Surprising Resilience Of Private VC-Backed Biotech Markets

Posted July 6th, 2022 in Biotech financing, Capital markets, Fundraising | Leave a comment

It’s biotech armageddon out there: with massive value destruction across public stocks, it’s clearly the worst market backdrop in over 20 years.

Nothing like this pullback has happened in recent memory. This is way worse than the short “sky is falling” downdrafts in 4Q 2018 and 2H 2015. It is also way worse, for biotech, than the financial meltdown of the Great Recession in 2008-2009. Biotech was anemic before that crisis and was only slightly more anemic after it. A much better comparison is the dot.com and Genomics Bubbles imploding, where the depth and duration of the pullback was similar.

Like twenty years ago, massive risk-off sentiment decimated the high risk and often speculative technology-driven sectors like consumer internet and biotechnology. We all knew it was getting frothy, but I don’t think there was widespread expectation for a complete public market implosion, like we’ve seen. The macro headwinds around inflation fears, rising interest rates, an invasion of the Ukraine, continued waves of COVID variants, deepening supply chain issues… all have combined to create a deeply bearish climate towards higher risk equities.

For those keen on exploring strategic options in a steep downturn, read Peter Kolchinsky’s 10,000 word tome on the subject.  While I may not agree with all of recommendations, it covers a lot of ground and is an appropriately provocative piece for Boards and management teams alike.

Without even rehashing the numbers, it’s very clear that the dislocation in the public markets has been profound. Hopefully we hit bottom here in June, but only time will tell.

But what about the private VC-backed biotech markets? 

STAT News raised concerns yesterday about fear and desperation in the private biotech world: citing deals falling apart and valuations plummeting, it claims that many are “really scared and frightened.”

There is no doubt the private markets are more challenging than they were during the ebullient markets of 2020-2021, and current sentiment reflects a jittery financing environment.

However, in times like this some historic comparison is useful, in order to rebase where things really are – and in this case offer a rather contrarian view of the state of the financing market today.

The reality is the private biotech ecosystem is awash in more capital today than all but two years in the 40+ year history of the industry.  There’s a huge amount of capital still available to fund innovation going forward. Here’s the data, according to PitchBook, dated as of today:

  • 2022 is off to the fastest start for private financings than every year except 2021: nearly $18B has been invested in the US into private biopharma companies in the first six months of the year (1H 2022). For comparison, 2017 was heralded as a year of “investor exuberance” by pundits, and yet 1H 2022 is already 40% higher than all of 2017.
  • Over $6B has been invested in 2Q 2022, well short of 2Q 2021 and nearly as much as 2Q 2020, but far more than 2Q in all prior years – that’s way more VC funding than any year during the 2012-2020 bull market run. In 2Q 2022 alone, there was more capital than in all of 2013, often highlighted as a “boom” year for backing biotechs as the IPO window really opened.
  • June 2022 was also huge: it was the biggest month of the quarter, at nearly $2.5B, beating all the June’s before 2020 ever. And June was nearly 18 months after the peak in the public markets, mitigating the impact of merely temporal dynamics in these data.

If you didn’t know where the markets were at their peak in 2021, and had been asleep since before COVID hit, you’d wake up today and think the private biotech financing climate was incredibly strong – one of the best ever.

That’s a staggering data disconnect from widely-held sentiment today.

This is in large part because sentiment is always a first derivative function: the direction of change. The VC-backed private market in 2Q 2022 is down considerably (50%) from peaking in 1Q 2022 and 1Q 2021 (both above $11B in a single quarter).  But the first derivative misses that it’s still a huge absolute number by historical comparison: $6B+ in a single quarter.

It’s also because the public equity markets often set the tone for the sector: it’s easy to watch the ups and downs (lately downs) every day, and feel that volatility viscerally.  And we also know the public equity financing environment has been very unwelcoming, largely closed for IPOs.

For later stage companies, the inability to tap the public equity markets means they will need to do another private round (and clearly many have in the recent quarters), and their valuations will need to reflect the “new” public market comparables to some degree.

Surprisingly, however, this valuation compression isn’t reflected in the latest cut of the data: median pre- and post-money valuations for June 2022, for 2Q 2022, and for 1H 2022 are all higher than their respective period in any prior year, including 2021, according to Pitchbook data. I suspect the gravity pulling valuations towards earth will appear in future data cuts.

