How to Make Money in Biotech With No Hope of Going Public, Slim Odds of Getting Acquired

5/23/11Follow @xconomy

Most biotech entrepreneurs I’ve met have a dream that ends one of two ways. They will either take their company public, or sell their startup to a giant drugmaker. Those are the paths to making money, making venture investors happy, and getting the resources needed to take a new drug all the way to the market.

Jim Posada looked at those two roads and essentially said to himself: Find another way.

“A lot of people in venture capital think they’ll fund a company and it will get bought. It’s surprising. It’s becoming more and more obvious it’s an antiquated view,” Posada says. He added: “We don’t think there’s a large probability of going public or being acquired. Our exit will be a licensing transaction. The probability of that happening is quite high.”

Posada made those comments in a small news story I wrote this past week when his company, Seattle-based Resolve Therapeutics, raised its first $2 million in financing. The bigger story here is how Resolve is shrewdly challenging the conventional wisdom, and carving out what could be an intriguing new business model for biotech drug development. Posada, a former dealmaker at Indianapolis-based Eli Lilly and Lebanon, NH-based GlycoFi, has set up Resolve as a limited liability corporation (LLC) so that it can distribute returns to investors if it passes a couple of early-stage clinical trials, and strikes a licensing deal with a Big Pharma company.

Here’s how this is supposed to work: The plan is for investors to put up $10 million to $15 million over the next three years. The money will be used to take a new protein drug for lupus through animal testing and Phase 1 clinical trials. If the drug is safe and has an effect on a biomarker of inflammation, then Posada will be holding a good set of cards. Since lupus represents a potential multi-billion market, Resolve is betting it can entice a Big Pharma company to pay for a license, worth at least $30 million to $50 million in upfront cash, plus $400 million to $500 million in milestone payments based on future success in development.

Forget for a second whether those really big milestone payment dollars ever materialize, because they often don’t. But if Resolve can strike one of these straightforward licensing deals, investors who take the substantial risk of backing Resolve will only have to wait three years, and then be rewarded with a 3- to 5x return on their investment from the upfront cash payment alone. Beyond that, the investors still have room for greater upside returns if the drug continues to progress.

Jim Posada

From the Big Pharma side, this could be pretty attractive, too. Instead of writing a monster check to acquire a company with a risky new molecule, it will have to commit a relatively small sum of upfront money to obtain an asset that has already been at least partly “de-risked” by an experienced team of scientists and drug developers.

Biotech companies have long sought licensing deals with Big Pharma as a means to an end—the IPO or acquisition—not really as the end goal itself. But as readers of this column know, the traditional end goals are quite elusive in biotech these days. IPO investors have very little appetite for new biotechs, and Big Pharma companies (having been burned by overhyped biotech promises of the past) have become very stingy—some would say predatory—in the financial terms they are willing to offer for innovative new biotech drugs. The stingy terms may still be there, but if a biotech like Resolve can keep its capital investment down, it can still get a pretty good return.

You’d think those dynamics would encourage lots of biotech companies to find new exit strategies, but old habits apparently die hard. Resolve had to set itself up as a limited liability corporation, instead of a typical corporate entity. Most VCs have never invested in a deal structure like this, Posada says. Others have done it—San Francisco-based Ablexis is a noteworthy example—but Posada said he encountered some curiosity and a lot of skepticism while pitching this idea to investors over the past year.

There are tons of different business models in biotech, and you can find examples of success in all of them. There is the classic fully integrated biopharmaceutical company (think Gilead Sciences, Biogen Idec, Dendreon, Vertex Pharmaceuticals), which seeks to capture the entire value chain for itself by discovering, developing, and marketing its own products. There is the platform technology play (Alnylam Pharmaceuticals, Regulus Therapeutics), where a company has a novel technology that it licenses to numerous partners that use the platform to try to develop multiple products. There are virtual companies that have no labs, but form small teams of crack scientists and developers that push one or two drug candidates through some critical early tests (VentiRx Pharmaceuticals).

