21 Red Flags to Watch for in a Biotech Company
Nutty things are happening in biotech. Irrational exuberance has returned. Generalist investors with lots of money are suddenly buying these stocks first and asking questions later. Companies can fire off meaningless press releases, and be rewarded. I heard a big-time money manager talk the other day about a recent biotech IPO being one of the “best performers” in the market. It had a two-week track record, and had done nothing fundamental to earn its tag as a “best performer.”
If markets are driven by cycles of fear and greed, and I believe they are, we are in the greed cycle.
Anybody who’s been around a few years has seen this before. Only one out of 10 drug candidates that enter clinical trials ever goes on to become an FDA-approved product. Companies often spend a decade of work, and $500 million or more, before finding out if they have a viable business at all. It’s the riskiest, most speculative business on the planet. When one of these products hits, it’s awesome. But it’s rare. Many investors buying today are going to regret it tomorrow.
Given that so many new investors are piling into the sector, I thought it would be helpful to compile a list of “red flags” that people should watch for before investing in biotech. When thinking about this column, I remembered a talk that entrepreneur Christopher Henney gave to generalist investors during the dark days of the recession. Like Henney, I think biotech is important and interesting and fun. People need to invest in it to make the whole ship float. But they also shouldn’t fall for the half-baked companies, the hopeless wishful thinkers, or the snake-oil salesmen, who unfortunately consume too much oxygen in this industry.
So, without getting into deep weeds of how to evaluate biostatistics and clinical trial design at biotech companies (bookworthy subjects on their own), here are some simple red flags to look for in evaluating these companies. As always, if you have any more suggestions of red flags you look for, please send them my way.
Weak science: Anyone who follows scientific literature knows a shocking number of studies look groundbreaking when they first appear in top peer-reviewed journals, but the findings can’t be reproduced by anybody in outside labs. Investors should be aware of this, and do some digging to find out if they are investing in established science that has been verified and reproduced by outside groups. An analysis done by Amgen’s Glenn Begley last year, published in Nature, found that only 11 percent of the results from 53 published biology papers could be reproduced. If a company has weak science, “there’s nothing that can correct for this,” says John Maraganore, the CEO of Cambridge, MA-based Alnylam Pharmaceuticals (NASDAQ: ALNY).
Story too complicated for an elevator pitch: If the company’s management team claims that the science is hard to understand, and they can’t explain the basic concept to an educated non-scientist in an elevator pitch, watch out. It could mean they are incompetent. It could mean the exec is just a lousy communicator, and therefore a lousy fundraiser. Troy Wilson, the CEO of Wellspring Biosciences and Avidity Nanomedicines in San Diego, says an executive should be able to explain the company’s story in 60 seconds or less.
Denial about competition: All investors need to know where a company stands in the competitive landscape. If a startup executive says he or she “doesn’t really have any competitors,” then he or she just failed a big credibility test. If a company is being honest, it should acknowledge who else is trying to do something similar, and be able to explain why their product is differentiated and bound to thrive even if it has to face down tough competitors.
The Emperor Syndrome: Biotech attracts a lot of odd characters, but one that surely ought to give any investor the heeby-jeebies is the “emperor” CEO. These are the control freaks who purport to do it all, and sometimes have the title of chairman, CEO, president, chief scientist, chief financial officer, chief pitchman, chief cook and bottle washer. You get the idea. They don’t let anybody else on their management team make a real decision. Oftentimes, their management team is too weak, timid, or afraid of the CEO to ever speak to an investor. If biotech companies could succeed on the back of a lone genius, then maybe this model could work, but that’s not how biotech works.
Weak management team: This one is related to the point above, but different. Maybe the CEO isn’t a controlling jerk, but he or she just doesn’t have the charisma or the confidence to hire standout heads of finance, operations, business development, R&D, or other functions. Investors should read the biographies of the entire management team carefully, and look to see if the company has management depth, people with proven track records. When I covered Genentech back in the day—and even today—it was never all about one or two executives. I am almost always impressed with the caliber of person there I’m talking to. This isn’t to say a good management team always gets it right, but the overall strength of the management team is probably the single most important factor for investors to consider. If a company has weak management, it can have great science and still fall flat.
Too much hype: If I hear a company say things like … Next Page »