On-Q-ity, a Cancer Diagnostic Company: R.I.P.

Posted in Diagnostics, Personalized Medicine, Portfolio news

Not every deal is a winner, and unfortunately On-Q-ity wasn’t.  After a few years of hammering away at its diagnostic business case, the board decided to wind the company down back in November and we are just completing the sale of the remaining intellectual property assets.  I’d prefer to be writing about great exits, like Avila or Stromedix, but think the lessons from deals that don’t go the way we hope are equally if not more instructive.  So where did On-Q-ity go wrong?

Lets start with some background.  On-Q-ity was formed in 2009 through the merger of two predecessor venture-backed diagnostic companies, Cellective Dx and DNAR (DNA Repair Inc).  This Series A round was $26M and had four VCs: Mohr Davidow Ventures led the round (and was the lead investor in the prior entities), and Atlas, Physic, and Bessemer all participated.  I looked back at my December 2009 investment memo, and these were the key reasons to invest:

(a)   “Hot space at nexus of two exciting themes in cancer and personalized diagnostics”: DNA Repair pathway tissue-based biomarkers for drug response prediction in breast and lung cancer; and, a circulating tumor cell (CTC) capture and characterization platform.  These technologies had lots of potential to change the treatment paradigm in a number of cancers, and its fair to say that CTCs have only gotten more interesting over time

(b)  “Strong team with a track record in building diagnostic businesses”, hailing from Genzyme Genetics, Myriad, Genomic Health, Dana Farber, etc… We also had a great board, including a former President of Affymetrix as the Chairman.  At the outset, it looked like a great team and syndicate for Dx startup.

(c)   “Robust financials with attractive recapitalization” at a good valuation (the $31M invested in the prior two entities was recap’d into <$5M pre-money valuation), with clear path to revenues, or so I naively thought;

(d)  “Very strong intellectual property”, especially in CTCs, which actually got stronger over the past few years; and

(e)   Perception of “multiple possible exit paths via either diagnostic or oncology-focused pharma M&A or possible IPO”.  Unfortunately none of these materialized.

I also flagged a few potential risks in the 2009 memo: the biomarker technology needed clinical trial validation, CTCs could be a research-phase money pit before the market matured, execution against the aggressive plan was going to be tough, merging management teams and technologies under one roof is not easy, etc…   At the time, I judged most of those risks to be manageable.  Well, let’s just say I got the risks right but their magnitude wrong – these risks became the big factors that brought down the company.  Here’s the short story:

By mid-2010, only six months after the Series A came together, it was clear that the DNA repair biomarkers were going to be tough, as an early trial failed to reproduce the nice Kaplan-Meyer curves of the original academic work.  By late 2010/early 2011, two more larger trials read out negatively so we decided to terminate that effort.  But unfortunately those trials and the biomarker lab work required to support them consumed 60%+ of the capital in the Series A round.

Not much had gone into the CTC platform in that first year and so early in 2011 the company refocused exclusively on CTCs and streamlined the team, but the clock was ticking.  As we dug in to the status of the CTC platform, it was very clear that lots more work needed to be done – the paper descriptions of what it was supposed to deliver didn’t map to the platform’s actual robustness (or lack thereof) at that time.  Antibodies that were supposedly functional turned out not to work, and several other things like this.  An early LabCorp partnership fizzled because of this realization.  Our new CSO and the R&D team rebuilt much of the platform and reagents from scratch, got it up and running in a reproducible and robust manner, validated it favorably against Veridex’ CTC approach with patient samples, and set us on sound technology footing.  It was an impressive technology turnaround, frankly.  But that took a year, and a very precious year.  We were out of money at the start of 2012.

