Dampening Public Market Enthusiasm
Plaguing the sector is the appearance of an escalating risk profile, both in terms of regulatory burden and reimbursement uncertainty. Increased regulatory risk is reflected in annual drug approvals pre- and post-Vioxx.
From 1997 through 2004, 33 new molecular entities and biologics were, on average, approved annually by the FDA. In the wake of Vioxx, that number dropped by one-third, with an average of 22 NMEs and biologics approved each year from 2005 through 2010.
Reimbursement, too, has become increasingly uncertain. Gaining in popularity are concepts such as outcomes-based pricing and comparative effectiveness, initiatives that together potentially equate to increased development costs and decreased revenue—this on top of the enormous clinical risk inherent in drug development.
Not surprisingly, the public markets’ tolerance for this aggregate of risk is reflected in the profiles of those companies that have succeeded in going public. More than 80% of the 2011 biopharma IPO class had drug candidates in Phase III development if not approved and on the market versus 2000, when nearly two-thirds of the new issues did not have a single compound in the clinic.
This trend is also reflected in the percentage of new issues coming from biopharma. While certainly IPO volume is down overall, the number of biopharma IPOs has declined even more sharply. The 53 biotech IPOs in 2000 represented 18.1% of all new issues that year. The eight biopharma IPOs last year made up only 6.9% of last year’s total.
The period of time venture investors are required to hold onto (and fund) private companies prior to an IPO event continues to lengthen as well. Among biotech issues to go public in the 1999–2001 IPO window, the average holding period for a venture investor was five years. During the 2005–2007 window, that time period had increased to seven years. Today, the average holding period is nine years (Figure 3).
This extension in time suggests that the public markets are willing only to back much more mature companies where the increase in regulatory- and reimbursement-related risk is offset at least to some degree by a reduction in clinical risk. Yet this extended holding period does not fit within the 10-year lifespan of many venture partnerships, complicating investment dynamics.
Even with greater maturity, public market reception to new biopharma issues remains tepid. Continuing an ongoing trend, six of the eight new issues last year priced below the indicated range—four significantly below. In addition, significant insider support was often required, with insiders in some cases buying as much as 50% of the shares issued.
For a period of time that lasted at least through 2000, the biopharma industry adhered to an established financing model, with venture investors typically funding companies through preclinical development and exiting those investments, often through an IPO, upon reaching an IND. Public market exits were the preferred path, often considered more predictable than the shifting sentiments of corporate acquirers.
Over the past decade the industry has undergone significant maturation. Evolutionary advances have replaced prior years’ revolutionary advances. Likewise, increasingly sophisticated investors are focused more on products and profits and are less influenced by hype and hope. With this change in investor sentiment has emerged a transformation of the established financing model.
While venture investment has not retreated from the biopharma sector, the venture community has been forced to adjust its investment horizon accordingly. With the shift in public market interest toward later-stage deals and with the dominant focus of the pharmaceutical industry on product-oriented acquisitions, the definition of early-stage venture investment has likewise shifted.
Where once the investment thesis was fund at late-stage discovery and IPO at IND, the thesis today is fund at IND, to be acquired in late-stage clinical trials. The implications of this change in the financial dynamics suggest a future industry structure quite distinct from its current form. The emergence of capital-efficient innovations, including virtual companies, project-oriented financing, and academic involvement in development activities, perhaps offer hints.