GETTING AHEAD: TOP TIPS FOR EARLY-STAGE COMPANIES SEEKING DEALS IN THE COMPETITIVE BIOPHARMA MARKET
Market experts are predicting more biopharma transactions in 2018 compared with last year, but positioning start-ups and emerging companies for the best deals is a tricky business. Scrip has collected advice from industry experts on how to value non-profit-making businesses and gathered tips on the best way to capture the attention of potential partners or buyers.
Albert Sokol, a partner at US law firm McDermott Will & Emery, highlights the challenges surrounding deal structures that include several milestone arrangements and less upfront cash. Martin Gouldstone, a partner at UK-based consultancy Results Healthcare, discusses evaluation techniques for pre-revenue-making biotechs and what information smaller firms should be presenting to pharma partners. And with an insider's view, Jill Jene, senior VP of business development at emerging artificial intelligence-driven biopharmaceutical company twoXAR Inc., adds her thoughts on creative deal making and standing out in a crowded market.
Changing Face Of Early-Stage Companies
It is expected that 2018 will see a lot of deal making activity, at all levels, by pharma and biotech businesses as established players try to fill up pipelines ahead of patent expires for top selling drugs in the coming few years. Several big players, such as Gilead Sciences Inc. and Merck & Co. Inc., are also sitting on large cash piles and many companies have stated their desire to seek 'bolt-on' transactions in 2018 to boost their R&D offerings. Tax reforms in the US will also spur M&A activity, freeing up more cash for deals.
Albert Sokol, partner at McDermott Will & Emery
"With the ability now for large pharma to bring large reserves of foreign-situated profits back to the United States, with a single tax-holiday-like toll charge on reserved profits (plus dramatically reduced rates on new profits), there will be more bio-side cash," Sokol told Scrip in a recent interview.
In parallel, there is a trend towards more unusual spin-offs from pharma companies, with assets being picked up and funded by venture capital firms. While VCs are forming 'early-stage' businesses, often their products have been within originator companies for several years. "Those deals are early-stage because they are the first stage outside of big pharma," Sokol noted, but the assets are attractive to VCs as they can present with lower risk profiles than assets emerging, for example, from academia.
Sokol told Scrip that the definition of an early-stage company could be changing. He added that the sector had seen not just one-off deals with VCs for pharma assets, but also formal alliances that "sometimes energize fallow assets."
"An example that is occurring to me is the alliance started a couple of years ago, by Eli Lilly & Co. and TVM Capital Life Sciences in Munich and Montreal," Sokol said. "It’s a formal model. When I say formal, I mean one after another, after another, after another. As opposed to just a singular spin-off and then a singular financing that follows, which is different."
Alongside this changing definition, Sokol said there had been continual experimentation by deal makers with different deal structures and different players. "There’s no longer just one way to do stuff; there’s no longer merely the classic venture capitalists. There are now many corporate venture capital arms of pharma. Most large pharmas have large CVCs," he noted.
While the definition of early stage might be changing, there are still hundreds of spin-offs, start-ups and emerging companies coming to market with novel technologies. Deals for smaller businesses are expected to hot up in 2018, but valuing these types of businesses can be a challenge.
The Challenge Of Valuing Innovation
Gouldstone told Scrip it was tricky to evaluate an emerging drug developer for M&A, especially when the company was not a profit-making business. However, Results Healthcare – a corporate advisory focused on public and private healthcare and life science companies – uses certain metrics as well as its knowledge of the broader industry to help put valuations on different businesses.
Martin Gouldstone, partner at Results Healthcare
"For a pre-revenue biotech with a small set of discovery stage or early clinical stage drugs, we would look across the whole portfolio," Gouldstone said. "We think about how to evaluate the potential success of those drugs and then also what other deals have been made with those drugs, or classes of drugs, in the past and what those deals look like."
However, he noted it was difficult to make like-for-like comparisons between different licensing deals or acquisitions. "Sometimes, you’re lucky and you’ve got the same drug target and the same type of approach and a comparator in that way. Oftentimes you haven’t," he said, adding that the process was more of an art than a science.