We also had a revolving door in the management suite during 2010-2011: we lost or transitioned the original CBO, CFO, CSO, CMO, COO, CEO, another CSO, etc… Some of the changes happened fast – within the first 6-9 months – but we didn’t replace them fast enough.  Then as the company’s strategy shifted from near commercial (DNA repair biomarkers) back to R&D (CTC) in early 2011, additional changes to the senior team made sense.  It’s also fair to say the background and experience of some of the team didn’t map well to the high strategic entropy and lack of organizational support common in startup roles.  As you might expect, it’s very hard to stabilize a new technology platform while shifting leadership.

As 2012 started, we had to make some tough decisions.  We were running out of money in a few weeks and had a limited senior management team, but felt we had a technology that had finally gotten its sea legs and a very good R&D team.  MDV, Physic, and Atlas decided to do a small Series B to carry the company to a CTC partnership (Bessemer dropped out, which history now shows that was the smart move).  We recruited an entrepreneurial executive, Mike Stocum, to lead the company, and hired Foundation Ventures to help him run a strategic partnering process.  Together they did more than any board could ask.

But at the end of 2012, despite heroic efforts by the On-Q-ity team to keep the technology maturing and an extensive process for a potential strategic partner/acquirer, we were once again low on cash.  And this time we chose to wind down the company in an orderly fashion.  The final sale of assets is wrapping up this month.

What are some of the lessons I’ve learned:

  • Crashing two Fords together doesn’t make a Porsche.  This is the obvious one.  Recap mergers aren’t easy, and bring all sorts of baggage that make the “attractive” valuation an illusion.  Trying to merge two really interesting diagnostic technologies embedded in two struggling, cash-burning businesses into one company and have it smoothly integrate was a very bad assumption.  The first year gave little airtime to the CTC technology, and we paid the price for it by being behind the eight-ball in the second year.
  • Tranche the capital.  I failed to follow my instinct here.  I remember pushing hard for tranching back in 2009 as the round came together, but ended up going along with the full raise against my better judgment (in part because the first $21M had already been wired).  I violated the axiom that if a technology can be validated on a smaller financing, it should be.  It gets back to our mantra at Atlas of Prove-Build-Scale.  Instead of raising a “Build-stage” $26M Series A without any tranche or milestone points, we should have broken up the capital to Prove the story first.  Sadly, we knew within months that the DNA Repair story was going to be an uphill battle.  I remember the late 1Q 2010 board meeting well: the initial trial data were far from clear, but clearly far from what we had all hoped for.
  • Team, team, team.  If we had in place a stable management team from the start, things might have been different.  There were questions about how to integrate the different management team members right at the start of the deal in fall 2009, and we ended up with the revolving door I mentioned.  This leadership flux kills startups, and certainly was a big part of the mortal wounds we had at On-Q-ity.
  • Getting the technology right, but the market-timing wrong, is still wrong, confirming cliche about the challenge of innovating.  The capture and characterization of CTCs will be an important part of oncology care in the next decade.  This I’m fairly sure of, and all the news from AACR earlier this week about “liquid biopsies” supports this premise.  But the reality is it’s a research-stage story right now, and in diagnostics (unlike drugs) it’s hard to get paid for research-stage stories.  We may have been right that CTCs are “hot” and will be important in the future, but we certainly didn’t have enough capital around the table to fund the story until the market caught up.  It will be great in 5-10 years to see CTCs evolve as a routine part of cancer care, though clearly bittersweet for those of us involved with On-Q-ity.
  • Diagnostics aren’t for the faint of heart and are a much tougher place to make returns today than other life science subsectors.  Despite the frothy commentary about personalized medicine and the dawn of diagnostics, it’s a very tough business that faces many of the risks and costs of drug R&D but without the upside.  It’s often not less capital intensive than therapeutics, faces similar “academic validation” concerns, is confronted by larger reimbursement and regulatory uncertainties, has commodity-oriented high volume, low price demands, and typically needs to get to commercialization before a material exit outcome.  All these things add up for a challenging investment sector.

My first total write-off in nine years of venture capital.  On-Q-ty, R.I.P.

