‘Small Ball’ Investing as an Alternative Model in Life Sciences

1/9/13Follow @CityHillVC

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things lean, and closely managed the burn to hit our value inflection points as efficiently as possible.

Advance the Runners: Drive Focused Value

We acquired the oncology assets from Biogen Idec by structuring a back-end loaded deal; recruited a team of renowned advisors and scientific talent; generated additional preclinical data that validated our lead program; selected a lead monoclonal antibody candidate to take into cell line development and early manufacturing; and signed manufacturing and antibody engineering deals.

Score: Creatively Monetize

Taking nothing for granted, we dual-tracked our financing and M&A discussions with VCs and biopharmaceutical companies, respectively. We did not have a preference a priori for the VC versus acquisition path. In the end, we selected the option with the best prospects for creating value for our investors, which also turned out to be the most creative: We sold Eclipse to Adelaide, Australia-based Bionomics (ADR: BMICY), a publicly traded company listed on the Australian Stock Exchange, for a stock-based $10 million up-front, and up to $65 million in cash earn-outs based on achieving late-stage development success or partnering outcomes based on Eclipse assets, plus royalties on product sales.

Win the Game: Generate Attractive Returns

Eclipse was successfully acquired less than 18 months after we founded it, generating attractive internal rates of return for all investors. The math is simple: $2 million in, and between $10 to $75 million out, creating a win-win deal for every stakeholder, on both sides of the table. More importantly, the potential benefits for patients and shareholders are amplified by Bionomics’ and Eclipse’s shared vision of building a leading oncology franchise. As entrepreneurs, we are driven by passion to build great companies – fortunately, the original Eclipse team continues to play an active role with Bionomics in shaping the destiny of the cancer stem cell assets.

Developing late discovery/early preclinical biotech assets is capital intensive and highly risky. The small ball strategy of seeking creative options with less capital invested helped maximize our range of options and probability of success, mitigating the risk and generating attractive shareholder returns for early stage assets in a challenging biotech financing environment.

We are only two years into the small ball investing strategy experiment, and it is still too early to tell whether this can be a winning strategy across an entire portfolio. However, it is an interesting alternative, or complementary, strategy for life science investors and entrepreneurs to consider, especially in an environment in which traditional financing sources are scaling back. The small ball investing principles also may be applicable to larger venture funds, and to venture funds in other industries.

Small ball investing is a potential strategy for racking up the wins because the probability of success for each investment is higher than a “swing for the fences” approach, thereby maximizing the overall win:loss ratio for all stakeholders.

Jonathan Lim, M.D. is a physician-turned-life sciences entrepreneur, investor, and CEO. He is the founder and managing partner of City Hill Ventures and the former CEO of Halozyme Therapeutics. Follow @CityHillVC

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  • Mike Sinsheimer

    This has been my approach running my own small portfolio of Medical Device/Diagnostic portfolio companies at MedTech Catalyst. There are strategic ways to make progress with strategic partners on a non-dilutive basis as well.

    • Jonathan Lim

      Thanks for your comment, Mike. Glad to hear you’re using this approach for Medical Device and Diagnostics.

  • Stewart Lyman

    Jonathan, I’m not sure that I would characterize this as a “win-win”
    outcome for everybody at the table. If the drug succeeds that would be an
    accurate description. If it doesn’t, hasn’t Bionomics just wasted $10-$75
    million (plus whatever else they spend on the program going forward)? You’ve
    simply transferred the risk to the other side of the table. This isn’t to say
    that a small ball approach isn’t a good one, for it has worked for your
    investors. But in the big picture, I would score this as an incomplete game to
    be finished at a later date.

