At three years and counting, America's economic crisis continues to make life miserable for small businesses, especially in biotechnology. Venture capital funds are retreating from biotechnology investments, and the IPO window is closed to most biotech companies. Those businesses that do manage to go public are getting, on average, 30% less than their asking price, according to the Biotechnology Industry Organization (BIO).
The three-year chill has already taken a bitter toll. Since 2008, BIO estimates the number of public biotech companies in the U.S. has dropped by 25%. Last year, 29 U.S. biopharmaceutical companies were liquidated, according to Biotechgate, a database run by Venture Valuation in Zurich. Another 30 folded in the first 9 months of 2011. Some of these companies failed because the drugs they developed simply weren't effective, or lacked an acceptable risk/benefit profile. But many other companies ran out of money because investors they counted on to keep them afloat lost their appetite for risk. (Ernst & Young spotlighted the problem in a paper titled "Beyond borders--global biotechnology report 2011 .") Despite a rebound in aggregate funding for biotech last year, "funds are increasingly concentrated in fewer companies, driving many firms to restructure, partner earlier or cease operations altogether," according to E&Y.
An unchecked collapse in biotechnology would be a disaster for the U.S. A meltdown would halt development of life-saving medicines, derail promising science, wipe out high-paying jobs, and weaken one of the pillars of America's high-tech future. The current crisis comes at a critical juncture for biotech. The industry has long been the innovation engine for large pharmaceutical companies. The big players cut deals with biotechs because the smaller companies possess unique technology, or they have promising drugs in the development pipeline and are willing to take on the initial risks.
Despite all their troubles, biotechs are still delivering what the big companies need: innovative treatments for cancer, autoimmune diseases, chronic ailments associated with aging and a host of rare illnesses. At present, there are nearly 900 cancer medicines in clinical trials or under Food & Drug Administration (FDA) review in the U.S., according to PhRMA, the drug industry trade organization. Most of these come out of biotech. Many will eventually fail, but suppose 10% were to win approval by the Food & Drug Administration (FDA). That would be 90 new treatments for patients in desperate need. Until clinical trials are completed, which can take several years, nobody can tell which drugs will prove effective--which is exactly why we need as many shots on goal as possible. It doesn't take a wholesale collapse of the sector to harm U.S. health care. The extinction of hundreds of small companies today will cause irreparable damage down the road.
How dire are the economics of biotech? Consider venture capital, a traditional source of financing for this industry. In 2007, U.S. biotech companies raised a total of $5.2 billion in VC funding. With the financial crisis, funding sank to $3.7 billion last year, according to BIO. Spending and deal volume picked up this past spring, according to a report released by the National Venture Capital Association (NVCA) and PricewaterhouseCoopers in July. However, many in the industry say the uptick may not be sustainable. "The venture capital industry has been investing significantly more dollars into companies than it has been raising from institutional investors," NVCA President Mark Heesen wrote in a summary to the July report. And, to the extent that VCs are still funding biotech, they are gravitating more and more to later stage companies and eschewing earlier stage companies where the risks are greater, but on whch the future of the industry relies.
Established biotech companies can still tap the equity markets. But there, the constant volatility has made investors more conservative. As one J.P. Morgan biotech analyst put it in an August review: "We have a bias toward the less volatile large caps"--or, as he explained: "boring is good."
Simply put, investors are having trouble squaring biotech's rewards with the high risks. At the best of times, this is a capital-intensive business. It's built on complex science and fraught with regulatory hurdles. Most companies spend 10 or more years perfecting a new medicine, testing it in animals and humans, and getting it reviewed by the FDA. During this long development cycle, the typical biotech startup has no profits, and the vast majority of experimental drugs ultimately fail at some point in clinical testing. That drives the average development cost per drug upwards of $1 billion, according to some estimates. And even though the payoff can be huge, the economic crunch has exacerbated the risks.
As conditions worsen, big fund managers are seeking ways to protect investments in biotech without having to own equity in vulnerable startups. In August, OrbiMed, a healthcare investment firm with $5 billion in assets under management, launched a $600 million Royalty Opportunities fund. The idea is for investors to purchase royalty streams from medicines that are in late-stage development or already on the market.
It's too early to say if royalty financing will become a bigger trend. My concern with this approach is that the funding may not flow to early-stage businesses--the kinds of companies that take huge risks to develop completely new treatments for diseases such as diabetes or Alzheimer's. As with the current venture financing trend, the funding may end up strengthening companies further along in the commercialization process, which appear to be a safer bet.
Even without a recession, getting a new drug to market tests the limits of ingenuity and endurance. My own company, Acorda , burned through a healthy chunk of my own cash and $2 million from angel investors right out of the gate. We survived hand to mouth on small business grants and $2 million from the federal Advanced Technology Program. Only after 5 years of bootstrapping were we able to command an initial VC round of $20 million. We then went through six rounds of venture capital funding in 8 years, for a total of about $165 million, and pulled back one IPO attempt before finally making it onto the Nasdaq in 2006. If, at any point, we'd run into an investment climate as toxic as it is today, our company would have failed. It's troubling to think where that would leave the tens of thousands of patients who have improved their walking with the help of our multiple sclerosis treatment, AMPYRA.
In the heat of debates about the economy and other issues swirling about us, people sometimes forget that biotech is all about meeting medical necessities (as well as our environmental and energy needs). That's the fundamental justification for having this industry. It's also worth remembering that the biotech industry is one of the very few remaining sectors in which America still leads the world--and one of the few still poised to grow high-paying jobs in this country. There are proven strategies for shoring up this vital industry: last year, BIO successfully advocated for legislation that lets biotech companies in a loss position earn tax credits for up to 50 percent on certain R&D activities, and to exchange these credits for a grant, on a one-to-one basis. More measures like this are essential. We'd also like to see a federal tax credit for angel investors, equaling 50 percent of their investment in early-stage biotechs. And investors in these startups should get the same reduced capital gains rates they receive for helping to finance small internet or software startups.
Reforms at the FDA could improve conditions for biotech companies and for patients. The goal would be to shorten the time it takes to get new drugs on the market while still providing the necessary balance with safety. Thanks largely to increasing regulatory requirements, between 1999 and 2005, the average length of clinical trials grew by 70 percent, pushing the span of drug development past the 15-year mark in some cases and increasing average costs by several hundred millions dollars. A more efficient system must be implemented.
How long the turmoil in biotech will continue is anyone's guess. What's important is that the causes and context be made clear. Observing the meltdown, some opinion leaders are likely to extract the wrong lessons. Invoking Joseph Schumpeter, they may see the forces of "creative destruction" at work. But Schumpeter's insight only makes sense if you have a functioning system where capital flows aren't obstructed. When funding infrastructure freezes up and a vital branch of the economy threatens to implode, I see it as "destructive destruction." Easing the flow of funds and streamlining regulatory processes are urgent imperatives. There is still time to act.
[Image: Flickr user PNNL ]