Why Biotechs Want to Be Bought
Jonathan Norris, managing director with SVB Capital’s Venture Capital Relationship Management team, told GEN that smaller biotechs face a challenge that has increased the appeal of mergers and acquisitions in recent years—the tightening of venture capital funding following the recession. Between 2005 and 2010, 60 biotech companies tracked by SVB Capital were acquired for $100 million or more.
“One of the major issues facing venture-backed companies is that there’s a lack of reserve funding in these companies from the traditional venture investors to be able to drive companies through their pivotal Phase II or Phase III trials,” Norris said. “Many venture firms are faced with the issue that they didn’t get liquidity as early as they may have thought they were going to. They’re faced with too many companies that need to be financed and maybe not enough overall reserves to cover all the financing needs of those companies.”
Interestingly, the squeeze felt by venture capitalists struggling with obtaining liquidity explains why, since the recession, SVB Capital recorded a spike in structured M&A deals, where there is some up-front payment, but the majority of the transaction value is paid out upon completion of milestones advancing new drugs through trials.
For example, in 2009, 11 of 13 exit deals were structured; the rest involved all payments being made up front. By 2010, all-upfront deals disappeared, and all seven exit deals were structured. Most exit deals were all-upfront between 2005 (when just one of ten deals was structured) and 2008 (two of eight deals were structured).
“Venture firms have to make that tradeoff between an earlier exit that’s maybe not as attractive an exit they could get, but it’s a bird in the hand,” Norris said. “They’ll take a structured deal, which gives them a decent multiple up front, maybe a 1 or 2x, with milestones to be earned, rather than trying to fund the next big clinical trial and either not having enough funds to support that company and getting their ownership decreased, or funding that company and having the risk with those clinical trials. You’re going for an increased opportunity to exit but you also have the risk that that asset doesn’t work.”
The VC squeeze, the lengthening of trials and reviews for new drugs, and investor impatience also explain why investors took less time to exit biotechs last year (3.94 years) than any of the previous five years, where exit times hovered around five years, rising to 5.54 years in 2009. The average number of venture rounds of biotech companies with exits has yo-yoed in recent years, from three or so before the recession, to 2.5 in 2008, to 3.5 the following year, then back down to 2.6 rounds in 2010.
Another factor, according to Norris, was interest by acquirers of biotech companies in spinout opportunities, which typically are in later stages—either ready for Phase I or II. “The age of allowing smaller, more nimble venture-backed companies to be the feeder system has arrived,” Norris said.
“More than 50 percent of the exits since 2005 are by biotech companies with either preclinical or Phase I assets. And helping companies stock their early-stage pipeline allows the bigger players to work on their later-stage opportunities that have higher probability. It’s a good use of resources,” Norris noted.
According to SVB Capital’s “Startup Outlook 2011,” which focuses on early-stage companies in a variety of industries, 23% of biotech startups identified growth through M&A as an opportunity, the highest percentage of four technology sectors. However, M&A scored only fifth highest among opportunities for growth, following expansion into new markets, business conditions in existing markets, access to equity financing, and international expansion.
Those results appear to reflect that biotech startups, faced in this economy with a shriveling VC market and exits tied increasingly to milestones, are at least thinking of trying to grow their businesses before selling them off, in hopes of gaining leverage with would-be acquirers. And big pharma and big biotech show no signs of abandoning their model of recent years, which calls for replenishing their pipelines through acquisitions. So the wave of biotech and pharma M&As is likely to continue at least short-term, as long as the price is right.