  • Roger Frechette

    Jonathan, nice story – and a cool acronym that seems to make it easier for people to pay attention. This is quite a similar approach to what we used in building and selling MaxThera – to Biota, another Australian company. Antibacterial drug discovery assets were acquired from Genome Therapeutics, with back end payments. We funded research exclusively with grants. When a bit more capital was needed to move the assets further along, we worked in parallel to develop relationships with VCs and Corporations, looking for equity investment, partnerships or M&A. Without spending any investor dollars, we picked up a decent payday, which could be substantial down the road with development and sales milestones. Currently working on a new venture called Frontiera Therapeutics – different therapeutic area, different stage of development, much higher potential market but still thinking lean, efficient and focused. May turn out to become a lasting R&D and sales entity, but more likely will be acquired by a company that appreciates the addition to their pipeline.

    With respect to Stewart’s comment, such an approach is indeed a win-win: the seller/investors get a respectable return in a relatively short time frame and the buyer gets a shiny new asset for their portfolio, likely requiring less capital than would have been required to build something similar organically.

  • http://twitter.com/sciencescanner David Grainger

    Jonathan – nice analogy.

    Your approach is very similar to the asset-centric investing approach we have been employing at Index Ventures in Europe for the last six or seven years. The principle is very simple: you dont know whether ANY early stage asset is really going to work, no matter how clever you are. So attrition rates are high. Hence you have to turn the card as cheaply as possible for the economics to work. Simple really.

    But, even after six or seven years and several successful exits for these asset-centric companies its still to early to claim the approach is validated across a whole portfolio. The signs are good though.

    But there are issues with the approach – you highlighted the ‘pros’ but the principle ‘con’ is that “small ball” is very hungry for bandwidth of your team. If you need to manage many small investments to get the capital at work, you need plenty of talent both on the investor side and probably more on the company management side. At Index, that problem is overcome with a “platform” of highly experienced drug developers (‘IDDs’ or Index Drug Developers) who serially take one asset at a time and move them forward: http://www.tcpinnovations.com/drugbaron/?p=219

    Importantly, though, these people have to come from a culture of “lean and mean” and that typically means not from a big pharma heritage. Finding people experienced in drug development from cradle to grave who havent succombed to the pharma mentality is the single rate limiting step for scaling the “small ball” strategy to interesting sizes.

    Quite simply not all entrepreneurs can work in highly cash constrained virtual or semi-virtual settings. It needs a particular kind of person: http://www.tcpinnovations.com/drugbaron/?p=28

    In the end, though, if you achieve the de-risking and you do it cheaper, the returns really have to be higher. The key is not letting “efficiency” mean “cutting corners”. You trim the spend by only doing the things that really take the risk out of the asset.

    Good luck with the model!

  • BKC

    Agreed well validated model to supplement the early stage therapeutic pipeline. Spreading bits of risk. Service companies also use this strategy with the added goal of growing the late stage pipeline and being positioned to capture that service business as well as share in the upside via back-ended terms

  • Jonathan Lim

    Thank you all (Mike, Stewart, Roger, David, BKC, Twitter responders,…) for taking the time to comment.

    Stewart, I think Roger did a good job of addressing your comment – to elaborate further, it truly was a win for the buyer because they were able to purchase the whole company at a lower up-front price than what they would have otherwise had to pay, in the event that more money had gone into the company (because the seller would have required a higher price tag to achieve an attractive ROI).

    David, Thank you for sharing your experience at Index Ventures. I completely agree with you that this model is difficult to scale because of the bandwidth issue, and the fact that it is highly dependent on gathering a team of lean and mean entrepreneurs. The key to success is being able to recruit talented, like-minded entrepreneurs to do this across a portfolio.

    Ultimately, I would like to remain open-minded and maintain the flexibility to seek the most value creating option that makes sense for each portfolio company (vs. approaching the portfolio with a one size fits all investment approach). Therefore, a mix of small ball investments and “swing for the fences” investments may become the most effective portfolio strategy. Each company has a different phenotype, and what may work for one company may not necessarily work for another. In fact, I’m currently managing a company that may potentially fall in the swing for the fences category. If there are any learnings that emerge from this experience, I’ll look forward to sharing in the future.