Pharma-Academic Partnerships & The Impact on Venture Funds

This past week, Yale University and Gilead announced a collaboration where the pharma company will provide $40 million in research support over a four-year period to the university to discover new oncology therapeutics, with a possible six year / $60 million extension.  Gilead has made no secret of the company’s intent to become an oncology powerhouse as they recently acquired Arresto Biosciences and Calistoga Pharmaceuticals for a total of $600 million upfront.  As the pharma company seeks to develop an early stage oncology pipeline, partnering with a strong academic center is a logical step to filling that desire.

Yale is a great choice for Gilead as an academic partner.  The Yale Cancer Centre is one of 41 comprehensive cancer centers in the nation designated by the National Cancer Institute.  In addition, Yale recently purchased the old Bayer headquarters in West Haven and a lot of Bayer’s oncology talent has remained in New England.  As Yale builds out the West Haven site, one can imagine many former Bayer vets working in their old stomping grounds.  The last essential piece of the partnership is the fact that Yale researchers are incredibly entrepreneurial and have a lot of experience in developing novel pharmaceutical compounds. 

The Yale-Gilead partnership comes on the heals of several other high profile pharma-academia partnerships such as: 

• Sanofi / Harvard
• AstraZeneca / University College London
• Genentech / UCSF
• Veridex / Mass General
• Takeda / Sanford-Burnham
• Pfizer / UCSF

Early stage development of academic technologies used to the bread and butter work of life science VCs. With pharma encroaching on the VCs territory, one has to wonder how the partnerships will impact venture firms. 

Below are my thoughts on of some possible outcomes:

The Uh-Oh Scenario:  Pharma companies will pick off all of the most promising molecules, leaving the VCs to choose from the leftovers.  This would be bad for all parties - VCs, drug companies, and academics.  If there is not an equitable distribution of quality molecules between pharma and VCs, the VCs will simply stop looking for academic assets.  This leaves academic centers exposed, especially if the pharma companies choose not to renew their partnerships. 

The Business Development Person’s Special:  Pharma companies will work closely with academics to discovery promising molecules and development them through the Hit stage.  Pharma companies will then seek to partner with venture capital funds and create spinout opportunities for the VCs to invest in.  This model works well for all parties involved.  For pharma companies, they can outsource later stage development and early stage commercial activities to VCs (activities VCs are good at) and retain rights to buyback assets at predetermined terms.  For VCs, they will assume less risk, and therefore give up some of the potential upside to pharma companies, but can expect a reasonable rate of return on their investment. 

Too Much to do Scenario #1:  Pharma companies are the first ones to acknowledge that they cannot do everything at once.  A successful partnership will most likely produce a lot of promising assets, meaning that the pharma company will have to pick and choose which ones to develop.  Many good molecules will be passed over due to nothing more than bandwidth issues.  Many of the partnerships include terms that enable the universities to license unused technologies to startup companies.  This could be net positive for investors as some of these assets will have already hit development milestones and be more de-risked than a typical academic spinout compound.

Too Much to do Scenario #2: Some assets that are not initially picked up by the pharma company could be co-developed with a VC.  The VC would fund the pharma scientists working at the academic center and take an option on the work.  That option could grant the VC the ability to purchase the asset outright or enter into a joint development project with the pharma company.

I don’t believe that anyone really knows how the trend of pharma-academic partnerships will impact venture capital firms in the long run.  The most likely answer is a mix of outcomes that will be drawn from the scenarios I listed above.  In some cases, pharma companies will certainly pick off the best assets at a research center, but in other cases they will openly partner with venture firms. 

Overall, I think pharma-academic partnerships are positive because at the end of the day, increased drug discovery activity at academic centers should result in the creation of novel therapies to improve the lives of patients and that is why we are all in this game.

Thoughts on "Predatory Pharma Practices"

Last month Xconomy interviewed Kevin Kinsella, founder of Avalon Ventures, about the current status of biotech venture capital.  Kevin’s honest statements have been the talk of the town ever since.  One of my favorite quotes is below:

“During one buyout negotiation, Kinsella says, “The acquiring company spent more time asking questions about the cap table [to decipher the amount of venture capital the company had raised] than about clinical trial data.” The first buyout offer that came in was exactly equal to the total venture capital invested in the company”.

There is no doubt that pharma is playing hardball right now with acquisition terms.  This forces venture capitalists to readjust their return expectations and risk assumptions for investments.  Many traditional therapeutics-focused VC shops are now diversifying to medtech, diagnostics, and even services and healthcare IT.  These are areas that traditionally have lower return multiples but offer lower risk profiles and a faster route to market.  