The key metric in assessing the value of an early-stage drug developer is attritional risk. Gouldstone said this varied based on the type of molecule and the disease area, as well as the stage of development. "Attritional risk is much lower once you get beyond Phase I," he noted.
Using past transactions to benchmark deal values is also becoming more difficult because deals are evolving to use complex setups with several contingencies.
"Common deal structures these days don’t yield a single purchase price up front," Sokol said. He added that it can be difficult to determine the value of a deal when there are multiple post-closing milestones and some of those earn-out considerations can carry on for five to fifteen years.
He added that while "everyone wants upfront value," most deals now have milestone agreements in place that defer the realization of large portions of the value of the deal over time and are contingent on achievements that cannot be guaranteed at the outset. This makes direct comparisons for company valuations complicated.
Positioning Novel Businesses
The hardest companies to value are those with new and disruptive technologies. "It is difficult to assess for new disruptive technologies just how likely they are to succeed," Gouldstone said. He highlighted immuno-oncology as an area where the first companies to seek deals faced the challenge of being disrupters. "When the first immuno-oncology product was being developed, I’m sure they had no clue how to pin its research risk because it would be very difficult to understand."
Another example of a difficult company to value for M&A, a transaction Gouldstone worked on personally, was the sale of German biotech Birken AG, a natural products company, to Amryt Pharma PLC in late 2015.
"Natural products historically have been anathema to pharma," he said. Birken was developing a treatment derived from birch bark that could be used to accelerate wound-healing. When Gouldstone worked on the sale of the business, this product was in Phase III and the company was seeking European approval for a novel indication, partial-thickness wound healing. This uncertain and new market was another strike against the product.
To be able to value the business and position it for strong M&A bids, Gouldstone said his team had to provide a better sense of the market size and the market penetration of the product, and a better sense of the approvability of the product. Gouldstone said Birken was able to leverage the fact it had done a lot of early research into how its product worked and the company had a strong understanding of the method of action of the treatment. This helped to get the attention of the pharma industry because historically with natural products, the method of action is often not well understood.
"They were well funded, so they’d actually done the clinical trials properly and they hadn’t cut corners at all. So, they had very well-controlled, well-designed clinical studies with the compound in enough patients," Gouldstone added.
In this case, Gouldstone said his team presented Birken to more than 200 potential buyers to find the right deal. "The number of buyers we would usually go out to in a process varies a lot and with these earlier stage, more risky businesses, you do need to cast the net wider. But if you’ve got a business with a defined profit, you can probably go out to 20 to 25 buyers quite happily," he noted.
With Birken, the problem was that pharma decision making was slow and VC investors were concerned about the uncertain nature of the product. In the end, the deal included a licensing-type structure, even though it was an acquisition, with an early-stage milestone for EMA approval of the product.
Gouldstone noted a trend recently of pharma companies licensing late-stage programs to alternative partners. "For a while now we’ve had project-based financing vehicle businesses out there, like Avillion, Nuevolution, SFJ Pharmaceuticals, that are investing in pharma’s Phase III assets for them because pharma can’t fund all of the programs that they want to. This can be a tax efficient way for them to do so. So, there are a lot of creative deals out there or creative ways of approaching this," he noted.
Jill Jene, senior VP of business development at twoXAR
Meanwhile, Jene added that it can be difficult to position emerging companies in 'hot' biotech areas and stand out when there is a sudden influx of competition in one space. "The AI space is hot right now and there is a lot of money running into it: one of the challenges is reminding people what we do, how we do it and the successes we have had – because there is a lot of noise," she said. TwoXAR does this by working hard to secure regular meetings with potential partners to keep conversations moving forwards.
Jene also told Scrip that offering flexibility was how the emerging Californian company attracted partners. "The way we position the business is to explain how we are different and the value we bring; we have preclinical evidence and animal studies beyond the computer to show this," Jene said, adding that having its own pipeline as well as AI technology helps to demonstrate twoXAR's drug discovery capabilities to potential partners.
"We can be flexible with our deal structures," Jene said. "We can do everything from traditional licensing agreements, with milestones and royalties, to deals with ownership stakes and everything in between."
