IFM’s Hat Trick and Reflections On Option-To-Buy M&A

Posted March 13th, 2024 in Capital efficiency, Exits IPOs M&As, External R&D | Leave a comment

Today IFM Therapeutics announced the acquisition of IFM Due, one of its subsidiaries, by Novartis. Back in Sept 2019, IFM granted Novartis the right to acquire IFM Due as part of an “option to buy” collaboration around cGAS-STING antagonists for autoimmune disease.

This secures for IFM what is a rarity for a single biotech company: a liquidity hat trick, as this milestone represents the third successful exit of an IFM Therapeutics subsidiary since its inception in 2015.

Back in 2017, BMS purchased IFM’s  NLRP3 and STING agonists for cancer.  In early 2019, Novartis acquired IFM Tre for NLRP3 antagonists for autoimmune disease, which are now being studied in multiple Phase 2 studies. Then, later in 2019, Novartis secured the right to acquire IFM Due after their lead program entered clinical development. Since inception, across the three exits, IFM has secured over $700M in upfront cash payments and north of $3B in biobucks.

Kudos to the team, led by CEO Martin Seidel since 2019, for their impressive and continued R&D and BD success.

Option-to-Acquire Deals

These days option-based M&A deals aren’t in vogue: in large part because capital generally remains abundant despite the contraction, and there’s still a focus on “going big” for most startup companies.  That said, lean capital efficiency around asset-centric product development with a partner can still drive great returns. In different settings or stages of the market cycle, different deal configurations can make sense.

During the pandemic boom, when the world was awash in capital chasing deals, “going long” as independent company was an easy choice for most teams. But in tighter markets, taking painful levels of equity dilution may be less compelling than securing a lucrative option-based M&A deal.

For historical context, these option-based M&A deals were largely borne out of necessity in far more challenging capital markets (2010-2012) on the venture front, when both the paucity of private financing and the tepid exit environment for early stage deals posed real risks to biotech investment theses. Pharma was willing to engage on early clinical or even preclinical assets with these risk-sharing structures as a way to secure optionality for their emerging pipelines.

As a comparison, in 2012, total venture capital funding into biotech was less than quarter of what it is now, even post bubble contraction, and back then we had witnessed only a couple dozen IPOs in the prior 3 years combined. And most of those IPOs were later stage assets in 2010-2012.  Times were tough for biotech venture capital.  Option-based deals and capital efficient business models were part of ecosystem’s need for experimentation and external R&D innovation.

Many flavors of these option-based deals continued to get done for the rest of the decade, and indeed some are still getting done, albeit at a much less frequent cadence.  Today, the availability of capital on the supply side, and the reduced appetite for preclinical or early stage acquisitions on the demand side, have limited the role of these option to buy transactions in the current ecosystem.

But if the circumstances are right, these deals can still make some sense: a constructive combination of corporate strategy, funding needs, risk mitigation, and collaborative expertise must come together. In fact, Arkuda Therapeutics, one of our neuroscience companies, just announced a new option deal with Janssen.

Stepping back, it’ s worth asking what has been the industry’s success rate with these “option to buy” deals.

Positive anecdotes of acquisition options being exercised over the past few years are easy to find. We’ve seen Takeda exercise its right to acquire Maverick for T-cell engagers and GammaDelta for its cellular immunotherapy, among other deals. AbbVie recently did the same with Mitokinin for a Parkinson’s drug. On the negative side, in a high profile story last month, Gilead bailed on purchasing Tizona after securing that expensive $300M option a few years ago.

But these are indeed just a few anecdotes; what about data since these deal structures emerged circa 2010? Unfortunately, as these are mostly private deals with undisclosed terms, often small enough to be less material to the large Pharma buyer, there’s really no great source of comprehensive data on the subject. But a reasonable guess is that the proportion of these deals where the acquisition right is exercised is likely 30%.

