These days, it seems biotech investors are happy to take all kinds of risk. But there are still times to hedge bets, which Atlas Venture did a few years ago with Cambridge, MA-based Annovation Biopharma.
That lower-risk investment is paying off nicely today. The Medicines Co. (NASDAQ: MDCO)—an investor in Annovation that had an option to acquire it right from the start—is buying up the startup’s remaining stock to grab the experimental anesthetic, ABP-700, the virtual company has been developing.
No deal terms were disclosed. But the Parsippany, NJ-based Medicines’s last quarterly report suggests it’s paying around $35.3 million immediately, as much as $26.3 million in future milestones, and “low single digit” royalties on sales.
Medicines held 36 percent of Annovation’s stock as of November, so it’s not clear if those payment figures include cash that would flow back to Medicines as an investor.
Atlas and Partners Innovation Fund (PIF) are the other investors. Atlas partner and Annovation CEO David Grazyel declined to elaborate on the deal terms.
However, Grazyel said Atlas—which seeded Annovation and joined with PIF and Medicines to invest a total of $8.75 million into the startup—will generate four times its investment from the upfront payment alone, with more to come if ABP-700 hits its milestones.
How Medicines ultimately fares from the deal depends upon the development of ABP-700, which only just completed Phase 1 testing. There’s a long way to go before it has a chance to generate revenue for the company.
But it’s a cheap gamble for a company generating some $700 million in revenue a year. The transaction is an example of a creative, risk-sharing biotech deal that works: investors make money, and a company gains a treatment with some upside.
Given that drugs fail more than 90 percent of the time, it’s no surprise risk-sharing triggers are common in biotech deals. Licensing transactions, for instance—when one company grabs the rights to a drug from another—are littered with “bio-bucks,” future payments tied to clinical progress. Buyouts often have various contingency triggers to guard an acquirer from failure.
Another way of handling this risk is to use a “build-to-buy” approach: A venture firm finds an idea from a research lab, forms a small company around it (Annovation had just one full-time employee and three part-timers), and gives someone an option to buy that company later on at a prenegotiated price. There are pros and cons here: these types of deals make for smaller venture returns, but the paydays come quicker, and the potential buyer is already known, interested, and committed.
Annovation, for example, was sold roughly two and a half years after it was formed—much faster than the norm in biotech—but presumably it could’ve fetched a higher price had it stayed independent and successfully progressed.
Avalon Ventures is using the build-to-buy concept in a joint venture with GlaxoSmithKline (NYSE: GSK); the British pharma has the rights to buy several of the startups that come out of their arrangement, though none have progressed to that point as of yet.
Once in a while a real biotech company will be built from scratch with a single buyer already attached, like Warp Drive Bio was via a prenegotiated deal with Sanofi.
The build-to-buy strategy has now paid off twice recently for Atlas. The firm also created Arteaus Therapeutics a few years ago as a vehicle for the rights to a migraine drug designed by Eli Lilly. Arteaus was to develop it through a proof-of-concept study and sell it back if things broke right. Lilly bought it back in January 2014.
Atlas has recently launched others. Biogen Idec has an option to buy the startup Ataxion, which is developing therapies for hereditary ataxias; and Roche could opt to buy Spero Therapeutics’s lead program, an antibiotic.
These deals don’t always work out. Novartis, for one, decided not to buy Proteon Therapeutics (NASDAQ: PRTO) after the two companies couldn’t come to terms on a deal. Proteon shifted gears, raised a new round of funding, and went public in October. Similarly, Cubist (before Merck bought it) walked away from a potential $40 million buyout of San Francisco-based Adynxx because the clinical response to the post-operative pain drug it was developing “did not meet Cubist’s exercise criteria.”
While not commenting on these specific transactions, Grayzel points to a few factors that can tip build to buy deals one way or the other.: If the partner’s pipeline priorities change along the way, or if the people who backed the deal leave for another company, things can go south
He also notes that it’s “critically important” to know what the goalposts are up front—exactly what a company has to do to trigger a buyout—and that they don’t suddenly move. And then, of course, the returns have to be big enough that it makes sense to pre-set a price, he says.
Annovation was able to avoid being tripped up by such issues, close a deal, and reward its backers. The coming clinical trials of APB-700 will prove whether or not Medicines got a bargain.