Stepping back though, these data are very clear: there’s still plenty of capital out there to fund private biotechs.

Further, this isn’t likely to dramatically change in the near term: I anticipate robust absolute private funding levels over the next few quarters. While the disconnect between private and public markets can’t go on forever, the private world still has copious amounts of capital available that has to be put to work.

This is in part due to a structural aspect of venture capital which allows it to work over longer timeframes and multiple cycles. VC fundraising in the past few years has been very strong, with over $113B being raised by VCs for all sectors in 2021 alone, an all-time high. Many biotech VC firms have raised large funds in the past few quarters. Importantly, these are close-ended investment vehicles with long-term commitments of capital from LP’s. Most of the committed capital gets deployed in the initial investment period, which is usually over 4 years. VCs have to put that money into deals, and can’t sit on it as “cash” like a hedge fund. That means all of those venture fund dollars that got raised in the past two years are likely to get deployed into private biotechs over the next few years. Most funds can deploy up to 20% into public equities, and I suspect many VCs will look at value-shopping there; but the vast majority of VC funds will still get deployed into the private markets. This represents a huge amount of dry powder for the VC-backed biotech ecosystem over the next couple years.

In summary, while sentiment is clearly negative, and every biotech should be belt-tightening and adopting fiscally-disciplined budgets, the private markets have been remarkably resilient and are going to continue to be robustly funding innovation going forward: companies with strong science, led by solid teams, will continue to get financed.  For private biotech, the desperation of Chicken Little isn’t yet warranted as the sky isn’t falling. Or at least not entirely.

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Responding To Tough Markets: Restructurings In Biotech

Posted April 14th, 2022 in Biotech financing, Boards and governance, Capital markets, Talent | Leave a comment

Another day, another “restructuring” – there’s been a flurry of press releases recently using phrases like “exploring strategic alternatives”, “extending the cash runway”, and “de-prioritizing” certain R&D programs.

These announcements are obviously responses to the tough market environment. In every downturn, belt-tightening happens as R&D-intensive, loss-making companies realize their balance sheets are too small and their cost of capital is too high to support their future aspirations.

In the past few months these restructurings are being announced with an unusually rapid cadence, in large part because burn rates ballooned during the financing bonanza in 2019-2021. And we’ve got so many more public companies. Here’s a table with many of the restructurings, announced or executed since last fall.

What has caused this veritable flood of restructurings?

A good portion of them are due to bad data – especially with the higher-than-typical volume of negative clinical and regulatory news. In the face of diminished prospects for lead assets, costs need to be cut.

But some of these changes are also just good fiduciary governance and smart stewardship of capital in a time of risk-off sentiments in the equity markets: the realization that the prospects for any near-term financing will remain tough for SMid-cap players with beaten down stock prices. In these cases, extending runway by cost reductions to get through to key value inflection points with lead asset(s) is the goal – and hopefully prevents punitive dilution from near-term capital raises at painful valuations.

As is well appreciated, the cost structure of most emerging pre-revenue biotech companies is directly a function of R&D spending: how many projects is a company working on and how many people are doing the work. This means the key restructuring elements are reductions in force (people) and de-prioritizing earlier stage pipelines (programs). Leases are also commonly part of the cost structure; fortunately, in most regions today subleasing space remains a strong secondary market and these costs can be recouped. But people and programs are the typical cost-cutting focus.

Across the sector, these restructurings are therefore affecting a lot of employees. But these headcount reductions aren’t only the domain of smaller biopharma companies: big names are announcing changes too, and far larger ones in absolute number. Biogen has reduced its headcount by ~1000 in the wake of the Aduhelm challenges, Sanofi is shutting down the Principia site, Merck is letting go folks in the Cambridge area from their Acceleron deal, Gilead is laying off folks from their Immunomedics acquisition, and Novartis is restructuring with 1000s of job cuts worldwide, as examples.

Fortunately, overall, the biopharma job market remains a competitive one, and many of these new job seekers shouldn’t take long to find new roles. But it does feel like the incredibly “hot” talent market of 2019-2021, fueled by the availability of capital, is likely to cool down somewhat, in light of these recent big and small company workforce reductions.

Given the number and cadence of these announcements, the topic sadly warrants deeper consideration – especially around the different flavors of these restructurings and how to successfully navigate them.