Jene, who has worked in business development for that the past 20 years at various pharma and biotech companies, cited twoXAR's 2017 arrangement with Santen Pharmaceutical Co. Ltd. as an example of a more creative structure. In February last year, Santen and twoXAR entered into a strategic research collaboration focused on the identification of new drug candidates for glaucoma. Jene noted that deals like this may include a joint ownership factor as well as some more traditional milestones.
"Our big differentiator as a discovery partner is that we can allow medium and large size companies to fill their pipelines very quickly and efficiently; and we can be flexible in meeting a partner's needs," she added.
Tips And Tricks
When it comes to advising emerging biotechs on how best to approach potential partners or buyers, Gouldstone and Sokol both highlighted frequently asked questions and common pitfalls. One common error is to approach potential pharma partners too early with an incomplete information deck, they both said.
Gouldstone's work involves packaging a business up for sale. "In its simplest form, certainly for businesses that are profitable, we make sure that the finances are very clean, that the all assets are in place and that the EBITDA number is representative of what the buyer’s actually getting," he noted, adding that Results Healthcare also ensures that business forecasts are solid and defensible.
With the earlier stage biotechs this is harder to do. "If they’ve already gone out with, usually, what is a very poor deck and very light on commercials," it can be a challenge, Gouldstone said. "Typically, that’s the biggest pitfall I'll come across, that a company has already pre-sold themselves but probably not done it in as thoughtful a way."
He therefore concentrates on the finer details and thoroughness when preparing biotechs for deal making. He added that biotechs looking to sell or partner benefit from external consultation because they can often be too close to their technology. "Nobody likes to be told their baby is ugly. We’re looking at them in a much more objective fashion."
Gouldstone's best bit of advice: know who all of the stakeholders are before approaching a business development discussion. "If the business is being sold, know who all of the stakeholders are because quite often the key stakeholders aren’t always involved directly in the business day-to-day. Their needs and wants are very, very different from the people involved in the business generally. So, trying to marry up all of those expectations is quite tricky at times."
For example, one job Gouldstone was working on involved five directors who were very different from each other. "You’ve got five balls you’re juggling in the air and no matter what you do, one ball always drops. It’s a different ball every time, so it can be very difficult," he said.
Sokol highlighted another issue with approaching potential buyers: internal competition. A common mistake was forgetting to assess the pipeline of a prospective partner for internal products that could clash. While this is not always a problem, not being aware of internal competition was an issue, Sokol said. "What is the effect on the dynamics of your deal?" should be the key question he noted. "If you are aware of potential conflicts between pipeline assets then you can do something about it."
Sokol's best advice for emerging drug developers seeking M&A or licensing deals is: "Know which battles to fight." Compromise is almost always necessary to get a deal done. "If you don’t understand your counter-party, you won’t reach a deal. You need to know not only your own interests but the counter-party’s business interests. And that helps you define which battles to fight and how to run the negotiation strategy," he said.
For Jene, the biggest mistake by emerging biotechs in her experience was lumping business development in with other job roles.
"In my career, I have seen a lot of companies that have folks do business development as a side job and then wonder why they aren't moving deals forward. I am amazed at how many companies don’t see business development as a separate function that needs to be staffed with full-time, dedicated professional resources," she said. This can be an issue at small and mid-size biotechs, she noted.
A Record Year Ahead?
While securing an appropriate valuation for an emerging business with novel technology continues to be a challenge, 2018 is likely to see many deal making opportunities for smaller drug developers. Tax reforms in the US and a quieter M&A front in 2017, mean the industry is eager to secure deals to advance pipelines.
Being able to produce a defendable and reasonable data pack is critical for biotechs approaching bigger pharma partners or buyers and jumping the gun on this process appears to be a common pitfall.
Meanwhile, flexibility and creativity are the keys to successful deals for smaller business, according to experts asked by Scrip. Competition is growing in 2018 for biotechs looking to secure acquisitions or partnerships, to become the option of choice companies might need to be open to new deal structures and fewer dollars upfront.
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