This estimate comes from triangulating from a few sources. A quick and dirty dataset from DealForma, courtesy of Tim Opler at Stifel, suggests 30% or so for deals 2010-2020.  Talking to lawyers from Goodwin and Cooley, they also suggest ballpark of 30-50% in their experience.  The shareholder representatives at SRS Acquiom (who manage post-M&A milestones and escrows) also shared with me that about 33%+ of the option deals they tracked had converted positively to an acquisition.  As you might expect, this number is not that different than milestone payouts after an outright acquisition, or future payments in licensing deals. R&D failure rates and aggregate PoS will frequently dictate that within a few years, only a third of programs will remain alive and well.

Atlas’ experience with Option-based M&A deals

Looking back, we’ve done nearly a dozen of these option-to-buy deals since 2010. These took many flavors, from strategic venture co-creation where the option was granted at inception (e.g., built-to-buy deals like Arteaus and Annovation) to other deals where the option was sold as part of BD transaction for a maturing company (e.g., Lysosomal Therapeutics for GBA-PD).

Our hit rate with the initial option holder has been about 40%; these are cases where the initial Pharma that bought the option moves ahead and exercises that right to purchase the company. Most of these initial deals were done around pre- or peri-clinical stage assets.  But equally interesting, if not more so, is that in situations where the option expired without being exercised, but the asset continued forward into development, all of these were subsequently acquired by other Pharma buyers – and all eight of these investments generated positive returns for Atlas funds. For example, Rodin and Ataxion had option deals with Biogen (here, here) that weren’t exercised, and went on to be acquired by Alkermes and Novartis (here, here). And Nimbus Lakshmi for TYK2 was originally an option deal with Celgene, and went on to be purchased by Takeda.

For the two that weren’t acquired via the option or later, science was the driving factor. Spero was originally an LLC holding company model, and Roche had a right to purchase a subsidiary with a quorum-sensing antibacterial program (MvfR).  And Quartet had a non-opioid pain program where Merck had acquired an option.  Both of these latter programs were terminated for failing to advance in R&D.

Option deals are often criticized for “capping the upside” or creating “captive companies” – and there’s certainly some truth to that. These deals are structured, typically with pre-specified return curves, so there is a dollar value that one is locked into and the presence of the option right typically precludes a frothy IPO scenario. But in aggregate across milestones and royalties, these deals can still secure significant “Top 1%” venture upside though if negotiated properly and when the asset reaches the market: for example, based only on public disclosures, Arteaus generated north of $300M in payments across the upfront, milestones, and royalties, after spending less than $18M in equity capital. The key is to make sure the right-side of the return tail are included in the deal configuration – so if the drug progresses to the market, everyone wins.

Importantly, once in place, these deals largely protect both the founders and early stage investors from further equity dilution. While management teams that are getting reloaded with new stock with every financing may be indifferent to dilution, existing shareholders (founders and investors alike) often aren’t – so they may find these deals, when negotiated favorably, to be attractive relative to the alternative of being washed out of the cap table. This is obviously less of a risk in a world where the cost of capital is low and funding widely available.

These deal structures also have some other meaningful benefits worth considering though: they reduce financing risk in challenging equity capital markets, as the buyer often funds the entity with an option payment through the M&A trigger event, and they reduce exit risk, as they have a pre-specified path to realizing liquidity. Further, the idea that the assets are “tainted” if the buyer walks hasn’t been borne out in our experience, where all of the entities with active assets after the original option deal expired were subsequently acquired by other players, as noted above.

In addition, an outright sale often puts our prized programs in the hands of large and plodding bureaucracies before they’ve been brought to patients or later points in development. This can obviously frustrate development progress. For many capable teams, keeping the asset in their stewardship even while being “captive”, so they can move it quickly down the R&D path themselves, is an appealing alternative to an outright sale – especially if there’s greater appreciation of value with that option point.

Option-based M&A deals aren’t right for every company or every situation, and in recent years have been used only sparingly across the sector. They obviously only work in practice for private companies, often as alternative to larger dilutive financings on the road to an IPO. But for asset-centric stories with clear development paths and known capital requirements, they can still be a useful tool in the BD toolbox – and can generate attractive venture-like returns for shareholders.