At a high level, there are two primary situations for these biotech restructurings: (a) the “we must live another day” because we’ve got great pipeline assets; and (b) the more severe “we’re done” so let’s capture the residual value of our assets by exploring “strategic alternatives”.

The latter restructuring could be to liquidate the business (involving delisting, dissolution, and distribution of cash), as Kaleido just announced.  Or, more commonly, the strategic alternative will be to run a reverse merger process to find a private company who can leverage the remaining net cash and “seasoned stock ticker” (with the public shareholders receiving value for their cash plus $5-10M for their established public company shell). There are plenty of these processes ongoing right now.  We did this with Unum Therapeutics and Kiq Bio in 2020, which became Cogent, and it’s up 500%+ since the announcing the deal. In many ways, these “we’re done” restructurings are more straightforward in their path to extracting some residual value.

The trickier restructuring to get right is the “live another day” situation. Management teams and Boards still have conviction around the future of the programs and/or scientific platform and are restructuring to support a leaner version of the company – with the hope of making it thru to value-inflecting milestones without massively diluting the existing shareholders.

To get these restructurings right, there needs to be an honest and objective assessment of where the real value is (e.g., what programs, what technologies, etc). The goal is cutting “excess” or non-essential activities out of the operating plan, refocusing the attention of the team on getting thru key data readouts. Earlier projects, which may eventually be of real value in more accommodating capital environments, often can’t be funded when there’s a stage asymmetry of assets in the pipeline. These restructurings often, and rightfully, favor the assets that can hit value inflections in the near-term.

But you can’t cut into the substance of those lead assets, or the team that is truly required to deliver on these programs. Cannibalizing the primary value driver by over-cutting defeats the purpose of the restructuring. It’s a tricky balance to get right, and the degree of the cuts is often very situation dependent.

Once you’ve committed to doing a restructuring, doing it in the right way is critically important. Not only for a management team and Board’s long-term reputation, but also because it’s just the right thing to do.

On first principles, it’s about treating people with dignity and respect: explain the business challenges in a transparent manner, and reinforce the message that the RIF is not performance-related. Help the affected team members with their transition, and work with them to find new roles (like building and sharing a resume book with the HR community). Give these folks adequate notice and severance, where appropriate. Create a retention plan for the go-forward team. Try to do all this with the mindset of “measure twice, cut once” – as repeated or serial RIFs are utterly destructive to a company’s culture. Importantly, how you treat people in challenging times speaks volumes about what kind of Board and leadership team you are – in biotech, the world is small and memories are long.

In addition, monetizing paused or shelved assets can be worthwhile to consider: out-licensing them to existing companies can add much-needed capital, or working with entrepreneurs to spin them out into a NewCo. Both can be incrementally accretive. In addition, it has broader emotional value in that it helps convey that what the team was working on had purpose and merit, and isn’t just being thrown away.

Many restructurings of late are from struggling SMid-cap companies that have traded off 70-90% from their IPOs or all-time-highs. The obvious billion-dollar question is whether these restructurings to “fight another day” ever really succeed. Is it even possible? While challenging to do, the answer is definitively yes.

One of the best examples is Jazz Pharma, which traded down below $1/share, restructured in 2009 a few years after its IPO, and is now trading at ~$160/share.  That’s quite a turnaround.  Others that restructured successfully when near $1/share and have remained independent: Exelixis, Fate Therapeutics, Chemocentryx, and (although 15+ years ago) Illumina, just to name a few.

Many companies have restructured and then grown into very strong acquisition candidates by larger Pharma: Array, Arena, Dicerna, Trillium, Five Prime, and Pharmacyclics – all went from deep restructurings/reprioritizations during retrenchment periods (in or near penny-stock land) into large acquisitions years later.

As for reverse mergers, beyond Cogent, there are additional examples where they’ve been successful in extracting more than residual value for the public shell’s shareholders: Madrigal, Arcturus, and Rocket reversed merged in 2016-2017 and are up 1000%, 300%, and 250% since their reverses closed, as of April 2022 (even while coming down significantly from their all-time highs).

It’s hard to know which ones in the current crop of restructurings will be successful, but some of them most certainly will – especially as the group gets materially larger over the next few quarters. Being prescient about picking those winners will pay off handsomely for some.

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