As we enter 2003, we have high hopes for the venture-backed life science industry. It still offers the unprecedented promise of new products and technologies that ultimately will greatly improve human health care. However, given the difficult market environment that may continue well into the New Year or beyond, and the corresponding challenges in raising money, the question for venture capitalists and entrepreneurs is how to marry leading-edge science with a realistic investment horizon and good returns.
First of all, a comment on the business model. Companies that are most likely to attract investment dollars and succeed commercially are those that offer both a platform technology and product. There are two benefits to this model. The first benefit is that the platform may be commercialized in collaboration with pharmaceutical customers who pay upfront access fees, licenses, milestones and royalties on products generated by using the platform. If the terms are well negotiated and the intellectual property is carefully licensed, non-exclusive agreements can be executed that allow the platform to be commercialized many times.
There are non-financial attractions as well: If the collaboration is done with reputable pharmaceutical companies, the technology will be endorsed and rise in value. The company also will learn from the collaboration, and this will be of value for future deals and generating its own products.
Build Your Own
The second benefit is when the platform also offers the company an opportunity to generate its own products that could have large future value. This will probably need more investment and will involve greater risk than the collaboration described above, but the potential upside will be greater. In return for the greater risk, the company will retain ownership of the products or at least a significant share of the sales or profits if the products are sold through a pharmaceutical company. A company that successfully combined the platform and product model is Aurora Biosciences, which merged with Vertex Pharmaceuticals. [Collinson is Aurora’s former CEO and chairman and helped merge the company with Vertex. -Ed. ]
Proof Means Money
On a different note, moving into 2003 and beyond, early-stage companies that can demonstrate proof of principle even before drawing investment dollars will be most likely to succeed. One example is a technology that has generated a therapeutic product within a university, perhaps funded by government grants to take the concept beyond the theoretical stage. The product could even have been tested in patients and considerable data could have been generated.
This suggests that in the case of some nascent technologies it may make sense to incubate the technology longer in an institution, clear some proof of concept hurdles and benefit from grant funding before forming a venture-backed company. CancerVax, a private San Diego-based cancer company illustrates this point. Although the company received its first institutional investment, a $30 million round led by Forward Ventures, in December 2001, work on the company’s cancer vaccine began 40 years ago at the National Cancer Institute.
None of this is meant to suggest that the “venture” should be taken out of venture capitalist. By definition the industry should take greater risk in return for greater reward. The industry is already responsible for medical breakthroughs that are helping to fill the void left by an unproductive pharmaceutical industry, and this demands risk.
At the same time, however, we have seen products and technologies get financed in the past few years that would never be funded in today’s more-discriminating times. Large amounts of capital have been sunk into platform technologies that were exciting science but could never become widespread disruptive commercial technologies addressing large markets.
In some cases technology companies, having wasted considerable money but still flush with capital from large fund-raisings in 2002, have abandoned their technology and converted themselves into drug discovery or development companies. Marginal therapeutic products are then licensed from willing sellers that do not meet significant clinical needs and are unlikely to generate a positive net present value.
What’s the point? In 2003, there needs to be a clear focus on the business model and on how much capital is needed to get a technology and/or product to generate revenue and get a company to breakeven. These obvious metrics have occasionally been forgotten in recent history, largely because nascent companies were funded with too much money at too-high valuations.
Lessons from the leveraged buyout industry tell us that companies that have scarce capital and an unwavering focus on how the marginal dollar is spent tend to generate significant shareholder value. This is not to suggest that life science companies should be treated the same way. I simply mean that there are relevant lessons that can be learned as we weather the current economic downturn.
I am optimistic and excited about the potential for the venture-backed life science industry. It will, however, require a return to the basics of a rational business model and efforts to wring even more risk out of early-stage investment opportunities. That said, as we look into the New Year, life science entrepreneurs and investors would undoubtedly be even more prolific than in the past at commercializing technologies and products that advance medicine and improve patient care.
Stuart J.M. Collinson is a member of Forward Ventures, a 10-year-old life sciences firm that manages $340 million. Previously, Collinson was chairman and CEO of Aurora Biosciences, which he helped merge with Vertex Pharmaceuticals in a deal valuing Aurora at $600 million. He sits on the boards of Vertex Pharmaceuticals, Oxagen Ltd. and GeneOhm Sciences.