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Insight & Intelligence : Dec 10, 2009
Early-Stage Investors Hedge Their Bets with Medical Devices
VCs are looking for a quicker return on their investments with less risk involved.!--h2>
Despite the biotech industry losing approximately $100 billion since the field's inception in the 1970s, the days of investing in biotechs are not dead. Biotechs are important sources of healthcare innovation. They have filled the gap created by the slowdown in the R&D pipeline of big pharmaceutical and medical device companies over the years. Additionally, biotech companies are responsible for creating a large number of drug candidates.
Few industries require as much time and money, however, to develop a product as the biotech industry. Since biotechs may need 10–15 years to create revenue-generating drugs/products, they often rely on investors until then. Early-stage biotechs rely heavily on venture capital in particular until their technologies become attractive to a wider range of investors including larger pharmaceutical and medical device companies.
Often, after a product reaches a certain stage of development, many biotechs are either acquired by or enter into a licensing agreement with a larger company to complete the development, production, and marketing of the product. It is estimated that by 2010, about 26% of sales from the 20 largest pharmaceutical companies will be derived from in-licensed biotech products.
Nontraditional forms of venture capital funding have significantly diminished as a result of there being less capital readily available for investing due to the financial markets being in turmoil, healthcare policy and reimbursement uncertainty, as well as patent restrictions. In light of the current selectiveness and risk aversion by larger pharmaceutical and medical device companies, one may wonder where early-stage venture capitalist will hedge their bets to get a faster and more likely return on their investments. Venture capital firms have gradually increased the level of their investment in the medical device and pharmaceutical sectors over time, alternating between the two and concentrating their investments in a fixed number of biotech start-up companies.
More Support for Medical Devices
These days venture capital firms are likely to switch their focus from biopharmaceutical products to medical devices. The rationale for this strategy is that medical device companies have a shorter product life cycle (18–24 months), smaller research expenditures, less competition from generic manufacturers, and a higher emphasis on development and commercialization. All of this leads to more predictable and faster-realized revenues.
Normally, medical device companies have to submit the results of large studies before launching new devices. Yet, medical device firms can argue that their devices are similar to other FDA-approved products, dramatically speeding up the approval process.
On the financial side, the medical device sector has also enjoyed higher profitability, higher IPO returns to investor, and higher barriers to entry. Despite being pressured to lower cost on high-tech implants and uncertainty about future reimbursement policies, medical device companies continue to develop new devices or upgrades that allow them to fetch price increases and enjoy hefty profit margins on such products. It also does not hurt that medical device companies have huge growth trajectories in emerging markets like China and India.
Biopharma Inks More Structured Deals
The biopharmaceutical segment, on the other hand, is viewed as high-risk. For example, new cancer drugs can take seven years to get approved, given that the FDA prefers companies to perform larger studies with comparison groups to measure results such as overall survival. Many biotech companies, though, cannot afford to spend more than $600 million to complete such studies.
Entrepreneurs and biotech CEOs report that raising capital to fund their businesses is a top priority, as modest success in trials could lead to billions in sales. Without the much-needed capital, many biotechs struggle or die prematurely. As funding declines and in order to survive, a good number of biotechs are forced to reduce operations, slash jobs, put clinical studies on hold, sell off assets, or file for bankruptcy.
Currently many stressed biotechs are merging with others, pooling what is left of their cash to develop the most promising products they have. While these survival strategies are part of the standard toolkit for biotechs in good economic times, they have become more of a necessity in this current state of financial instability. Despite the economic downturn and given such factors as the slowest growth in U.S. retail sales of prescription drugs in the last 47 years, increased sales of generic drugs, and the potential launch of biosimilars, there are a number of drug makers still acquiring companies and forming partnerships. This helps bolster their pipelines to offset losses from top-selling products coming off patent and provides access to products in later stages of development.
Mergers carried out among big pharmaceutical companies like Pfizer with Wyeth and Merck & Co. with Schering-Plough are not the only deals getting done these days. Yet, the days of big pharmaceutical and medical device companies investing in biotechs through large up-front payments and taking a smaller licensing fee on the sale of marketed products seem to be behind us for now. The deals happening now are of two varieties: structured acquisition agreements and straight-up acquisitions.
Both big pharmaceutical and medical device companies are increasingly structuring takeover deals with biotechs to pay only for successful products and are limiting their investment money as a means of reducing the risk in the event of product failure. In the case of larger companies, such deal arrangements allow them to wait for success before writing a large check. For the biotechs, structured deals provide much-needed cash at a time when few other options are available.
Rahsaan W. Thompson ([email protected]) is of counsel to Quarles & Brady's health law and biotech/life sciences practice groups.
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