Each business model can work depending on the situation, but none of those approaches changes the cold reality that most drugs fail in clinical trials, and that even if successful the drug development process takes a decade or more and costs hundreds of millions of dollars.

Posada is the first to admit his model isn’t a silver bullet for what ails the biotech industry. He says it can only work in certain situations where you can gather really strong medical evidence on a tight budget. That’s not really possible in most types of cancer drug development, where you often need months or years of follow-up on patients. And this model is absolutely lean and mean—Resolve is a virtual company in the sense that it doesn’t have fancy company labs, and it relies on a small team of consultants and a network of contract research organizations that must deliver on aggressive time frames, and on slim budgets.

But until we come up with a really revolutionary technology that makes drug development much cheaper, faster, and more predictable, entrepreneurs are going to have to think hard about new business models like the one Resolve is putting to the test. If everyone continues with business as usual, a lot of people betting on an IPO or the M&A deal are going to end up very disappointed.

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  • Kerry Dolan

    Luke –I don’t see what’s new about this. Biotech companies have been licensing drugs to big pharma for quite a while. It’s been a lifeline for many of them, too.

  • Rogan

    Kerry — I think the big change is that the company is set up to only do the licensing deal. After they make a deal, the company essentially disappears.

  • http://www.xconomy.com/author/ltimmerman/ Luke Timmerman

    Rogan—thanks. I agree, licensing deals like this have been around a long time, but they haven’t really served as the liquidity event that rewards investors and provides the “exit” strategy for management.

  • http://www.locustwalkpartners.com Geoff Meyerson

    I couldn’t agree more with the “new” model. As a Managing Director of a business development advisory firm that focuses on partnering, we’ve heard these comments on numerous occassions with few people acting on it. One of our clients, in fact, is structured as an LLC and enjoys these benefits. Partnering happens much more frequently than M&A so it is really the only “liquidity” option for most companies. http://blog.locustwalkpartners.com/frontpage/2009/7/31/is-licensing-the-new-ma.html

  • http://jherriman.com Jim Herriman

    I worked on the selling side of the recent SmartCells/Merck deal and we took this general approach from the start (2004). With Pharma/Biotech getting out of in-house R&D, outsourcing early development to specific-purpose entities makes operational and financial sense.

    There are a few issues that Resolve may want to address, including reliance on CROs for mission-critical work and the total tax burden to an investor (a license though an LLC does not give them the best rates). Finallly, using the the assumptions for development cost, upfront earned (both very optimistic) and investor return leaves nothing for the insiders.

    That said, best of luck to them. They are on the right track.

  • http://www.northcoastbio.com Johnny T. Stine

    There’s something about this that sounds so liberating……

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  • D Symmes

    So i don’t think he’s saying the licensing exit itself is what is new… I believe he thinks the LLC structure gives him greater control in some way to exit, and distribute? is that right? I have always thought the LLC is NOT helpful in that situation. This will hit investors P&L as income as well, is that correct? …big tax implications for ROI of course.

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  • Brenda Izzo

    Luke,

    Sorry to be so late to the party – I just ran across this article.
    I work with life science companies in raising funds and M&A advisory. While much of Mr. Posada’s strategy is admirable and not new, it is easier said than done.
    Those Phase I results had better be revolutionary or no pharma – big or small – will care, let alone the investing public. Almost 85% of Phase I trials proceed to Phase II. That’s where the real sticker is.
    Also, Big Pharma is notoriously sneaky about licensing and payments. It often seems like nothing is “de-risked” enough for them.
    Micro companies now have a bit of competition from universities/teaching hospitals who are finally developing better tech transfer departments to monetize research.
    Having said all that, yes it is a good strategy and I wish him luck for success.

  • http://jotabiz.net John

    Good article straight to point. Keep more like coming. Money tips are welcome.

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