How Emerald BioStructures Escaped deCode’s Bankruptcy With Help From Boston VCs

5/10/10Follow @xconomy

Lance Stewart woke up many times over the past two years, and asked himself, “How did I get here?”

He had reason to be confused. Stewart had spent more than a decade building one of the world’s best structural biology research teams inside a light manufacturing facility on Bainbridge Island, WA. Revenues had climbed every year. His team of 40 people had an A-list crew of customers that included Merck, Johnson & Johnson, and the National Institutes of Health. Most importantly, his Emerald BioStructures operation had been profitable for years.

Yet there he was in October 2008, staring into the abyss. His parent company, Iceland-based deCode Genetics, was in big trouble. While deCode CEO Kari Stefansson was great at generating attention for the company’s groundbreaking genetic discoveries, its free-spending ways also had created a mountain of more than $300 million in debt. About a third of the assets the parent company had left were invested in auction-rate securities with Lehman Brothers. The country of Iceland itself, where deCode was based, had been teetering on the edge of bankruptcy. When it became obvious that much of deCode’s cash had vanished with the implosion of Lehman, deCode sought advice on how to survive from the Stanford Group. Bankers there started helping Stewart figure out how to avoid getting shut down through a deCode bankruptcy.

Then about six months later, the SEC accused Stanford of running an $8 billion fraud.

“One day we called, and they [Stanford] just didn’t answer,” Stewart says.

Through this Kafkaesque financial ordeal, Stewart’s scientific team knew the pressure was on to show they were worth more than just collateral with a bunch of expensive equipment that needed to be sold fast to pay down debt. They kept doing their work, meeting deadlines over the next 12 months. In the end, when deCode Genetics filed for bankruptcy last November, Emerald BioStructures found a way to stay intact through a divorce from its corporate parent.

Lance Stewart

Lance Stewart

The lifeline came through an undisclosed amount of financing that included three key players in the Boston area—Gemini Investors, Kendall Square Partners, and one of New England’s biotech highfliers, Cambridge, MA-based Forma Therapeutics. Emerald, through its rebirth as an independent company, said nothing publicly about what happened behind the scenes. The company said in a statement that it would remain “committed to serving a global customer base with world class service.”

It would have been a real shame if Emerald had been sliced up and sold for parts, according to Steven Tregay, the co-founder and CEO of Forma.

“Emerald has built one of the world’s premier X-ray crystallography capabilities,” Tregay says. “Occasionally you find great teams that have been high performers for a long time. The throughput these guys have is truly astounding.”

Stewart recently sat down to tell me the story, about six months after Emerald survived its brush with death. He still sounds amazed at how he got into such a jam in the first place. “We were always profitable, and we were steadily growing our revenue.”

He added: “This is a pretty wacky business.”

The Emerald story actually has even more dramatic twists and turns if you trace it to the beginning. The company was co-founded in 1998 by Stewart and Hidong Kim. At the time, Stewart was a research assistant professor at the University of Washington, specializing in structural biology at Wim Hol’s lab. Stewart liked the work, but he wasn’t on the tenure track, and he saw more of a future in business than academia. The dot-com boom was in full flower, and venture capitalists were chasing genomics dreams.

“I figured it would be easier to get money for a company than for an academic lab,” Stewart says.

The key skill Stewart and Kim had to offer was with X-ray crystallography. This is basically a way of taking high-resolution snapshots of proteins. It can be time-consuming, difficult work, and sometimes biologists throw up their hands and say a structure can’t be precisely determined. But for those who are good at this line of work, it can be extremely valuable for drugmakers. That’s because they want to design small molecule compounds with just the right binding properties for a target.

While many labs around the world were racing to sequence the genome as fast as possible in the early 2000s, the world soon learned that a lot more information was needed before this could translate into new drugs. Those genes provide instructions for making proteins, but proteins express themselves in the body in a variety of ways, and drugmakers often need detailed snapshots from X-ray crystallography to serve as a guide for how the drug binds with the target, and how it functions in the body. It’s really about making the leap “from gene to structure,” in Emerald lingo.

Neither Stewart nor his co-founder had any experience in business at the time. (Stewart later got an executive MBA from UW in 2003.) But back in 1998, Emerald got going with a modest $70,000 investment from friends and family, and a $100,000 Small Business Innovation Research grant via the NIH. When Stewart started looking around for lab space, there wasn’t any available in Seattle in those boom times. So the company ended up in some inexpensive light manufacturing space on Bainbridge.

Naïve as Stewart may have been about business then, he found financial support for Emerald’s work. The original company was acquired in May 2000 by MediChem Life Sciences, a Chicago-area contract research firm that specialized in synthesizing new drug candidates. “They said, ‘We’ll do the chemistry for drug discovery, and you can do the structural biology,’” Stewart says. “It was a good match.”

Then came Stewart’s first education in business. The air was popping out of the dot-com and genomics bubble. MediChem Life Sciences decided to go public anyway, in October 2000. “It was the last life sciences IPO for about two years. That will tell you something,” Stewart says.