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  • http://twitter.com/nimshah123 Nimesh Shah

    Another excellent post but you lost me at the very last point. It certainly hasn’t been our experience. You said yourself that you broke some cardinal rules. So it makes the last point a bit of a non-sequitur. It takes technology. It takes a market opportunity. It takes a team. Those remain true for all investments. But it also takes a business model that makes sense, because ultimately they need to be a business in order to be successful. I think plenty of folks either ignore the last one or really get tripped up by it. One of our oldest investments–Biosite–nailed it in every aspect. Those standards remain in place. And its been remarkably capital efficient. Just my two cents.

  • LifeSciVC

    Nimesh, thanks for the note, and I clearly don’t agree. Had the biomarker technology been able to validate the academic clinical signal, or CTC market matured faster, or the exit environment for Dx companies been more interesting, etc than it might have had a different outcome. All of those are intrinsic to the Dx world as a whole. Its a tough space. I’ll expand on the challenges on Dx in a future blog post, but in general it has been a very challenging place to make venture returns. There are exceptions of course (like BRAHMS which was a great outcome for HBM), but the aggregate data I’ve seen (albeit sparse) suggest that Dx has underperformed therapeutics over the past decade.

  • http://twitter.com/nimshah123 Nimesh Shah

    No doubt we’ll have to agree to disagree! I hear your points. But we are after all in the exceptions business, and one that needs to be forward looking. I’m a device investor so I can take exactly zero credit for the hard work of others at my firm and the management teams to invest and develop an exciting diagnostics and lab products portfolio, a collection of what appear to be real businesses. I will say it took the well articulated vision of my colleague/mentor/boss Jim Blair to call it early. Of course, the proof will be in the pudding. But its a lot easier to paint a picture of great returns when you have a bunch of companies that have achieved revenue stage–real revenues–on relatively small amounts of capital. Gotta go to where the puck is going…

  • DV Henkel-Wallace

    I think the life sciences (and pharma in particular) suffer more than other industries with the startup personnel issue you raise (“..background and experience of some of the team didn’t map well to the high strategic entropy and lack of organizational support common in startup roles.”). You get the key experience in big (or medium sized) pharma, yet you learn startup-incompatible habits and culture at the same time. It’s harder to spend your whole professional life in the startup milieu if you’re in life sciences than it is if you’re in, say, the software or mechanical engineering worlds.

  • Fred Meyer

    Excellent post. Thanks for sharing a story where everything didn’t go according to plan. I also completely agree about the challenges of diagnostics, which I believe are often not appreciated by investors.

  • http://twitter.com/juvechelski Jason M. Pileggi

    As a former On-Q-ity R&D team member who remained to the end, I have to say I cannot dispute much of anything in this post. I will, although a little less bluntly, echo the sentiments from @twitter-45321857:disqus pertaining to the hire of our original CEO. Like she did, I also came from GG (just after she departed On-Q-ity for Ventana), and could see first-hand the wake she left behind in multiple ways. It is a shame that we ran out of time and money – as was stated clearly, if the focus had been CTC’s from the start, we may very well be singing a different tune today, based on what we were able to accomplish in the limited time we did have to work with. For what it’s worth, thank you Bruce for your efforts despite the outcome.

  • http://twitter.com/pgwu Pengguang Wu

    Thank you for sharing the story. I always wonder how those academic stories kind of walk on water sometimes. Looking at the 2011 news release of the company, the precision of those numbers from lab tests makes you cringe.

  • A Marshall

    So Bruce you are flesh and blood after all!…An interesting and instructive story. The diagnostic space for venture looks more and more tricky…even Kleiner Perkins seems to be cooling off. Very much looking forward to your post on it! I wonder whether models like lab tester HDL http://bit.ly/ZcbnoI might cause disruption in this space…apparently rumored to be receiving the largest amount of FedEx traffic on the East Coast!

  • Carl Cohen

    Thanks for an exceptionally honest and interesting post. Most folks in your position would wait until they retire before being so candid.

