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.


Biotech’s January Chill: Big Drop In New Startups

Posted April 4th, 2022 in Biotech financing, Capital markets, Talent | Leave a comment

While the pace of startup formation in biotech has been accelerating over the past decade, early signs suggest the malaise in the markets is finding its way back into the venture creation ecosystem.

Startups get formed, often in stealth, and frequently launch with fanfare around their first financing news. Because of the importance of the new calendar year, and the timing around the JP Morgan Healthcare conference, it’s not a surprise that January is almost always the biggest month of the year for announcing new startups. In fact, January was the largest month for new “first financings” in biotech in all put one year of the past decade (when it was the 2nd highest month by a slim margin).

But according to Pitchbook data, January 2022 doesn’t look nearly as robust, and is the lowest level of new first round financing activity in over a decade.

Could these data be a canary in the coal mine, signaling an alarm for the early stage biotech community?

It appears that the yearlong downdraft in the public markets finally found its way upstream into the startup world. As is well appreciated, the past decade has witnessed an explosion in both new startups and in emergent public companies. The number of new startups formed each year has doubled over the past decade, from ~200 or so up to ~400 each year.  And the number of publicly-traded biotechs is up two- to three-fold over that same period. In light of these new numbers, the markets could be recalibrating to a new normal, adjusting to the indigestion of the past few years and to the perceived increase in risk in the sector (e.g., financing risk, differentiation risk, regulatory risk, etc).

These data are only one month, and the year is still tracking to add 250+ new biotech companies this year (on top of 1000+ private biotech firms already), so it’s too early to draw sweeping conclusions. The sky certainly isn’t falling. But I do think it’s a cautionary flag around the pace of startup formation.

There’s been an ongoing debate as to whether we have too many or too few biotech companies as a sector; objectively, that’s an impossible question to answer as a blanket statement.  Are there too many CD19-focused cell therapy companies?  Likely true.  Are there too many heart failure companies?  Almost certainly not.

To get a sense for what’s limiting the overall number of biotech companies, it’s worth exploring the constraints on venture formation in biotech today across the three key startup ingredients: capital, ideas, and talent.

In recent years, we’ve been awash in capital for private biotech companies. There’s been a dramatic increase in seed and Series A round sizes, and, as noted above, a 2x proliferation in the number of startups.  Even in 2022, there hasn’t been a real lack of capital; in fact, 1Q 2022 is likely the 2nd largest quarter of all-time for biotech venture capital funding. But this could all change if the financing market tightens up more significantly. But I doubt this occurs in a dramatic way, as lots of venture capital firms have reloaded recently with large new funds that have a mandate to get deployed in the next few years into biotech: from venture creation firms like Atlas and Arch, to multi-stage firms like Vida Ventures and RA Capital, as well as tech-turned-biotech funds like A16Z and GV. There’s plenty of capital out there ready to get deployed – so access to money in the private markets isn’t a real constraint right now or in the foreseeable future. Valuation and pricing may need to adjust, but availability of capital isn’t a meaningful constraint.

We also aren’t running short on credible ideas for new startups.  Academic labs, entrepreneurial folks in industry, as well as assets spinning out of Pharma – there are plenty of new nucleating ideas for startup formation. Not all of these are transformational new innovations, but many ideas are incremental riffs improving on prior concepts, which has historically been a source of positive benefit to patients and shareholders alike in our sector. This may be a concern for those worried about hyper-competition, but the backers of every new mousetrap always think it is better than the prior model.  It’s the nature of the startup capital markets: give investors the permission to believe you have a shot at being the best, and you’re likely getting funded. Further, there are plenty of unmet medical needs that patients face, and lots of new and conventional modalities in the tool kit to deploy in our attempt to address them. So I don’t believe ideas are a constrained input into the startup ecosystem.