While investors began to realize genomics was overhyped, the chemistry business at MediChem also started facing tough, low-cost competition from outsourced chemistry labs in China and India. MediChem’s hot technology at the time, combinatorial chemistry that rapidly synthesized lots of new molecules, suddenly started showing warts. Shares of the new public company tanked.

Then along came deCode.

DeCode Genetics was founded in 1996 by Stefansson, a charismatic neuroscientist from Iceland. During the genomic wave, he capitalized on the detailed family tree and medical records from a small and relatively homogeneous population in Iceland. That made it easier for researchers to mine the emerging genomic data for links between genes and disease. Stefansson and his team published many papers in the journal Nature, which generated lots of mainstream press attention.

But Stefansson knew the company needed to add broader capabilities of a real drug company to sustain his operation. Having served on the faculty of the University of Chicago earlier in his career, Stefansson was familiar with MediChem Life Sciences. So he acquired the company for its chemical capability for synthesizing drug candidates, and its structural biology group on Bainbridge Island.

The arrangement wasn’t bad for the Emerald team at first, Stewart says. DeCode gave them a lot of autonomy. Emerald was asked to do structural biology projects for the parent company to help guide its drug discovery efforts, but Emerald was free to continue making money by serving its pharmaceutical and biotech industry clients.

But Iceland is obviously a long way from Bainbridge Island, literally and culturally. “They were getting papers in Nature every two weeks, and they spent money wildly,” Stewart says.

All of those years of living beyond their means came to a head in the fall of 2008. After a dozen years in business, deCode had no products on the market, two drug candidates in clinical trials in mid-stage testing for cardiovascular disease, and one drug candidate for memory improvement approaching human tests. That was nowhere near enough evidence to keep investors sticking around any longer. And then the really horrifying stuff came with the implosion of Lehman, and the realization of how much pain that would inflict on deCode.

Emerald stopped doing research for its parent company, and picked up the pace of work for its corporate and government clients. “I floated the boat with my business for about a year,” Stewart says.

It was a stressful time, to hear Stewart reflect now. The parent company was drowning in debt, the venture capital market had evaporated, and the stock market was down. The bankers couldn’t find a way to sell off assets like those at Emerald, because nobody was really buying. While Stewart was flying around the world trying to find a way to keep the doors open, he had 40 employees back home on Bainbridge who wondered about their job security.

All that changed just three days before deCode filed bankruptcy. That’s when the investor group with Stewart’s Boston connections swooped in and paid deCode an undisclosed sum to get ahold of Emerald. The group wasn’t going to be sold off at some fire sale after all.

Interestingly, part of the investment deal involves a strategic partnership with Forma, in which Emerald is being hired to perform its X-ray crystallography work on protein structures, which will be fed into Forma’s in-house drug discovery engine. Hiring Emerald to do the work means Forma won’t have to invest in that capability in-house, Tregay says.

Stewart sounds a lot more relaxed now. He has been able to hire a few more people, building up the staff to 50. He didn’t disclose revenues, but said the independent company is still profitable. Emerald is the biggest contract research firm in the U.S. specializing in structural biology, he says. It competes with Germany-based Proteros Biostructures and Evotec and Belgium-based Galapagos. Emerald seeks to distinguish itself by using a lot of proprietary equipment, combined with the experience and know-how to use it in-house. That should enable it to compete globally for years to come, Stewart says.

What kind of prospects does Emerald have as an independent business in the future? The investors want it to remain as a fee-for-service operation, Stewart says. But Emerald is also dipping its toe into “shared-risk” arrangements with drugmakers. That means Emerald will sacrifice some upfront payments and shoulder some of the risk in drug discovery. In return, it will get a piece of the action in the form of milestones and royalties if its partner goes on to develop a marketed drug.

The ultimate proof will be in whether Emerald’s work makes a serious contribution toward the actual FDA-approved drugs that help patients and make money. Stewart won’t name names because of his firm’s confidentiality agreements, but says that his teams have worked on one FDA-approved drug. And one of his firm’s big projects of the moment is an infectious disease consortium with Seattle Biomedical Research Institute, the University of Washington, and Pacific Northwest National Laboratory, which is seeking to determine the protein structures of 75 to 100 new targets per year for infectious disease research.

Determining 100 new structures per year is an “astounding” rate of productivity, Tregay says. Emerald, even during its darkest hours, continued to deliver on ambitious goals like this, Stewart says.

Now that he’s out of the woods, Stewart is back to thinking about more traditional questions of how you manage a stable company and keep your customers happy. It’s only human nature for the team to relax a bit after they survived their yearlong period in fight-or-flight mode.

“Some of our finest work was done under our most stressful of situations,” Stewart says. “You know what they say about how necessity is the mother of invention.” But even though they were productive, it required money, and trusting relationships to keep things going. “I’m really glad that I ran into Steve [Tregay] and some people who were willing to listen to me during that time,” Stewart says. “We kept doing our work, and they stuck with us.”

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