  • http://twitter.com/dmadsen98 Dion Madsen

    As someone who traveled the journey with Bruce on this one, I have to say that the column represents the Investor and Board experience very accurately. Given the process that we followed, I am unconvinced that we knew whether the biomarker technology failed because it didn’t work or whether the company didn’t execute well or whether our clinical samples were of low quality that prevented an answer being found. Facing the struggle of trying to answer a question with multiple possible routes to answer and dwindling resources, I believe the board made the right choice. I fully agree with the mistake that was made of not trancheing and to revisit history, the round was done in the heart of financing darkness in 2009 where refinancing risk spiked (and remains high) and where capital certainty for the syndicate was really important. So this is a risk to the other investors if the deal is tranched and there is a difference of opinion on how to proceed if some but not all of the milestones are achieved. Clearly here, we would have shared your opinion on stopping the company on the initial failure as the overall investment model was set back and the original thesis fell apart.

    The failure of the company and loss of capital stings a lot as like Bruce, I have relatively few failures in this space and it certainly makes you look in the mirror. What stings more is that the collective effort of the team at the company over the last two years was extraordinary and it resulted in very little at the end due to market conditions and the early stage nature of the company. I would work with any of them again and have the highest regard for their talents and dedication.

  • Murali Apparaju

    It’s always painful to see a promise not living up to the faith of those who believed….

    I’m not exactly sure, but what you said about recapitalization sounded like ‘despite the value of the combined capital raised by the two merging ventures prior to 2009 was USD 31mio, the merged entity (On-Q-Ity) prior to investment was valued at USD5mio’, To me this initial valuation (& disregard of capital) is where the deal started going wrong?? – wasn’t this one of the risks flagged in 2009?

    While not tranching the investment does look like the most probable reason for the VCs losing out on the return, I’m wondering what promise of return led to the VCs risking a USD 21mio investment upfront into a company wherein a cumulative capital of USD 31mio only resulted in a USD 5mio valuation? – probably there was something prophetic about the then CEO using a term “diagnostic blackhole” back in 2010….. (different context ofcourse..)

    PS:
    It’d be interesting to understand why the exit-route expectations involved “oncology focused Pharma M&A”?, consdiring Dual Capture OnQChip techonology wasn’t really being worked on as a customizable companion diagnostic platform? OR was it?

  • John Audette

    We just completed an analysis of consolidation among companies that develop diagnostic tests utilizing molecular biomarkers (the leading edge of the IVD industry), and we were able to identify 34 acquisitions of such companies over the last decade. Average deal value was $1.2 billion, and average valuation was 5 times revenue (among those deals where terms were disclosed). When they get it right, Dx companies can clearly create significant value for investors. At the same time we found that an average of only 3 new molecules per year came to market in FDA-cleared or approved IVDs. This is a trickle compared to the number of new biomarkers that are discovered each year. The costs to conduct clinical studies are among the key factors pushing new biomarkers into lab-developed tests instead of IVDs, or are stopping diagnostic projects before they even get rolling. I think your basic conclusions regarding investments in diagnostics businesses are pretty accurate. The risks and investments are not out of scale with therapeutic development without the same level of upside, a point that has been made by numerous people commenting on the industry. But the fact that significant value can be created and realized in the sector argues for efforts to be made in addressable areas (e.g. regulatory) toreduce risks and costs, to ensure that we not only create more investment opportunities, but also realize more tangible public healthcare benefits from our $30 billion annual investment in NIH-funded research.

