Early-Stage Biotech Companies: Strategies for Survival and Growth

A to-do checklist based on three areas that are key for navigating the industry’s stormy seas. Failure to execute in any one area could sink your ship.

Abstract

The promise of start-up biotechnology companies is enormous. So are the risks and the uncertainty of product development. The authors present a checklist for young biotech companies, covering environmental factors, alliances, and strategic planning.

A few key strategic elements are critical to the early-stage biotechnology company’s growth and success. These elements serve as a checklist — and a necessary one, because the early-stage company often can be a business case study for high attrition rates among product candidates, huge technical risk, and very long product-development time lines of 8 to 12 years.

The promise of positive net present value (NPV+) market returns and commercial success are fleeting for most startup biotechs. The pharmaceutical development process is complex, calls for significant investments in financial and human capital, and involves risks in project execution, the regulatory process, and scientific technical attrition. Further, the cost to gain market approval for a single product is estimated at $800 million (DiMasi 2001). Of the companies that set out to develop a drug beyond proof of principle, most fail due to lack of product efficacy or safety, or insufficient cash for clinical trials or business operations.

Wendy Tsai

Stanford Erickson MA, MBA

Industry data indicate a 20 percent likelihood for a compound to advance from initiation of phase 1 trials to market approval. With these odds, there’s a need to mitigate product development risks, from startup capital through early-and late-stage clinical trials. Further, leadership and commitment from the company’s executives are essential to determine tactics and strategies for developing product candidates, to set the right course for clinical development, and to manage capital. Ask any CEO who has founded a company and then kept it in business: it’s the toughest job she or he has ever done. It calls for flawless operational execution, talented management, perseverance, and scientific expertise and vision.

ENVIRONMENTAL TRENDS

As reported by the Biotech Industry Organization, the U.S. Food and Drug Administration approved 38 biotech and biotech-related products, as well as expanded labels and other therapies. The biotech industry reached a maturity level in producing a “steady stream of new and unique therapies” with the goal of producing more targeted therapies that will result in more effective medicines (Coghill 2006).

Biotechnology, broadly defined, uses living organisms or their products for commercial purposes. In this and other ways, the biotech industry is viewed separately from the pharmaceutical industry. Still, it is useful to recap some key environmental trends for the pharmaceutical industry as it relates to biotech:

• Gradual slowing of growth due to industry maturity

• Continued consolidation of companies

• More personalized medicine

• A greater role for nanotechnology in diagnostics, drug development, and drug delivery

• Increased concern for drug safety in the post-rofecoxib (Vioxx) era (Shamel 2006)

Expertise in scientific research, leadership in business, and at least one great idea for a biotech product are needed to start a bioscience company. Surprisingly, barriers to market entry can be minimal. Early-stage and research-stage bioscience companies have the opportunity to obtain study funding from numerous programs. Some of these, like Small Business Innovation Research and Small Business Technology Transfer, can provide substantial funding to small businesses.

Building and sustaining an early-stage biotech company calls for a business model that optimizes financing, market, and operational strategies. Depending on the availability of seed capital and financing options, the company may undertake 1 of 3 business models on which tactical and strategic plans can be executed by the company:

• Build: Develop a product in-house from bench research to market approval

• License: Secure strategic alliances, partnerships, and licensing deals

• Sell, divest, joint venture, other: Other alliance, divestiture, or exit strategies

At some point, all three of these strategies may come into play.

Strategy is how a company differentiates its identity from the environment and competition. This should not be confused with core competency, expertise, tactics, or mission. Financing strategy is often the foremost focus of the start-up biotech company. Funding and balance sheet liquidity — cash for operations — are its lifeblood and are needed to drive product development and business strategies. To obtain financing, many companies raise venture capital, partner with big pharma or other bioscience corporate partners, or secure capital from angel investors and government or small-business grants.

