Several preclinical-stage biotechs have opted for the early Pharma structured buyout as their exit path in recent weeks: Resolve Therapeutics with Takeda, Zacharon with Biomarin, RQx Pharma with Genentech, and Lotus Tissue Repair with Shire.
Here are the quick takes on each:
- Resolve Therapeutics struck a deal with Takeda (here). The deal included an $8M upfront payment to fund the company’s work through a Phase 1b lupus study, and a predefined option to acquire in 2 years of ~$60M or so (from what I can guesstimate from the disclosures), and up to $247M if you include the two downstream development milestones. Resolve raised about $8M from its investors over the past 2-3 years. The lead program is in preclinical IND-enabling work.
- Zacharon was bought by BioMarin for its rare orphan genetic disease programs (here). The company raised about $4M with a post-money of $7.5M, according to VentureSource. BioMarin paid $10M upfront and a set of undisclosed milestones. The most advanced programs were in the lead optimization phase of drug discovery.
- RQx Pharma struck a unique deal with Genentech (here). On the surface it looks like a normal R&D collaboration, but from what I understand Genentech is funding the R&D from this point forward and so the upfront will be distributed. The company drew down a little more than half of its $7M Series A round across a number of micro tranches of capital, and when the upfront is distributed it should net about ~1x the invested capital. The total payments could go up to $111M. The lead gram-negative bug program was in drug discovery stage.
- Lotus Tissue Repair was acquired by Shire (here). The company was in preclinical development for a very rare orphan disease, dystrophic epidermolysis bullosa. They had raised about half of the announced $26M Series A, all of which came from Third Rock. The upfront payment was $49M, or roughly a 3x return, with potentially $275M in milestones.
These deals have lots of similarities worth highlighting:
- Innovation. All were high risk, high science plays. Two were orphan disease focused, two in areas of larger markets but very high unmet need conditions (lupus, gram negative bugs). More evidence that innovative approaches are what it takes to get Pharma to the table early.
- Capability-sharing and risk-sharing deals. They all chose to bring on a strong partner’s expertise, capabilities, and resources to increase the odds of success in the future, and by doing so offset some downstream risk while deferring the real returns into the future through creative structures.
- Capital efficient. These companies only raised between $4M and $12M in equity capital prior to these deals, and none of them should have to raise additional funding going forward as they leverage their partners’ larger balance sheet.
- Lean, asset-centric plays. To my knowledge, all of these companies really only had one asset or tightly related set of assets, and the acquirer/partner was clearly interested in that program. Even were there was a “pipeline” they were tightly focused around the same target or MoA and were more legitimately “backup” compounds than standalone #2 programs. In addition, I’m pretty sure all of them had very lean teams: all had only single digit numbers of employees, and in the case of Lotus, I think only one.
- Downstream return potential. All four appear to have the potential, however small the probability, of achieving outsized 10-20x returns should the deal hit all the downstream milestones. The “all-in” value of these deals could be between $100-300M inclusive of upfronts and milestones. Its worth noting these exit valuation ranges aren’t extreme: they are at or above the median for all biotech M&A deals, but not in the top decile of exit values (>$400M). But because they were so equity capital efficient, the return multiples could easily be in the top 1-5% of all venture deals in the vintage should the milestones deliver. Even assuming only a third of the milestones are met, which appears to be the recent historic average, then all of these are likely to deliver 3-6x returns, certainly in the top quartile of outcomes in venture.
There are, however, a few key differences worth noting though, and the upfront return is one of them. Only Lotus really delivered an attractive multiple and particularly IRR off the upfront payment (~3x in 18 months); congrats to the team at Third Rock Ventures who owned 75% of the deal. RQx Pharma and Zacharon took their money off the table with these deals (~1x upfront) so are protected the downside while looking to their partners’ diligent efforts to drive the real returns. Resolve is more of an option structure, so while attractive (i.e., no equity dilution, capable and committed partner, control over execution), the shareholders there are unlikely to see a return until Takeda (hopefully) exercises their option to acquire.
These are all interesting deals, and each board made the decision to sell early rather than go longer. The tradeoff is a tough one. Several have given up control entirely, others maintain it through the achievement of meaningful milestones. The important calculus was whether raising more equity and “going it alone” would increase or decrease the odds of getting to that $100M-300M exit range and attractive multiples. They all clearly came down in the camp of partnering early as the preferred route.
Broader questions are raised by deals like this:
- Are these types of deals going to replace the typical Series B round? B-rounds were often what got drug discovery startups into the clinic; to a big extent, these deals were done in lieu of that Series B raise. Asked another way, will early stage partnering deals fill the perceived gap in early stage funding?
- If more deals get taken out early in preclinical development, will we have enough substrate as an industry to create the next $500-1B exits, or the next $5B Pharmacyclics? I don’t think this will be the issue, but its a question often asked. I think there’s plenty of companies that are still choosing to “go long” into clinical development. Most of those companies end up regretting it unfortunately.
- Will the dearth of interesting unpartnered Phase 2-3 programs that exists today begin to shift backward in development as earlier deals are being done? This issue faces both the capital market buyside and the strategic Pharma buyer eager to find new clinical stage innovation. I doubt there will be a mad rush to consume all the hot preclinical programs, but even an slight uptick will affect the pool of available clinical stage assets in 2-4 years.
- Are these types of deals likely to shorten the time to liquidity for drug discovery deals, or once in the arms of a big bureaucracy will the pace of the projects slow and actually extend the timelines? This is especially important for the IRRs of deals where the upfront doesn’t provide a healthy return on capital.
- Will these deals deliver big enough $ returns to support some of the large Life Science funds out there? Returning only $40-80M to a fund is a solid win for a $250M fund, but not much for a $500M fund. These early deals clearly raise this issue, though owning 75% of them may address it.
- With more and more of the returns in these early deals embedded in milestones, it poses a bunch of interesting questions. How should VCs value their milestones with their LP’s? We currently build discounting models to create a fair market value for them, but there is no standard. Also, will we finally see the emergence of a market for milestone payments like that which has emerged in the royalty space? I continue to believe this market liquidity is likely to get created.
Many more questions come to mind, but those are a few. Interesting deals though, and fully anticipate that we will be seeing more creative early stage partnering going forward.