  • http://www.amplion.com/ John Audette

    We just completed an analysis of consolidation among companies that develop diagnostic tests utilizing molecular biomarkers (the leading edge of the IVD industry), and we were able to identify 34 acquisitions of such companies over the last decade. Average deal value was $1.2 billion, and average valuation was 5 times revenue (among those deals where terms were disclosed). When they get it right, Dx companies can clearly create significant value for investors. At the same time we found that an average of only 3 new molecules per year came to market in FDA-cleared or approved IVDs. This is a trickle compared to the number of new biomarkers that are discovered each year. The costs to conduct clinical studies are among the key factors pushing new biomarkers into lab-developed tests instead of IVDs, or are stopping diagnostic projects before they even get rolling. I think your basic conclusions regarding investments in diagnostics businesses are pretty accurate. The risks and investments are not out of scale with therapeutic development without the same level of upside, a point that has been made by numerous people commenting on the industry. But the fact that significant value can be created and realized in the sector argues for efforts to be made in addressable areas (e.g. regulatory) toreduce risks and costs, to ensure that we not only create more investment opportunities, but also realize more tangible public healthcare benefits from our $30 billion annual investment in NIH-funded research.

  • Jane Meyer

    Thank you, Bruce, for this post. I have always believed that we miss valuable information if we don’t look at what went wrong. I worked at On-Q-ity as a scientist. Throughout my career I have learned from mistakes. That’s a big part of our learning process during our whole life. Here are a few things I have thought about:

    How do we connect the big picture, like the “buzz-words” we hear at conferences and in journals (CTCs, Next-Gen Sequencing, etc.), how do we connect them to what we are working on in developing a product? We do need the big picture and we need to know how it fits into what we are doing. But our excitement and passion need to be focused on
    our task at hand. The scientists need a clear path to the goals for developing a product. And it’s important for this group to be “on the same page” in order to make greater strides toward the goal.

    How can the science and the business work together? I think of these two as water and oil. They don’t naturally mix. But they can work together and I think of this as an “emulsion”, the two shaken together. Not easy, but possible. Maybe more thought needs to be given to how this can take place.

    Are timelines for early start-ups in diagnostics in need of change? Might it not be much more favorable to get more solid scientific data before expanding the company? Early on, more people may not translate into more data. Once strong data emerges, next steps can be put into place fairly quickly. Support for the company in other areas besides the science can move much faster than the science itself. When those other areas are moving along and the science has to catch up, you’re usually in trouble.

    How can we make the change or transition from research to product development? I like what William Bridges writes in his book, “Transitions”. He says, “Change is situational. Transition, on the other hand, is psychological. It is not those events, but rather the inner reorientation and self-redefinition that you have to go through in order to incorporate any of those changes.” I believe this is what is happening when you are taking research to product development. You have to have the right people to do this well.

    How does one balance producing strong data with keeping on a timeline, especially in the field of science? Science takes time. Product development needs a timeline. Could it be that we need to make sure the research is more complete before making that transition to product development?

    I have thought about these during my career and appreciate Bruce talking about what we can learn from On-Q-ity. Maybe we need to learn something from the open source people who are ready to learn from one another.

  • http://www.amplion.com/ John Audette

    We just completed an analysis of consolidation among companies that develop diagnostic tests utilizing molecular biomarkers (the leading edge of the IVD industry), and we were able to identify 34 acquisitions of such companies over the last decade. Average deal value was $1.2 billion, and average valuation was 5 times revenue (among those deals where terms were disclosed). When they get it right, Dx companies can clearly create significant value for investors. At the same time we found that an average of only 3 new molecules per year came to market in FDA-cleared or approved IVDs. This is a trickle compared to the number of new biomarkers that are discovered each year. The costs to conduct clinical studies are among the key factors pushing new biomarkers into lab-developed tests instead of IVDs, or are stopping diagnostic projects before they even get rolling. I think your basic conclusions regarding investments in diagnostics businesses are pretty accurate. The risks and investments are not out of scale with therapeutic development without the same level of upside, a point that has been made by numerous people commenting on the industry. But the fact that significant value can be created and realized in the sector argues for efforts to be made in addressable areas (e.g. regulatory) toreduce risks and costs, to ensure that we not only create more investment opportunities, but also realize more tangible public healthcare benefits from our $30 billion annual investment in NIH-funded research.

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