In aggregate, the biotech industry — comprising about 300 publicly traded companies and more than 1,200 companies — is not highly profitable, and typically lacks economies of scale in research and development, sales, marketing, and distribution. A small number of biotech companies are extremely profitable, which drives the entry of a high number of competing companies and inflow of capital. While the potential for generating free cash flows on a company- or product basis is extremely promising, biotech companies are sometimes hard pressed to retain any great share of the profits or majority ownership in the company. Product attrition, technical risk, long R&D horizons, and rapid cash burn often result in the biotech forgoing majority ownership in exchange for financing from venture capital or corporate partners.

CORPORATE ALLIANCES

Biotech is typically thought of as a high-growth and high-risk industry. The upfront investment on R&D and clinical trials can soar into the tens of millions dollars even before initiation of large population human efficacy trials. Potential blockbuster market returns are possible, but they usually come with a high front-end investment and a proportionate high risk of R&D technical attrition (where studies are halted because the compound fails efficacy, safety, toxicity, or other criteria). Risk also is baked into the decade-long investment horizon and commercialization time line — all part of navigating the FDA regulatory approval process for biopharmaceuticals.

The deep financial pockets of fully integrated, established, or large-cap drug companies play a key role in the growth of the biotech industry. As big pharma encounters patent expirations on core franchises or blockbuster products, or as pipeline productivity struggles to keep up with forecasts or analyst and shareholder expectations, big pharma can turn to biotechs as a way to bolster pipelines. The number of compounds in big pharma phase 3 trials dropped 23 percent from 2000 to 2005, which contrasts with a 60 percent increase in products from biotechs and small drug companies. Today, biotechs and small pharmaceutical companies are developing nearly two thirds of phase 3 compounds (Longman 2005). Pharma companies are well positioned to “backward integrate” into biotech through licensing deals and strategic alliances, using biotech companies to supplement their pipelines and portfolios. Two such examples are detailed in the table on page 52.

Corporate alliance deals structured as licensing transactions, codevelopment agreements, joint ventures, or sales and marketing alliances play an integral role in many growth strategies for biopharmaceutical companies. Licensing also may afford an aggressive strategy for identifying and providing lead products for the pharmaceutical licensee and the biotech early-stage company acting as the licensor. Strategic partnerships can involve research focused on discoveries characterized by unique mechanisms of action at the molecular level and within cellular processes that can be targeted as a way to develop best-in-class medicines.

Pharma companies have the capabilities, operational scale, and cash reserves to partner with biotech in the development and commercialization of new products. By providing clinical trial funding, large pharma companies essentially secure rights to percentages of equity or product-licensing rights in a biotech company, in exchange for future royalties or product revenues.

While benchmark alliance deals vary across therapeutic categories and naturally step up in value at later stages of clinical trials, a typical phase 1/2 biotech-pharma licensing deal could involve upfront and milestone proceeds to the biotech licensor of up to tens of millions of dollars. The biotech licensor seeks to secure back-end reward by structuring the deal with royalties on product sales. This also is a way to gain compensation for the front-end risk taken in the R&D of an unproven compound. Unfortunately, a biotech that depends on large cap pharma for financing often gives considerable control and profits to the drug company. This is often necessary to secure future marketing, distribution, clinical trials testing, and revenue for a product in development. The upside to the biotech partner giving away overall NPV of the asset valuation comes in the form of netting near-term alliance revenues and proceeds that may provide the cash flow needed to keep the company in business.

RECENT NOTABLE BIO/PHARMA DEALS

Pharma partner/Biotech licensor	Alliance type	Strategic focus or partnering goals	Deal terms
GlaxoSmithKline (GSK) / Pharmacopeia (PCOP)*	Drug discovery and development alliance (early-stage licensing deal)	PCOP to discover active molecules and advance them to proof of concept. GSK will have exclusive options to conduct phase 3 trials and commercialize on worldwide.	PCOP receives $15 million cash from GSK. GSK receives warrants to purchase PCOP stock at 25% premium to trailing 30-day closing price average at alliance commencement.
Novartis/Idenix Pharmaceuticals†	Worldwide development and commercialization license agreement	Leverages execution and capabilities of Idenix in advancing new treatment options and drugs for hepatitis patients. Alliance with Novartis part of Idenix’s growth and pursuit of building a leading antiviral franchise.	Novartis bought 54% of Idenix outstanding stock from shareholders for $255 million cash. Novartis paid $75 million licensing fee for lead hepatitis B candidates. Novartis agreed to provide full development funding for these products and make milestone payments potentially totalling $35 million on achieving regulatory approvals, plus additional payments based on achievement of predetermined sales levels.

