to take a longterm perspective in its investments and also has the advantage that it precludes some of the restrictions to which traditional VC funds are subject. Novo A/S. Spain and Ireland were among the investment destinations. for instance when they pursue investments in the interim between a fully vested and a newly raised fund. There were roughly equal investments in European and US companies. Denmark Novo A/S’ approach to VC investments is unique due to its special ownership structure. 121 . Novo’s venture investments are structured as an ‘open evergreen’ fund with a single investor. its venture investments are fully independent of the two major Novo Group companies. medical devices. Although Novo owns significant shareholdings in Novo Nordisk A/S and Novozymes A/S. diagnostics or drug delivery systems. Investments in 2009 were spread over a wider range of destinations. license terms are negotiated at the time of investment and are based upon benchmarks that are relevant for the stage of the asset at the time the option is meant to be exercised. Switzerland. UK. with the intention of enhancing the therapeutic focus with investments in medical devices. diagnostics. Within Europe. reflecting the European headquarters of the parent company.

Areas of focus include: Products for diagnosis.36: Novo A/S ownership structure Novo nordisk foundation 100% ownership 25% ownership Novo Nordisk Novo A/S 25% ownership Novozymes Novo seeds Pre-seed and seed programs aimed at identifying unexplored commercial potential in academic and arly stage applied research projects Novo ventures Novo growth equity Invests in late stage private or public life science companies emphasis on late clinical/commercial stage product Novo finance Responsible for financial investments. HR.from seed capital over private placements to IPOs and public companies.Figure 6.e. IT . i. in any part of the world. legal affairs Source: Novo Annual Report and company website Business Insights Ltd Novo A/S seeks opportunities in which the financing amount varies from €1 to €15 million. The strategy is stage and location-agnostic. nutrition and health for humans and animals Development of sustainable solutions for the environment. may occur at any stage of development of a business idea . control. and prevention of disease Development and application of biotechnology Instruments and medical devices Improvement of food. treatment. accounting and reporting. 122 .

Novo seeks to add value for investment partners by providing access to scientific and business expertise through board participation in the areas like: Intellectual property rights Scientific evaluation (through internal/external networks) Strategic business development Licensing and collaborations 123 . by the fund managers. 2000-2008 Accumulated number of companies 2008 2007 2006 2005 2004 2003 2002 2001 2000 60 50 40 30 20 10 0 0 500 1000 1500 2000 2500 0 Accumulated investments in DKK million Private Exits Direct investments Venture funds Source: Company website Business Insights Ltd In extraordinary situations.Figure 6. a trade sale or a merger. in dialogue with the portfolio company. Typical exit strategies could be an IPO. the firm provides funds on a smaller scale for embryonic start-ups. Due to the structure of the fund it can justify making investments with a longterm perspective.37: Novo A/S investments. In addition to financial support. The exit strategy is determined on a case-by-case basis.

38: Novo A/S investments in 2009 25% 20% Product/ technology focus 15% 10% 5% 0% 3% 13% 36% Stage of investment 39% 10% Growth Capital/Expan Series B Series D Source: MedTRACK Venture Finance database Series A Series C Business Insights Ltd 124 .Financing strategies Figure 6.

SV Life Sciences currently advises or manages five funds with capital commitments of approximately $2. The firm invests in equity or near equity securities in private businesses. medical devices and healthcare information technology. The invest amounts of between $1m and $40m in North America and Europe. Like other VCs. Its investment in PanOptica highlights 125 . SV Life Sciences SV Life Sciences Advisers LLP (formerly known as Schroder Ventures Life Sciences) is a venture capital firm with a focus on the human life sciences sector. Among the five funds is the International Biotechnology Trust ('IBT'). an investment trust vehicle listed on the London Stock Exchange into which both corporate and private investors may invest. Investment focus in 2009 All of the firm’s investments in 2009 have been in US-based companies. more typical VC firm. This section profiles two independent VC firms from among the Top 15 life sciences VCs in 2009. and sometimes in smaller public companies. It has offices in Boston.Independent venture capital funds The motivations of independent VCs have been discussed at length in previous chapters. SV Life Sciences is a for-profit. whereas the Texas Coalition for Capital is a non-profit group with a more regional mandate. SV Life Sciences has maintained a clear focus on the ophthalmology therapeutic area with six of its 16 rounds of investment being in companies that either target diseases related to the eye (specifically back-of-the-eye diseases). but they are open to considering innovative investments in other regions. London and San Francisco.0 billion. including bio pharmaceuticals. SV Life Sciences invests in companies that combine good management talent and a business model that provides a strong increase in value while maintaining competitive positioning via strong patent protection.

39: SV Life Sciences investments in 2009 60% 50% Product/ technology focus 40% 30% 20% 10% 0% Biotechnology Medical Device Inf ections Autoimmune Diseases 4% 2% 21% Stage of investment 20% 53% Later Stage Series A Series B Series C Source: MedTRACK Venture Finance database Business Insights Ltd 126 Ophthalmology Series D . Figure 6. Panoptica is a US based company which acquires late stage ophthalmology assets and finishes the clinical work to the next value inflection point.this focus.