But talent, on the other hand, has been the primary constraint in recent years. The lack of experienced talent, knowledgeable about drug R&D and willing to take the career risk of joining a nascent startup, is a real challenge. Many of these talented folks have golden handcuffs to their current roles, often in bigger biopharma firms – it’s hard to leave the compensation packages of larger biotech and pharma players. Further, experienced teams are being “soaked up” by more public companies (up 3x since start of secular bull market in 2013), especially in recent years.  Every one of the 400+ newly minted public companies needs a 5+ person C-suite. That’s a lot of skilled folks largely locked into their seats for the time being (we’re trying to pry some loose!).  With fewer M&A deals, there’s been fewer teams freed up for recycling back into earlier stage startups. And despite the number of restructurings of late, the talent available in the market from these RIFs are generally not from the C-suite. Anyone who has tried to recruit for CxO biotech positions in the past year knows how competitive the talent market is today. The tight supply of experienced talent certainly has been a powerful governor holding back an explosion of startups.

Different sides of the debate about whether or not we’ve had too many or too few biotech companies will probably respond differently to the January 2022 tightening.

On one side are many folks from Wall Street, where a good number of analysts and public investors feel the indigestion of the past few years from the exploding number of SMID-cap players. Many seem to share the general sentiment wishing for fewer SMID-cap names. And despite my defense of early stage biotech IPOs, I acknowledge no one knows what the “right” number of public and private biotechs should be. A common refrain from this crowd is that there are too many companies chasing the same opportunities, creating negative effects of hyper-competition. If it continues into a meaningful change in company formation, the cool-off in the number of new startups will likely be welcomed by this group.

On the other side, younger entrepreneurs promoting the concept of “founder-led biotech” (which in this case really means PhD-to-CEO) want to see lots more companies get formed, and backed by more arms-length investors that let young founders lead their startups (rather than putting in industry veterans into the C-suite). They claim that talent is only a constraint because the definition of “experienced talent” essentially boxes them out of the roles, and that the available talent would balloon if the sector thought of talent differently: give more young graduate students and post-doc’s the chance to be CEO, and the sector could greatly expand the number of biotech companies. The tightening numbers around new startups is probably not what this constituency hopes for.

What about venture creation VCs? Although our “walled gardens” are commonly decried as closing off access to out-of-network entrepreneurs/executives, the reality is that our venture creation communities create efficient platforms for company formation in a systematic manner, and allow experienced veterans to take more career risk by jumping in as EIRs.

More importantly with regard to the pace of startup formation, venture creation firms are only a small contributor to the overall number of new biotech startups. Atlas only helps create 6-8 companies a year. Our friends in the venture creation space, like Third Rock, Flagship, Arch, and others, are also only producing a handful of startups each year; most of these firms have a time-intensive, laborious process, that goes through the foundational steps of venture creation in a systematic way, and naturally constrains itself via the venture partnership model. My somewhat educated guess is no more than 15-20% of the biotech startups in a given year (e.g., ~60 out of 300+ new startups) come from true “in-house” venture creation platforms by established firms. That implies lots of activity outside these “walled gardens”.

My hypothesis is that the tightening in the data for January 2022 around startup formation is also not likely related to a decline in in-house venture creation: most of the firms that do this, as noted above, have significant resources and are likely continuing to do what they love to do – start, seed, and build companies. Our pace at Atlas continues to be what it has been over the past few years.

Instead, it’s likely that the tighter numbers around venture creation recently are more likely from fewer “arms-length” investors willing to take bets on “standalone” startups in this tough biotech market and overall risk-off climate. For this group of startups, unaffiliated with venture creation firms, the diminishing numbers could indeed be a canary in the coal mine – a worrying trend towards a more challenging financing climate, with fundraising timelines slowing down and access to capital becoming more difficult.

For those of us doing what we do as venture creation specialists, fewer new biotechs and a more constrained overall pace of startup formation is probably a good thing: less competition for talent, a greater share of voice, and a more favorable supply/demand balance in the downstream partnering and public equity markets. I’m not sure this is something to celebrate, though, as the sector benefits from a diverse set of company creation models and approaches to building biotech.

These early data could be biomarkers of a meaningfully tighter pace of startup formation, or they could just be an anomalous blip in the data. If the overall biotech markets regain momentum later this year, it’s likely just the latter. But if things remain challenging, it could reflect a more constrained “new normal” for biotech venture formation.