SOURCES:

^*PRNEWSWIRE–FIRSTCALL 3/30/2006, «WWW.BIOSPACE.COM»

^†SEC FILINGS – MAY 2003 «WWW.SEC.GOV/EDGAR.SHTML», «WWW.IDENIX.COM» NEWS RELEASE 1/3/2006

STRATEGIC PLANNING

Goals and mission of the company invariably drive strategic planning. Investment climate, balance sheet cash, company life cycle, and capabilities for R&D or strategic alliances also must be considered. Typically, a baseline scenario for strategic planning provides a starting point, and it could involve both qualitative and quantitative methodologies. Alternative business planning scenarios may evolve from the exercise of assessing the technical strengths, and monetization and market potential of the pipeline or assets. Business or financing strategies and exit strategies could become an outgrowth of strategic planning. Another critical challenge for any biotech’s management is maximizing investor return while maintaining the highest quality standards in R&D and workforce retention, morale, and culture.

The foundation of a strategic plan that enables a competitive advantage in the biotech industry includes:

• Leveraging business and R&D operations that focus on free cash flow generation

• Executing a viable financing strategy to fund operations and R&D projects

• Hiring and retaining seasoned management

• Researching and developing compelling science product candidates

• Securing intellectual property, technologies, and business ideas for a compelling growth story vis-à-vis opportunity costs and competing investments

Product candidates should be evaluated and prioritized based on merits relative to other pipeline opportunities and even opportunity costs external to the company (e.g., acquisition of outside assets versus developing a homegrown project).

Technical and market criteria for identifying projects with the highest strategic value could focus on:

• Differentiation in product profile

• Unique mechanism of action

• Best-in-class efficacy

• Potential for establishing new standard of care

• Improved side-effect profile or administration mode

• Therapeutic areas with unmet needs, clinical or commercial

• Returns that meet threshold NPV, internal rate of return, market size, and peak sales potential

As part of strategic planning, biotech companies need to balance an opportunistic approach to leveraging assets that have high market potential with the right scientific decisions about projects that are technically viable. Such decisions about resource allocations and company objectives set the course for how the staff organizes around tactical plans. The strongest assets will meet or exceed technical and commercial criteria. Platform technologies, such as those with a mechanism of action that could work in more than one therapeutic category, are other ways to boost productivity.

Naturally, a biotech company needs to achieve project milestones on time and on budget and to focus on the needs of investors or the investment climate. Examples of balanced strategic execution could involve a combination of:

• Partnering with companies that have complementary scale or functional areas of strength and capabilities

• Targeting therapeutic markets with demonstrated market returns and unmet needs

• Licensing or spinning out non-core assets that maintain the company’s focus

• Generating alliance revenues that further fund R&D of core assets

Identification of key therapeutic areas should factor in the company’s internal scientific capabilities and strengths, along with external and market environmental factors.

CONCLUSION

Biotech companies have raised more than $120 billion in financing, the majority of which is used for R&D purposes (Coghill 2006). This financing and investor climate provides the “fuel in the tank” to drive scientific ideas from discovery research to clinical stage testing and market approval.

Funding is available, but as early-stage biotech companies advance product candidates to clinical stage trials and beyond, the tactics and strategies executed by these companies may well depend on some combination of corporate alliances, financing strategy, and strategic planning. Success in each stage of the life cycle of the early-stage biotech company nonetheless necessitates a thorough and methodical consideration of the checklist of key strategic elements outlined herein.