Which source of funding – venture capitalists or pharmaceutical makers – provides the most innovative and useful path for a small biotech company?
Abstract
Does it matter who pays for biotech innovation? When it comes to developing the most effective and affordable medicines, which source of funding — venture capital or pharmaceutical companies — provides the most innovative and useful path for a small biotech company? Advocates for both sides make their case.
Tuan Ha-Ngoc understands the ins and outs of getting affordable medicines to market.
Tuan Ha-Ngoc, CEO and president of GenPath Pharmaceuticals, a biotech company based in Cambridge, Mass., believes that venture capitalists are more likely than big pharmaceutical manufacturers to provide the money and flexibility needed for longer-term biotech bets.
PHOTOGRAPH BY SARAH EVANS
After spending several years at a medical-device manufacturer, he oversaw corporate development and commercial operations at Genetics Institute, which became part of Wyeth, the drug maker, in 1992. In 2002, Ha-Ngoc became CEO and president of GenPath Pharmaceuticals, a biotech company based in Cambridge, Mass., that is developing drugs that target gene products critical for the maintenance and recurrence of established cancers.
When it comes to sorting out decisions relative to funding, research innovation, and commercializing of biotech products, he doesn’t flinch; he believes that venture capitalists are more likely than big pharma to provide the money and flexibility needed for longer-term biotech bets.
“Any company needs the best possible clinical program to win FDA approval. It can be extremely helpful to have a thought partner who can fashion that, not simply write checks.”
— Russell Gantt, AstraZeneca Pharmaceuticals
“We all know that money buys you time, and that time and money are key ingredients for innovation,” says Ha-Ngoc, who sits on the board of two other biotech companies. “Entrepreneurs need the right investors and business partners. You don’t want to be dominated early on by a big pharmaceutical company, because it may curtail your flexibility later.”
Still, this philosophy didn’t stop GenPath from striking a deal last year with Merck & Co., one of the largest drug makers, which invested $100 million in exchange for the exclusive worldwide licensing rights to a number of small molecule targets that GenPath is developing.
The dichotomy underscores a dilemma that, ultimately, affects payers and consumers, when it comes to developing the most effective and affordable medicines: which source of funding — venture capital or pharmaceutical companies — provides the most innovative and useful path for a small biotech company?
The way in which biotech companies that are too small to launch an initial public offering navigate the funding path helps to determine which treatments reach market and how soon they get there. There is little debate that biotech companies burn through a great deal of cash and, as a group, rack up high failure rates as they identify disease targets and try to discover proteins to neutralize those targets.
For early-stage biotech investors, that can mean little or no return. Consider this yardstick: $1 invested in publicly traded biotech stocks in 1981 would have yielded just $7.92 by the end of 2003, compared with $20.78 from the Dow Jones Industrial Average, according to a recent analysis in the Wall Street Journal.
While the pharmaceutical industry generally looks to develop and market treatments for a finite list of diseases — cholesterol, diabetes, depression, schizophrenia, arthritis, and, more recently, sexual dysfunction — that reach the widest possible pool of patients, biotech companies can develop treatments for smaller populations and still yield a return that some venture capitalists may find acceptable.
With this kind of agenda, a biotech startup can face difficult choices : rely on venture funding to fuel research, which may not yield a huge-selling product; or join forces with a pharmaceutical manufacturer that can offer various kinds of expertise but may want to keep a tighter reign on the direction taken. The trick for a biotech company is to choose the approach that serves a variety of interests — management, investors, and patients.
NOT RISK AVERSE
Not surprisingly, venture capitalists and their counterparts at the big drug makers see things differently.
Ashley Dombkowski, a principal at MPM Capital, in South San Francisco, argues that venture capitalists generally are more willing to take bigger risks and to take a broader view of what constitutes a desirable investment. For early-stage biotech companies, she says, this kind of outlook is in stark contrast with that of a large drug maker, which may want only to fill a precise hole in its product pipeline.
“Venture capitalists tend to be willing to take on projects outside the scope of big pharma interests,” says Dombkowski. “For instance, we will take on products for smaller markets. Certainly, we’re interested in blockbusters, but a venture capitalist may be more willing to finance a product that would yield only a few hundred million dollars in sales. That includes many compounds that could be of great value to patients.”
Although some investors may consider publicly traded biotech stocks a dicey investment, venture capitalists certainly have not lost interest in biotechnology. Biotech attracted nearly $1.5 billion in 57 deals in this year’s first quarter, the largest-ever infusion from venture capitalists. That’s triple the level of investment during the first quarter of 2003, according to a recent survey by Ernst & Young, the consulting group, and VentureOne, a research company.