Other therapy areas of interest for SV Life Sciences include autoimmune/ inflammation and infections. captive VC funds of big pharma companies are often seen as the co-participants in SV Life Sciences’ rounds of funding. as is Google Ventures in projects where computational biology plays a significant role.There is also a clear focus on medical devices. To date. the TETF has allocated $127. Texas Coalition for Capital The Texas Coalition for Capital is a non-profit. many of which are linked to the ophthalmology space. None of the investments have been in companies that focus on small molecule therapies.5m dollars to Texas companies and partnering universities. The TETF provides up and coming technology entrepreneurs in Texas with the support needed to develop and commercialize new technologies. 127 . The Texas Emerging Technology Fund (TETF) was created by the Texas Legislature at the urging of Governor Rick Perry in 2005 and reauthorized in 2007. thereby creating a deal flow infrastructure that will serve the state well for many years to come. and most have clear big-pharma validation. For example. Six of its 16 investment rounds have been in companies developing medical devices. many of which have ties to universities. statewide coalition of leaders supporting economic development and job creation through long-term access to capital for Texas entrepreneurs and emerging companies.

Figure 6.40: Texas Coalition for Capital investments in 2009 35% 30% 25% Product/ technology focus 20% 15% 10% 5% 0% Biotechnology Diagnostic Medical Device Oncology Other Autoimmune Diseases Stage of investment 44% 56% Not specified Growth Capital/Expan Source: MedTRACK Venture Finance database Business Insights Ltd 128 Technology .

2009. Global Private Equity Report 2010. Ernst & Young 129 . BVCA The Role of Corporate Venture Capital Funds in Financing Biotechnology and Healthcare: Differing Approaches and Performance Consequences. James Henderson IMD MoneyTree Report 2009.Chapter 7 Appendix Research methodology A combination of primary and secondary research sources were used to write this report. NATURE Vol 465|17 June 2010 Beyond business as usual? The global perspective. A list of sources used is given below. BIO CEO & Investor Conference 2008 British Venture Capital Association National Venture Capital Association Health care reform’s new $1 billion therapeutic research projects program. BVCA A Guide to Private Equity 2010. Pricewaterhouse Coopers. Ernst & Young Swiss Biotech Report 2008 Recap Consulting Global Investor Attitudes to Private Equity in the UK 2009. Bain & Co US biotech firms line up for tax credits. National Venture Capital Association Valuing a Technology Platform .

NATURE Biotechnology Mar 2010 Biotech sector ponders potential ‘bloodbath’. NATURE Biotechnology May 2010 Coming to terms. Dec 2006 Seeking the biotech eBay. Private Equity Industry Guidelines Group The rise of option agreements. NATURE Drug Discovery. NATURE Biotechnology Exit strategies in Europe. NATURE Biotechnology Mar 2010 Coming to terms. NATURE Biotechnology Feb 2010 Other ways of financing your company. NATURE Biotechnology Feb 2010 Deals that make sense. NATURE Drug Discovery. NATURE Biotechnology 2008 130 . Mar 2010 The lengthening handshake. June 2010 Biomarkers: the next generation. NATURE Drug Discovery. NATURE Biotechnology Apr 2010 Negotiation 2.Updated US Private Equity Valuation Guidelines. NATURE Biotechnology June 2010 Avoiding capital punishment. NATURE Biotechnology. NATURE Bioentrepreneur Aug 2006 Selling out. NATURE Biotechnology Feb 2008 Trends in discovery externalization. June 2010 Report concludes industry–academia partnerships on the wane. NATURE Drug Discovery. NATURE Biotechnology Jan 2009 Beyond venture capital. NATURE Biotechnology Dec 2009 Six steps to successful financing.0. Jan 2010 Avoiding premature licensing.

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28 Common stock. 113. 90. 113. 72 . 21 China. 76 Grant. 90. 38. 30 GSK. 115 Macroeconomic. 10. 49 Angel investors. 31 Licensing. 95. 96 Joint venture. 46. 130 Japan. 124. 43. 68. 95. 107. 48 Kurma Biofund. 13. 23 CEDD. 90. 64 France. 25. 128. 126. 122 M&A. 95. 96. 124. 70. 113. 54. 95. 96. 94. 31 UK. 78. 55 Due diligence. 10. 27. 130 SV Life Sciences. 90. 48.Index Alliance. 23 Mezzanine investors. 11. 81. 119 Corporate venture capital. iii Spain. 9. 95. 120. 127 Therapeutic Discovery Project Program. 59. 44 India. 121. 90. 13. 122. 21. 31 Term sheets. 70. 73 Canada. 54 Real options. 45 Sales. 126 Government. 114 Preferred stock. 15. 96. 96 IPO. 95. 106. 71 Bill and Melinda Gates. 78 Discounted cash flow. 52. 112 Capital. 96 132 Texas Coalition for Capital. 97. 107. 107. 21. 13. 54. 128 Capital expenditure. 107. 107. 125. 114. 107. 82. 29 Board. 31 TDR. 50. 96. 56 Options. 13. 54. 56. 79 Buyout investors. 123 Comparables. 120 Germany. 1. 92. 16 Medicare. 13. 20. 101 Funding. 120. 96 Non-dilutive. 29 Grand Emprunt. 14. 31. 78 Novo A/S. 36. 36. 82 NHS. 130 Seed. 122 Italy. 18. 113. 41. 44 NICE. 55. 28. 13. 81. 71. 38. 28. 54. 68. 90.

94. 80. 111. 11. 124. 128. 129 Valuation. 83. 90. 120. 108. 13. 95. 29. 97. 91.US. 20. 31. 106. 129 Venture capital. 23. 72 133 . 53. 14. 96. 52.

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