Like others in the biotech ecosystem, Atlas hasn’t done many of these deals in recent funds. And it’s unlikely these deals will come back in vogue with what appears to be 2024’s more constructive fundraising environment (one that’s willing to fund early stage stories), but if things get tighter or Pharma re-engages earlier in the asset continuum, these could return to being important BD tools. It will be interesting to see what role they may play in the broader external R&D landscape over the next few years.

Most importantly, circling back to point of the blog, kudos to the team at IFM and our partners at Novartis!


Biotech Venture Ecosystem: Quick Health Check

Posted January 12th, 2024 in Biotech financing, Capital markets, Fundraising | Leave a comment

Biotech feels like it’s got some wind in its sails here at the start of 2024, with positive sentiments from the JPM conference. Indeed, the public equity markets feeling somewhat buoyant for the first time in ages.

With the close out of 2023, it’s time to take stock of the health of the private venture ecosystem. Analyzing Pitchbook data for venture funding into US-based biopharma companies, at least four themes are worth highlighting related to overall funding, startup creation, mega-rounds, and valuations.

1. VC funding overall has stabilized at around $5B per quarter, which is a historically very healthy amount of capital.

Overall venture funding for US-based biopharma companies was just shy of $5B in 4Q2023, softer than the prior quarter. To smooth out some of the quarterly variability, taking a three-period rolling average of the quarterly funding data reveals what appears to be real stabilization in terms of overall funding.  While off the peak quarterly funding level by ~50%, by all historic measures this is a robust level of financing, and supports 800+ private biotech companies each year in the US alone. 2. Pace of new startup creation has slowed considerably, and the proportion of private rounds going into new startups is the lowest its ever been.

On the venture creation side of things, using the proxy of “first financings” as a good metric for new startup formation, things have clearly tightened up significantly over the past year or so.  With a little over 50 new startups raising capital in 4Q24, we’re back to levels not seen for nearly a decade, at the start of the biotech secular bull market in 2013-2014.

Further, the share of rounds going towards startups raising their first financings, versus follow-on rounds, is the lowest ever recorded, according to Pitchbook data, coming in just below 25% in 4Q24.  This is clear evidence for the “digestion” process – the venture ecosystem experienced rampant startup formation in 2020-2021, and now has to work through that backlog of existing startups.

3. Mega-rounds greater than $100M continue to be fairly common.

Starting in 2018, large rounds became more frequent in biotech venture funding. These peaked in the pandemic bubble, but have not returned to their 2018-2019 levels.  We’ve seen at least one mega-round per week, on average, throughout 2023.

Multiple reasons for this: larger rounds help hedge future financing risk in choppy markets; bigger VC funds have been raised in recent years which require bigger check sizes, driving rounds larger; and, among other things, costs and burn rates continue to climb, especially for funding complex modalities and later stage assets privately (given lack of an IPO market).

4. Private round valuations have remained surprisingly robust despite 2022-2023’s choppy market turbulence and resetting of public equity valuations.

Post-money valuations in private deals have held up remarkably well in 2023: the median post-money in the 2H of 2023 was ~$70M+, higher than it’s ever been, and more than 100% greater than a decade ago.  A significant driver of this relates to the prior observations: as more venture funding activity was focused on later stage rounds in 2023 relative to prior periods, as well as the persistence of these mega-rounds, it has pulled up the median post-money valuations. That said, even first round valuations remain robust, holding up at roughly twice the valuation of 5-10 years ago.

Stepping back from the specifics of these data, the venture funding market for private biotech companies feels like it’s returned to a healthier place than the bubblicious euphoria of a few years ago. It’s also not feeling like the nuclear winter of 2002-2003 either, where venture-backed biotech was starving.

These days good ideas around solid science and stellar teams are often able to find venture financing, even if timelines for diligence and closing rounds are taking longer than in the heat of the pandemic bubble. It’s clear the private market is still digesting the huge number of new startups created in the 2020-2021 frothiness; some will attract financing and progress, others will shut down or be acquired – all of which is good for the overall health of the herd.

Given the significant dry powder in venture funds raised in the past couple years, 2024 is likely to be a continuation of a number of  these themes – supporting the progress of a healthy and hopefully disciplined venture ecosystem.