Large and experienced investors, notes Ashley Dombkowski, a principal at MPM Capital, in South San Francisco, are increasingly adding their own kind of value to help develop effective medicines. Her company, for instance, includes partners with big pharma and biotech experience.
Russell Gantt takes issue with the pro-venture capital view, albeit diplomatically. As vice president for licensing in North America for AstraZeneca Pharmaceuticals, he makes the case that big pharma is willing — and able — to do things that a venture capitalist cannot.
As he sees it, a big drug manufacturer can help an early-stage biotech company tailor a development project so that it can muster regulatory approval. More than simply throwing a large sales force at doctors, the pharmaceutical industry can help a biotech company make greater use of resources. A successful medicine delivered at the right price, Gantt believes, is more than just a matter of money — which, ultimately, is better for payers and patients.
“I’m biased, but I believe that big pharma is capable of adding value,” he says. “We can be a partner, and in different ways. Consider clinical-trial design. Any company needs the best possible clinical program to win FDA approval. It can be extremely helpful to have a thought partner who can fashion that, not simply write checks. And I think that, as you go along, venture capitalists are sparse when it comes to signing up for that level of commitment.”
Big pharma’s reliance on biotechnology is becoming clear. In 1997, biotech companies discovered six big sellers, compared with 15 by big pharma, according to Defined Health, a Millburn, N.J., strategic business development consulting company. Since then, the gap has narrowed; in 2003, biotech was responsible for 10 products, compared with 11 from big pharma. And by 2010, the company projects that each sector will discover 12 big-selling treatments.
NATURAL PARTNERS?
At Defined Health’s recent Therapeutic Insight 2004 conference, Frederick Frank, a vice chairman at Lehman Brothers, the investment company, noted that there isn’t enough capital to support all the biotech companies now working to discover and develop treatments. By his count, there are about 1,500 in the United States and roughly 4,400 worldwide. He argued that big pharma and biotech are natural partners.
“Big pharma is cash long and opportunity short, while biotech is cash short and opportunity long,” says Frank, a mergers and acquisition specialist in health care. “The market, however, is totally product-centric. New investors don’t value the technology enough. This is one area where biotech can be naive. It’s one thing to become a U.S. player, but another thing to become a global player.”
Ed Saltzman, Defined Health’s president, argues that big pharma and biotechs will have to embrace what he calls “mutualism,” a form of partnership that underscores the need each type of company has for the other. For biotech companies, he says, there’s a need to overcome the notion of being able to go it alone and still reap greater rewards than if a deal had been struck with a big drug maker.
“Big pharma is so starved for innovation,” he says, “that it’s changing the nature of partnerships. Generally, I don’t think it matters who the investor is — it’s the science [that matters]. Whether something becomes a success is a result of the nature of the product, not the investment. But biotech companies that do go it alone may not develop drugs that are as innovative as they would be if they would partner with a big pharma.”
In his view, a successful product will most likely have financing from both private and public sources. Yet, he also argues that a potential product has to have a big payoff to secure venture capital investment. In the end, though, Saltzman stresses that affordability — whether the patient population is huge or modest — is a function of drug coverage, or at least patients’ ability to pay for a new product.
Big pharma and biotechs need to embrace “mutualism,” says Ed Saltzman, Defined Health’s president. Biotech companies, he adds, need to overcome the notion that they necessarily can go it alone and reap greater rewards than if they strike a deal with a big pharmaceutical manufacturer.
“I think the type of investor or partner is an issue of [comparing] apples and oranges,” he says. “There are clearly some companies that have gone to market only with venture capital financing, but they’d be in the minority. Hopefully, big pharma is looking to make cost-effective medicines; but whether one is affordable depends on who has coverage.
Saltzman takes issue with the view that venture capitalists will be happy with a smaller return than big drug companies. “Remember that in the beginning every product may look big. But it’s got to be a huge product, or venture capital doesn’t want to get involved. Tell them you have a very early stage product that will sell $200 million, and there isn’t a venture capitalist in his or her right mind who wants to finance it. Of course, it’s also possible that a company has five products going into clinics, and each has a small potential that can add up to a lot. But this isn’t an either/or situation.”
NOT EASY AT FIRST
One biotech executive believes big pharma offers an advantage, regardless of whether a large or small patient population would benefit from a new drug. Still, he acknowledges that it can be more difficult for an early-stage biotech company to capture the interest of a big pharmaceutical manufacturer. Often, then, such companies have little recourse but to pursue venture capital.
“Typically, I think there’s room for both types of financing,” says John Conley, a cofounder and former chief financial officer of Alnylam Pharmaceuticals, in Cambridge, Mass. The company is using a technology called RNA interference (RNAi), which interrupts the synthesis of disease-causing proteins in specific genes, to develop drugs to treat cancer and infectious diseases, among others. Alnylam, named for the center star in Orion’s belt, has received investments from several venture capital companies. In late May, Alnylam took the next step in its growth when it began trading on Nasdaq at $6 a share.
