Is there such a thing as a “garage biotech”? According to a 2007 study by the Ewing Marion Kauffman Foundation, a nonprofit devoted to entrepreneurship, 40% of youths between the ages of eight and 21 say they would someday like to start their own business. In our highly entrepreneurial society, risk-takers and innovators propel our continued economic growth. With little funding, today's biotech startups, working on shoestring budgets, have sometimes been termed garage biotechs.
The seeds of a biotech startup often have their humble beginnings deep in the trenches of academic laboratories. A professor or post-doc may work on a promising technology for years before the outside world ever hears about it. Starting out in the world of “publish or perish”, the entrepreneurial researcher pursues an altogether different calling, where protection of IP is of utmost importance, where the world becomes, “publish AND perish.” Because of our antiquated patent system, any previously published invention cannot be patented. As the scientist becomes an entrepreneur, goals must be realigned.
During the early stages of development, startup biotechs have no saleable products- there is only an idea and a promise. At least initially, the customer is likely to be its investor; the startup therefore must take into account what this customer is shopping for. Investors such as VCs, pharma and biotech companies, and the public market, each have different expectations and requirements. The major investor for startups is likely the VC.
For a startup seeking Venture Capital financing, an exit strategy should be a an integral part of its planning. As Bob Mulroy, CEO of Merrimack Pharmaceuticals, advised in a presentation to the Harvard Biotechnology Club- “Want to get your biotech start-up financed? Then begin by thinking of an exit strategy.”
VCs must make a return on their investment. High numbers of failures are expected when investing in early stage companies; just a few successful blockbusters contribute the majority of a VC fund’s returns. A profit is only generated when investors are able to exit their investment, accomplished through the sale of their shares in the portfolio company either through an IPO or trade sale. Biotech companies require long holding periods- now approaching ten years- and continued investments. Considering the life of a VC fund typically lasts only ten years, it is no surprise venture funding is drying up for early stage companies.
The entrepreneur must run through a gauntlet of obstacles before VCs will even consider providing the first round of financing. By the time a VC is willing to invest, the startup has proven the viability of its technology, developed a clear business plan, and formed a competent management team. In the eyes of the entrepreneur, a key hurdle standing between his company and success is the lack of financing. But for a VC, it is the company’s ability to succeed that will determine whether it receives an investment.
The startup can strengthen its position and improve its chances of success by forming a strong board of directors, usually consisting of only a few members, but each should be an individual who can provide guidance and connections. Along with the board of directors, a scientific advisory board consisting of experts in the company’s area of work will not only provide important counsel, but may also lend credibility to a young firm.
Generating interest from today’s risk-adverse VCs requires startups to show they can quickly reach important milestones without burning through too much cash. Venture funds have shifted their investments to more validated startups in order to reduce risk, although that has substantially limited their potential upside. To recoup their investments, VCs need their portfolio companies to maintain a tight timeline and low budget. With a closed IPO market, VCs may need to fund their companies through the latest stages of clinical development, adding to their investment costs.
Keeping market conditions in mind, the startup can prepare an exit strategy- with a likely scenario being a strategic acquisition. This may have repercussions in the type of partnerships formed, as well as the selection of partners. Although an acquisition doesn’t have the glamour of an IPO, pharma’s appetite for novel compounds has resulted in a wave of biotech acquisitions, keeping this door open.
On the other hand, institutional investors are increasingly demanding late stage data before participating in biotech IPOs, increasing the time and cost of financing a biotech startup. The cost of going public can also consume 10-30% of all the proceeds of an IPO. Add to this the continued distractions and costs of complying with Sarbanes-Oxley regulations and investor relations, and an IPO may not be in the best interest of a small firm. However, for a fast growing biotech in advanced stages of development, access to the public markets can provide a significantly higher return to its shareholders. By staying independent, the company has the ability to continue growing, with the potential for an even larger payoff if its product succeeds.
An exit strategy may not be the first thing on a startup’s to-do list and may change over time- as drug development and the markets are impossible to predict. But without one, the entrepreneur may find it difficult to get his enterprise off the ground.
- Park Life Scienc LLC: Biotech M&A as an Exit Strategy
Disclosure: No Position