Guest col­umn: The 3 big waves re­shap­ing in­vest­ment strate­gies in ear­ly-stage biotech

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We are at a time in life sci­ences when sig­nif­i­cant strides are be­ing made to solve some of the most com­plex med­ical chal­lenges. Rapid ad­vance­ments in sci­ence and tech­nol­o­gy cou­pled with abun­dant cap­i­tal are lead­ing to new in­vest­ment strate­gies that may per­ma­nent­ly change how com­pa­nies at the cut­ting edge of drug de­vel­op­ment are fund­ed.

Let’s take a step back. For years, ear­ly-stage in­vestors and drug de­vel­op­ment com­pa­nies faced im­pos­si­bly high fundrais­ing hur­dles, ham­pered by the high cost of cap­i­tal, low clin­i­cal suc­cess rates and a long reg­u­la­to­ry process that might stretch years.

Now, this is all chang­ing. Bio­phar­ma in­vest­ing over­all is on pace to reach new heights in 2018. In par­tic­u­lar, bio­phar­ma Se­ries A in­vest­ments are ex­plod­ing; by mid-year 2018, these have al­ready ex­ceed­ed full-year 2017 to­tals. Some ear­ly-stage com­pa­nies are now at­tract­ing in­vest­ments at lev­els once seen on­ly in lat­er-stage deals.

Source: SVB “Trends in Health­care In­vest­ments and Ex­its 2018,” Pitch­Book, SVB Pro­pri­etary Da­ta

Click on the im­age to see the full-sized ver­sion


Move to port­fo­lio-style in­vest­ing

What is dri­ving this shift in in­vestor con­fi­dence and fu­el­ing new bio­phar­ma com­pa­ny cre­ation? For­ward-think­ing in­vestors and en­tre­pre­neurs are look­ing at ear­ly-stage drug de­vel­op­ment op­por­tu­ni­ties from a mu­tu­al fund per­spec­tive. Their goal is to in­crease the odds of a large re­turn from a sin­gle suc­cess­ful drug in­vest­ment, while re­duc­ing the typ­i­cal­ly high risk of a sin­gle ear­ly-stage in­vest­ment. They achieve this by build­ing and in­vest­ing in a port­fo­lio of drug de­vel­op­ment as­sets that, when pooled, car­ry a low­er cor­re­la­tion of risk and a high-enough prob­a­bil­i­ty that at least one will reach clin­i­cal and reg­u­la­to­ry suc­cess. The odds are im­proved by that fact that life­sav­ing ad­vances are be­ing made to un­lock mech­a­nisms un­der­ly­ing many spe­cif­ic dis­eases, lead­ing to more ef­fec­tive treat­ments.

While this new mod­el re­mains cap­i­tal-in­ten­sive, it works to spread the risk and, by ex­ten­sion, pro­vides a more pre­dictable pat­tern for re­turns. As a re­sult, pri­vate eq­ui­ty and deep-pock­et­ed in­vestors now have more con­fi­dence in ear­ly-stage bio­phar­ma — in a few cas­es enough that some port­fo­lio as­sets are be­ing spun out as in­de­pen­dent com­pa­nies.

This shift in ear­ly-stage bio­phar­ma in­vest­ing, in fact, has evolved in three waves.

Source: Com­pa­ny web­sites and press re­leas­es

Click on the im­age to see the full-sized ver­sion


First wave: Spin off a sin­gle as­set

In the first wave, ex­em­pli­fied by Adimab and Nim­bus Ther­a­peu­tics, small­er com­pa­nies di­rect­ly took on the risks of drug dis­cov­ery. For ex­am­ple, Adimab launched as an LLC with no clear in­ten­tion of ever ex­it­ing as a whole com­pa­ny, an event that tra­di­tion­al­ly would have led to a big lump-sum pay­day for in­vestors. In­stead, Adimab’s busi­ness mod­el cen­tered on de-risk­ing the ear­li­est stages of drug dis­cov­ery for larg­er bio­phar­ma and prof­it­ing from the over­all de­creased un­cer­tain­ty. This pro­vid­ed in­vestors with a some­what pre­dictable div­i­dend stream from reg­u­lar as­set-li­cens­ing deals, and the large bio­phar­ma as­set pur­chas­er with a source of less risky as­sets. Still, the larg­er bio­phar­ma com­pa­ny had to move ear­ly to ac­quire the as­set, and as a re­sult as­sumed a rel­a­tive­ly high risk of fail­ure. With­out trans­fer­ring all the risk, the in­vestors were left with some con­straints that lim­it­ed their re­turns.

Sec­ond wave: Build to buy

The next wave took the con­cept a step fur­ther. In­stead of de­vel­op­ing a sin­gle drug can­di­date, “build-to-buy” com­pa­nies were es­tab­lished around each as­set and spun out as new com­pa­nies. Ver­sant Ven­tures’ In­cep­tion Sci­ences, a drug dis­cov­ery in­cu­ba­tor that spawned young com­pa­nies, and or­phan drug com­pa­ny Daunt­less Phar­ma­ceu­ti­cals are prime ex­am­ples. Very ear­ly on, they part­nered with a big bio­phar­ma com­pa­ny that gained the ex­clu­sive ac­qui­si­tion rights at pre­set terms. How­ev­er, ear­ly-stage in­vestors had to take a small­er re­turn on their in­vest­ments to com­pen­sate for the low­er risk as­so­ci­at­ed with a pre­de­fined ex­it. On the flip­side, strate­gic part­ners were will­ing to pay slight­ly more than nor­mal be­cause they were ac­quir­ing more-ma­ture as­sets, of­ten with sci­en­tif­ic teams in place to help bring the drug can­di­dates to the fin­ish line, in­stead of hav­ing to ded­i­cate their own R&D staff.

