Venture-Backed Biotechs Taking Chances With Big Pharma Earlier On

Dow Jones VentureWire
09.08.09

Venture-Backed Biotechs Taking Chances With Big Pharma Earlier On

Harsh economic conditions are forcing some venture capitalists to rethink how biotech companies should interact with pharmaceutical giants.

Venture investors traditionally have advised these companies to maximize leverage by waiting until mid-stage clinical trials before partnering or agreeing to be acquired. But the rising cost of getting that far, combined with the inability of companies to go public, is prompting some to call for dropping the arm's-length approach in favor of much closer relationships.

In some cases, venture-backed biotechs are forming drug development deals around products that have yet to enter clinical trials but could earn large milestone payouts down the road. In addition to early alliances, some investors are also urging executives to consider unconventional deals, including structured mergers, in which a corporation gains the right to buy the company once it reaches a given milestone.

The tactics come as firms strive to cope with the capital crunch and an increasingly complex regulatory climate, which have made it difficult for small drugmakers to go it alone for long. Through these early collaborations and creative deal structures, some venture investors hope to cut their reliance on funding sources that are drying up -- the public markets, crossover funds -- and boost their chances of ultimately selling their companies.

"I think the evolution of early-stage biotech investing will involve much more co-dependencies [with] bigger pharma companies," said Atlas Venture Partner Bruce L. Booth.

While venture investors haven't given up on taking companies public, most now acknowledge that the bulk of their exits will come through mergers. Consequently, Booth and some other venture capitalists are grooming companies to be acquired. In some cases, this means developing an asset, such as drug or technology, to fit a corporate division instead of building a fully integrated business that would appeal to Wall Street.

Firms like Atlas are seeding biotech start-ups and running them virtually in the early going, hiring few full-timers and contracting out many services. They also encourage start-ups to find partners early on. By minimizing the amount they invest to create value, they aim to increase their M&A options. There are more corporations that can handle a $200 million acquisition, for example, than a $700 million one.

One early-stage company, Vitae Pharmaceuticals Inc., in June forged its second partnership with Boehringer Ingelheim GmbH around pre-clinical compounds. That deal involving an Alzheimer's disease treatment included $42 million in upfront and near-term payments, an equity investment and research funds, plus potentially $200 million in pre-commercial clinical and regulatory milestones.

Other venture-backed companies have won over big drug makers with preclinical products recently as well, including Concert Pharmaceuticals Inc., which in June agreed to a deal with GlaxoSmithKline PLC that could net it over $1 billion as the companies develop drugs for HIV and other conditions. Before this deal, the company had about two years' worth of funding, said Chief Business Officer Steven Bernitz. With the upfront funds and near-term milestones, the company now has capital for several years to advance other programs not included in this deal.

If these types of collaborations go well, there is also the possibility that a corporation will elect to buy its partner instead of paying it all the milestones.

Venture firms are also minimizing risk and setting themselves up for profit through back-ended M&A deals or those structured so that a corporation secures an option to buy after a company's drug has proven itself. Investors, of course, would prefer to get all the money upfront, but some predict that those arrangements will grow scarce.

Backers of Proteon Therapeutics Inc. recently calculated that granting Novartis AG an exclusive acquisition option was their best bet. Proteon this year has secured $50 million in Series B financing -- from MPM Capital, which led the deal on behalf of MPM Bio IV NVS Strategic Fund LP, and others -- and gave Novartis the right to buy after successful completion of Phase II studies of its lead product, PRT-201, a drug used for renal-disease patients undergoing dialysis. The initial acquisition payment, plus milestones, could exceed $550 million.

Proteon may have gotten more by partnering or selling after Phase II, but this structure appealed because of the difficult financing market and the total amount that Novartis agreed to pay, said Brendan O'Leary, general partner of Prism VentureWorks and a Proteon board member.

Phase II studies for PRT-201, designed to keep arteriovenous fistulas and grafts from failing, are also expected to produce clean data. Good results should therefore attract other suitors if Novartis decides not to buy, said Garheng Kong, general partner of Intersouth Partners. "If Novartis chooses not to exercise the option, the quote-on-quote taint will be pretty minimal," he said.

Other benefits of engaging pharmaceutical companies early include access to their clinical-development expertise. That figured into Actimis Pharmaceuticals Inc.'s decision last year to agree to a $515 million phased merger with Boehringer, in which Boehringer acquires shares as Actimis's asthma treatment progresses through the clinic.

Large asthma studies are more likely to be done to world-class standards with the help of a respiratory-drug expert like Boehringer, whose products include Spiriva, the chronic obstructive pulmonary disease drug, said Peter C.M. McWilliams, a principal of Sanderling Ventures. With Boehringer on board, "I think we stand a much better chance to see a payout down the road," he said.

Phased-merger agreements may also help a firm forecast its return for a company sooner than if it waited longer to make deal. But problems can arise as well. If it takes longer than expected to reach important milestones, the returns might not flow in until well after the life of the fund used to a back the company. Moreover, the acquiring company may go on to be acquired itself, or the people who handled the purchase may move on -- two developments that can make it difficult to be ensure that milestones are paid promptly.

Venture investors must therefore be particularly vigilant when negotiating terms, said Stuart J.M. Collinson, a partner of Forward Ventures. In addition to trying to secure as much as possible upfront, and being very clear on what triggers a milestone payment, firms also should ensure that they will be able to track a product's progress, since the acquirer might choose to reveal little about the drug publicly after dropping it into its pipeline.

Keeping track of these things is "a lot more difficult than you would think," Collinson said. "Even getting contractually required information can be a problem."

Structured acquisitions may not be ideal, but they are better than none at all. And many observers take pharmaceutical companies' willingness to be flexible as a positive development -- one of the few for early-stage investors recently.

Bristol-Myers Squibb Co., which began a push to work more closely with biotech companies two years ago, is now open to deals it wouldn't have made before, for example. Last month, it led a $14.4 million Series G for partner XDx Inc., a first for Bristol-Myers, said Jeremy Levin, senior vice president, strategic transactions group.

While Bristol-Myers doesn't want to get into the venture business, it does want to take opportunities to help partners succeed, Levin said. The new thinking means there are more ways for biotech concerns to interact with the company. "We are completely open to transaction structures of all kinds, we're not constrained one way or another," Levin said.

Of course, the more start-ups rely on alliances, the more important it is to choose and manage them well. This means considering how the collaboration fits the long-term vision and how the cultures mesh, said Kleanthis G. Xanthopoulos, CEO of Regulus Therapeutics Inc., which is working with GlaxoSmithKline PLC to develop therapies of inflammatory disease.

The human and cultural aspects are "where a lot of partnerships fail," Xanthopoulos said. "I wouldn't create an alliance simply to check a box."