Beyond Borders: Global biotechnology report 2010

“Since by definition, increasing efficiency
requires raising the amount of output
(innovation) generated per unit of
input (funding), the efficiency of capital
deployment and the efficiency of drug R&D
are effectively two sides of the same coin.”
These approaches generally have some
combination of three broad types of
solutions. The first of these is lowering drug
R&D costs. This is not surprising, given the
tremendously capital-intensive nature of
drug development. Any model that makes
an appreciable dent in R&D costs could
potentially make the venture investment
model more efficient, by allowing VCs to
fund innovation with smaller amounts of
capital. Similarly, measures that increase
the R&D success rate could enable a more
efficient use of capital by increasing the
return on investment. Lastly, there has
been increasing emphasis on models that
allow projects to “fail fast.” Since drug
development costs increase exponentially
in later stages of development, approaches
that allow researchers to identify early on
the ones most likely to succeed — and pull
the plug on likely failures — can significantly
increase the return on investment.
It is worth noting that each of these
potential fixes for the venture funding
model is inextricably tied to the R&D
process. This is not surprising, since the
vast majority of funding that VCs provide is
spent in research laboratories. The returns
that investors earn are, in turn, directly
tied to the innovations that come out of
those labs (the key output of the model,
as we pointed out in last year’s Beyond
borders). Since by definition, increasing
efficiency requires raising the amount of
output (innovation) generated per unit of
input (funding), the efficiency of capital
deployment and the efficiency of drug R&D
are effectively two sides of the same coin.
One approach that some investors are
adopting is asset-based funding, where
more early-stage venture capital is
allocated to funding bare-bones research
projects rather than to building full-fledged
companies. Proponents of this model argue
that the traditional venture funding model,
with its focus on building companies, is
wasteful given the very high failure rates in
the early stages of R&D. In “Asset-centric
financing” on page 7, Francesco De Rubertis
and Michèle Ollier of Index Ventures
describe their approach to asset-based
funding, which allows them to take an early
asset to a go/no-go point with a smaller
investment than is typical in the traditional
venture funding model, thereby reducing
the average cost of drug development.
Of course, models based on “virtual” drug
development are not new — they have
been tried in various forms since at least
the 1990s. The fact that they have never
come close to dethroning more traditional
approaches to drug development testifies
to the challenges associated with virtual
models. For one, it is more difficult to
incentivize and motivate virtual teams of
service providers around a common goal.
Employees at emerging biotechs often
bring a high degree of passion to pursuing
the company’s vision — both because of the
culture of small, entrepreneurial companies
6 Beyond borders Global biotechnology report 2010
as well as incentive structures that directly tie
their rewards to the company’s success. While
the quality and variety of service providers
has improved steadily over time, it is not clear
that third parties working for a fixed fee can
replicate the degree of ownership and passion
that biotech companies typically get from
their in-house teams.
But that passion, as De Rubertis and Ollier
point out, can equally be a hindrance.
Management and employees at traditional
biotech companies can have a greater
incentive to protect the survival of the
enterprise rather than make decisions
purely based on R&D results. To raise
the next round of financing, companies
may be more inclined to design a study
to demonstrate that their technology has
potential or is making progress rather than
expose its weakness. Instead of folding
up shop after the failure of their lead R&D
project, management may try to hang on
by in-licensing a new R&D project, which
may not always be in the best interest of
investors. Instead of failing fast, biotech
companies sometimes end up pursuing a
lingering subsistence.
Another reality of the new normal is that
pharma companies are divesting assets
(discussed more fully in the “Big pharma”
section below), either because they are
moving out of certain disease areas (e.g.,
after a large merger) or because they
simply don’t have the resources to pursue
everything in their pipelines. Driven by
this trend, we expect VCs and other
investors to use more project-funding
approaches for developing promising
assets from these pools. These Symphony
Capital-like models would involve the
in-licensing of products from pharma
companies and could include options
that allow the companies to purchase the
assets back at pre-negotiated prices if
they hit certain development milestones.
continued on page 8