Third wave: Port­fo­lio-the­o­ry ap­proach

Now, in­vestors are ex­per­i­ment­ing with a full port­fo­lio-the­o­ry ap­proach, which is par­tial­ly based on an in­vestor the­o­ry called “re­search-backed oblig­a­tions,” de­vel­oped by eco­nom­ics pro­fes­sors An­drew W. Lo and Roger Stein of the Mass­a­chu­setts In­sti­tute of Tech­nol­o­gy. Most in­vestors are fa­mil­iar with the con­cept, known as port­fo­lio in­vest­ing. It works like this: The goal is to own a con­trol­ling in­ter­est in a large num­ber of high-risk, po­ten­tial­ly high-re­turn ear­ly-stage com­pa­nies built around sin­gle as­sets. The idea is to spread the risk across a large enough num­ber of com­pa­nies that the bi­na­ry risk of fail­ure is re­duced, in the hopes that one com­pa­ny will sig­nif­i­cant­ly out­per­form.

To do this to­day in bio­phar­ma, an in­vest­ing en­ti­ty needs mas­sive sums of cap­i­tal, which in the past was tar­get­ed on­ly to late-stage com­pa­nies. As a re­sult, the pi­o­neers in port­fo­lio in­vest­ing with ear­ly-stage com­pa­nies have very deep-pock­ets. For ex­am­ple, Bridge­Bio is backed by pri­vate eq­ui­ty firms KKR, Viking Glob­al In­vestors and Per­cep­tive Ad­vi­sors. Bridge­Bio has fund­ed sub­sidiary com­pa­nies work­ing on a va­ri­ety of drugs to treat every­thing from skin con­di­tions to in­her­it­ed heart dis­or­ders, most of which are ear­ly-stage. In these cas­es, the in­vestors may be pre­pared to take a loss of tens of mil­lions of dol­lars in the short term with the ex­pec­ta­tion that clin­i­cal break­throughs will lead to at least some of these bets pay­ing big re­turns in the end.

The fu­ture of bio­phar­ma in­vest­ing

Oth­er com­pa­nies are ap­ply­ing a port­fo­lio-the­o­ry ap­proach to bio­phar­ma R&D with a broad­er strat­e­gy be­yond pre-clin­i­cal R&D. Ve­loc­i­ty Phar­ma­ceu­ti­cal De­vel­op­ment (VPD), for ex­am­ple, is based on in­vest­ing in un­der­fund­ed or shelved drugs. VPD es­tab­lished a “project-fo­cused com­pa­ny” around the as­set. Sim­i­lar­ly, Roivant Sci­ences, which in­cu­bates and launch­es new sub­sidiaries known as “Vants,” is pool­ing as­sets and has at­tract­ed some mas­sive in­vest­ments. As its first bio­phar­ma in­vest­ment in Au­gust 2017, Soft­Bank Vi­sion Fund made a $1.1 bil­lion in­vest­ment in Roivant Sci­ences, not its sub­sidiaries. Mereo Bio­Phar­ma Group is an­oth­er port­fo­lio play that keeps de­vel­op­ment of clin­i­cal-phase as­sets un­der a sin­gle en­ti­ty.

Look­ing ahead, as the port­fo­lio-the­o­ry ap­proach evolves we en­vi­sion large pools of low-cor­re­la­tion risk as­sets com­bined with a more pre­dictable fi­nan­cial re­turn mod­el, at­tract­ing huge new sources of cap­i­tal from in­vestors, even re­tail in­vestors. This has the promise of fu­el­ing new drug de­vel­op­ment at ear­li­er stages and solv­ing med­ical chal­lenges faster. These mod­els al­so lend them­selves to very so­phis­ti­cat­ed cap­i­tal en­hance­ments, such as lever­age and se­cu­ri­ti­za­tion. We could be at the very be­gin­ning of a new in­vest­ing strat­e­gy that may lead to ma­jor dis­rup­tions in tra­di­tion­al sci­en­tif­ic in­vest­ing as we know it.


Jen­nifer Friel Gold­stein, BSE, MB, MBA, is the head of Sil­i­con Val­ley Bank’s West Coast life sci­ence and health­care prac­tice. An­drew Ol­son, PhD, is a se­nior man­ag­er lead­ing mar­ket re­search in sup­port of Sil­i­con Val­ley Bank’s life sci­ence prac­tice.

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Welcome back to Endpoints Weekly, your review of the week’s top biopharma headlines. Want this in your inbox every Saturday morning? Current Endpoints readers can visit their reader profile to add Endpoints Weekly. New to Endpoints? Sign up here.

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