The structural changes roiling the pharmaceutical sector are driving innovation of biotech business models. With shrinking operating margins, patent expirations, a paucity of new product launches, significant reimbursement pressure, and an unpredictable regulatory environment—Big Pharma’s high risk bets on early stage biotechs of the past decade look cavalier through the lens of the current market environment.
The days of multi hundred million dollar upfront payments to acquire early stage biotech companies are likely gone for good, creating an exit trap for early stage private company investors. This trend is proving challenging to the sustainability of the venture capital model of the past. Various prognostications are that one quarter to one half of venture capital firms will disappear in the coming few years. The old biotech model of building early stage companies with loads of venture capital in the hope of a rapid Big Pharma acquisition at a large multiple to the invested capital, now seem oddly prosaic. Risk-sharing, earnouts, and contingent value right (CVR) agreements are the order of the day. The strategy of going public looks even more remote in today’s market. So, with that gloomy backdrop what does the future hold for those of us not ready to hang it up and head to the golf course?
Amidst all this turmoil a couple of things remain constant. The pace of innovative research and discoveries by our talented scientists in the public sector has not slowed; and pharma’s need for promising compounds is more dire than ever. However, the way in which one reaches the other is in flux at the present time, presenting a challenge but also an opportunity. In its latest efforts, pharma seems to be trying to sidestep the richly priced acquisitions and licensing deals of previous years by cutting out the middle market and going directly to the source – with a recent trend for generously funded research collaborations being doled out to top tier universities. Whether pharma has the agility to stock its pipeline through this mechanism without relying on biotech companies seems unlikely.
In the meantime, one biotech model gaining traction is the single asset, infrastructure-lite, development model, which deploys modest amounts of capital to develop a single compound to an early clinical data package which can be partnered with pharma. The asset resides within an LLC, and following the license transaction, the LLC is wound down and distributes the upfront, milestone and royalty payments to the LLC members on a pro rata basis. The key to success in this model is choosing the appropriate asset/indication – one where it is possible to get to a clinical data package on limited capital. This approach excludes many molecules and indications often favored by biotech, and tends to drive towards clinical studies using biomarkers – directly in line with one of pharma’s favored strategies.
The model seems to be gaining popularity in large part due to the fact that the probability of an M&A exit for any given private early stage biotech company is approximately 2 percent, and the probability of a licensing transaction on an attractive asset with early clinical data may be 30 to 50 percent. So on a risk-adjusted basis, the return profile of the single asset LLC model makes good sense for a growing number of investors with the flexibility to invest in these structures. The structure is also very motivating to founders and development teams since there is a real possibility of retaining undiluted equity ownership and reaching membership distributions of licensing revenue in the near term. That is something that has proven elusive for the scientific founders of more typically capitalized venture-backed companies.
With these principles in mind, we have recently founded Resolve Therapeutics, LLC and have begun work on a compound sourced from the University of Washington, discovered by researchers and scientific co-founders Keith Elkon and Jeff Ledbetter. In addition to the scientific founders, Resolve has built a highly experienced development team to advance the asset from preclinical research to an early biomarker phase IIa study in lupus patients, with the goal of partnering upon the successful completion of the study. As the team hones the model and strategic relationships are formed with key vendors, the next assets are coming into focus.