“Speaking broadly, there are very few early-stage companies with significant backing from big pharma within their first year or two. But from a small company’s perspective, it can be better to get money from big pharma partners,” says Conley, now a biotech entrepreneur who left the company earlier this year. While he was Alnylam’s CFO, the company struck an alliance with Merck that calls for Merck to invest in the company and provide Alnylam with a series of proprietary drug targets that have well-validated roles in disease and are attractive candidates for a new therapeutic approach using RNAi. Alnylam will develop RNAi compounds against these targets and advance RNAi-based drug candidates through preclinical development. The two companies will then decide to separately or jointly work on promising candidates.
“Venture capitalists don’t want to pay too much and can pressure you to cash out as an end game,” says Conley, who spent more than 10 years at Biogen before helping to launch Alnylam in 2002. “With big pharma, you get the imprimatur and the validation. And when big pharma does invest in the equity, it’s often willing to pay a premium and to provide funding that is nondilutive; by this, I mean fees and milestone payments.
“An entrepreneur who gets venture capital financing and generates data may be able to secure funding from big pharma on more attractive terms. ”
— Ashley Dombkowski, MPM Capital
“The issue of control by a pharma partner matters, but it would have to be a very big deal indeed before that became a major issue,” says Conley.
MPM’s Dombkowski cautions that venture capitalists, at least large and experienced investors, are increasingly adding their own kind of value to help develop effective medicines. Her company, for instance, includes partners with big pharma experience, such as Ed Skolnick, the former chief scientist at Merck. Among the general partners is Dennis Henner, a former senior vice president for research at Genentech.
“One issue for entrepreneurs ends up being economics,” she says. “A lot of times, big pharma isn’t interested in investing in something in the early stages. Or maybe big pharma is interested, but won’t pay a lot until the company reaches a certain level of development. But an entrepreneur who gets venture capital financing and generates data may be able to secure funding from big pharma on more attractive terms. And pharma wins because risks have been eliminated. The positive for the patient is an innovative medicine.”
As a selling point, however, a Hoffmann-La Roche executive believes big pharma can make an attractive and successful partner in developing a useful and affordable medicine, but only if key transitions and relationships are staffed and managed properly. Nigel Sheail, a vice president and head of acquisitions and strategic alliances, notes that, sometimes, a big drug maker will have just one person working with a biotech in which it has invested. And that, he argues, is shortsighted.
“We talk about expertise, but I wonder how a small company can get the benefit of that expertise when you really have just one person” acting as liaison, he says. And he points out that a great degree of handholding is needed when a biotech is entering phase 2 and phase 3 clinical stages. “These transitions are quite dangerous times,” he warns.
“Going for a home run as an under-funded company — forcing you to change your agenda — can cause the product to be a flop.”
— Tuan Ha-Ngoc GenPath Pharmaceuticals
Another pharmaceutical executive acknowledges that big drug makers have to do a better job of positioning themselves to become effective partners with biotech companies. At the Therapeutic Insight 2004 conference, David Thompson, vice president for corporate strategy and business development at Eli Lilly & Co., posited that drug makers should remain flexible to gain the confidence of biotech executives.
“I want to have a robust biotech industry, and I want somebody who can buy my stuff, other than the government,” says Thompson. “But there’s a gross underestimation of what it takes to get to market. Developing a successful product often suggests margins will come down, but you have to be extremely fast and efficient for that to happen. There’s a disconnect in terms of capabilities. At the same time, big pharma has to become much more flexible in terms of selling and partnering.”
LOOKING FOR A BAND-AID
In the end, GenPath’s Ha-Ngoc sees innovation and flexibility as always being constrained by the realities of the financial markets.
Biotech companies are “all looking for a quick Band-Aid, from a two- or three-year to a five-year time frame,” he says. “The problem is that there are only a small handful of products available that can get to the marketplace quickly. In our case, we’ve received tremendous support from both venture capital and big pharma. Whether or not they have foresight, doesn’t matter. For us, it’s an issue of future innovation.
“Ultimately, only a handful of companies will probably get funds from venture capital and big pharma,” he says. “The low-hanging fruit is gone. You get funding where you can, because you don’t have the leeway to be choosy. But, if your investors don’t have a long-term view, you’re wasting your time. It’s true that lower risk also means lower innovation. Yet that may get the company funded in the short-term, while the bigger innovation will have time to be nurtured and mature. Otherwise going for a home run as an under-funded company — forcing you to change your agenda — can cause the product to be a flop.
“And that doesn’t help the patient, does it?”