The Xconomy article has been circulating around for the past few weeks, but I wanted to hold off on blogging about it until some comments were posted in response to Kevin’s interview.  There are a few comments that I would like to respond to:

Fewer funds are doing early stage bio investing and those doing later stage are crafting deals to try and get them early stage returns to offset the issues Kevin talks about: True, in that fewer funds are doing early stage bio investing.  However, there are still a number of great shops still doing early stage therapeutics deals: 5AM, Alta Partners, Bay City, Domain, The Column Group, KPCB, Third Rock, TPG Biotech, Pappas, and Versant.  I disagree that any VC thinks they can get a huge multiple on a late stage deal, even with preferences in place.  At Osage, we have made 7 life science investments in the last 18 months and have yet to do a deal with a liquidity preference greater than 1x and all preferences were capped for investors. 

I have seen biotechnology VCs crush entrepreneurs with their board seats, control provisions, cram downs and other tools of the trade and I can tell you that whining when the shoe is on the other foot is quite hypocritical:  Protective provisions are an essential part of venture capital and I don’t know of any VCs who views them as tools to “crush” an entrepreneur.  Protecting the capital of venture fund investors is the responsibility of the Fund’s Partners and is something VCs take quite seriously.  Not to mention, that many VCs, along with entrepreneurs, were crammed down as companies were refinanced.  Cram downs are a normal part of the VC business and the economics of how participants are crammed down is typically boilerplate.  Unlike the venture investors that are crammed down, management options are often refreshed after the down round.  

If VCs don’t like a pharma deal just do what my momma told me when I passed kids smoking on the street – “just walk away”… the VC model which is driven by putting large amounts of money to work regardless of capital efficiency: I found this comment to be rather confusing.  By definition, if VCs were to walk away from all partnering discussions, then they would be fully responsible for funding companies through late stage development. Drug development is inherently expensive and capital efficiency is somewhat of a misnomer, as many people would consider a capital efficient company to be one that burned $35 million to get through Phase IIb studies.  Raising $35 million would have most likely taken the participation of several large VC funds.  While capital efficiency is great and something that I value, it is just not that applicable to drug development.  That is why you see smaller VC funds choose to do medtech, diagnostics, healthcare IT, and other less capital-intensive areas.

Despite the frustrating and anger provoking behavior of some black sheep I do not believe that this is representative for “pharma” as evidenced by many lucrative deals that actually got done:  I would argue that Kevin was on point with his comment about the lack of large scale exits with significant upfront payments.  There certainly have been some this year – Avid Radiopharmaceuticals, Calistoga, BioVex, Plexxicon – but not enough to sustain an industry.  Part of the reason for this, and a key point that was omitted in the interview, is the fact that pharma went through a massive consolidation in 2008 and 2009.

Aside from GSK and BMS, almost every other pharma company is still working through their mergers.  Until those mergers are completed, business development groups will not have clear directives about what companies to hunt for and what gaps to fill in the pipelines.  Acquisitions will pickup but it is unclear when they will start.

Other factors that hamper the prosperity of VCs and their portfolio companies certainly include the unpredictable behavior of the FDA, the recent financial crisis, which shifted the risk-reward paradigm toward risk in red capital letters, the virtual disappearance of the IPO market and, last not least, a certain overindulgence of the VC industry itself, which is now experiencing a drought: Dead on. 

Targeted Licensing

There are many strategies that university licensing reps use to market technologies to companies.  The most common strategy is for licensing reps to develop relationships with their peers at pharma licensing departments in order to drum interest in university technologies.  But, is this the most efficient way of doing things?

A recent piece by the Boston Consulting Group (“R&D Management Under the Microscope: BCG’s Benchmarking Methodology”), suggests that developing relationships directly with “high science” business units within pharma companies might be more efficient than developing high-level relationships with corporate licensing heads. 

BCG defines high science units as those groups within a pharma company that “generally spend more of their R&D budgets on bigger, riskier, and longer projects”.  This strategy is inherently out of place in the corporate world, which places a greater emphasis on shorter goals that equity analysts like to track.  High science groups are also more open to external innovation and “ideation”.  According to BCG, high science units are also more likely to “perform more up-front work to guide decision-making”, which is a key value-add that universities seek in licensing partners.  Universities want the licensee to develop the licensed technology to its fullest potential (thus generating money for the university and TTO), and having a corporate partner that fully develops a business case for a licensed asset upfront is a huge advantage.

By targeting high science business units at life science companies, licensing reps can maximize revenue potential for a license while minimizing the time spent marketing a technology.