Our Shrinking Biopharma Ecosystem

Posted September 9th, 2011 in Exits IPOs M&As, Pharma industry

The sustainability of the biopharma sector depends on a continual flow of new startups to both feed Big Pharma’s pipelines and to create the next generation of emerging mid-cap companies.  At the BioPharma America conference this week, several panelists asserted that we aren’t starting enough new companies to resupply the “corporate pipeline” for future acquisitions, and that this was leading to fewer maturing mid-cap biotech biotech companies and a dearth of compelling biotech assets.

Based on a quick analysis of Capital IQ data, there certainly has been a significant reduction in the number of small, mid, and large-cap companies in our sector.  In 2005, there were 329 pharmaceutical & biotech (“biopharma”) companies with market cap’s from $50M up to $200B in North America.  Today there are only 240 companies bigger than $50M, or a 27% reduction in just over five years.

I’ve tracked the flow of companies in the chart below: 129 of the original 2005 cohort were either merged, acquired, or shutdown, representing almost 40% turnover.  A good deal more shrunk into micro-cap land, leaving only 136 as active operating companies today above $50M. However, there were obviously some additions: a few grew out of being micro-caps, but most came from the 148 new offerings. During the time period, roughly 40% of those disappeared to M&A, shutdown, or banishment to micro-cap land.  Interesting to note it was the same percentage loss to M&A or shutdowns as the original 2005 cohort. This leaves us with the 240 companies today.  I caveat that this is a quick analysis with Capital IQ but its certainly directionally correct.

So while the data might not be as bad as some suspected, it still raises alarm bells as it can’t go on much longer like this without hollowing out the small- and mid-cap universe of biopharma companies that make up a critical and dynamic part of our ecosystem.

There a few drivers of the shrinking trend: not enough companies are maturing into public companies, not enough new ones are getting started, and/or too many are disappearing into mergers.

I think the first of these has far more to do with the disappearing statistics and the sentiment voiced at the conference: there’s really not an open, viable path for biopharma “maturation” today.  In order to have a sustainable, stable-or-growing pool of emerging biotechs we need to have a functioning IPO market for biopharma today that can provide low cost-of-capital growth funding for aspiring companies.  Public market pricing is often more punitive today than just staying private (unlike the first 25 years or so of biotech).  There are at least 75 biopharma companies who have raised $75M or more in equity capital from private sources, primarily venture capital.  This represents a large backlog of companies that would certainly consider going public if there was an appetite for public funding of early stage companies aiming to become the next Gilead, Vertex, or Celgene.  Sadly, the only companies that seem to get public are those that reformulated an active drug or in-licensed someone else’s later stage compounds (e.g., TZYN, SGNT, ZGNX, PCRX, ACRX, HRZN, AVEO, etc…). If we really want to build a solid pipeline of maturing research-driven public biotech companies then we need to figure out how to get public investors more excited about novel biopharma.  Exactly how to do that isn’t clear, but calming their nerves around the FDA through rapid reforms, improving tax policy, and wringing more uncertainty out of the payor market are all important.  We also need more steak and less sizzle in the promotion of our rising stars: over-promising and under-delivering has been a hallmark of biotech companies for years and has earned us the scorn of the public markets.

With regard to the lack of company formation, we’ve heard for years about the reduction in early stage biotech venture capital, and its certainly true the landscape has changed. As I’ve noted before, when we’re looking to syndicate our early stage deals, corporate VCs are some of the first folks we call – a striking difference from five years ago. And there’s certainly been a challenging environment to get early stage deals done, but a large number of promising startups still get financed. According to VentureSource, 545 first round financings were closed in the U.S. between 2005 and today.  Not to mention the pre-existing universe of private biotech companies, probably more than doubling that number.  That’s at least 4x the number of public biopharma companies.  Now many of these will fail to deliver anything, and many more will deliver less than exciting or relevant products, but that’s certainly not for a lack of trying.  Do we need even more innovative new startups? Sure, and there’s a bunch of us trying to help create those new companies.

Lastly, the mega-mergers and big acquisitions have certainly left us without the diversity of big firms we once had: Genentech, Genzyme, Wyeth, etc have all become names in history books.  This trend certainly contributes to the shrinking number of big players competing for deals, and effects the ecosystem significantly, but it doesn’t fundamentally move the statistics above.  The acquisitions of the small and mid-cap players are important for driving the liquidity that gets recycled to fund new startups and the expansion of emerging ones.  As an investor, I’d like to see more rather than less on the acquisition front frankly, especially since there are no other attractive liquidity paths right now.

We should all be concerned about the shrinking state of the biopharma ecosystem.  The major issue from my vantage point is that for most of the past decade there’s been no real access to public market sources of the low cost-of-capital financing required for building and scaling biopharma companies.  This has lead us to pursue other business models and experiments on the startup front, involving closer ties to larger players, and we’re confident some of these will create real value.  This type of adaptation is important if not critical in this environment; but we also need to figure out how to restore access to attractive growth capital for the long term health of the sector.

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  • OK, I guess I needed more than 140 characters for this one.

    Still, my basic point is simple: all the good ones get taken. It is extremely challenging for an emerging biotech company to achieve escape velocity in this environment. Instead, driven by an imperative to “exit” for their investors, companies are forced to seek an acquisition. And while this may be great for product-starved pharma companies and return-hungry investors (and, let’s face it, for management teams as well), my argument is that it’s not good for the ecosystem as a whole. It’s the most successful companies, arguably the most innovative, with the best and most effective teams that succeed in this path; the rest of us go with a whimper not a bang. At a macro level, then, the current system effectively eats its own young. Now I acknowledge that I’m generalizing — there are certainly exceptions in which incoming teams and programs are nurtured and grown, even cases in which the inmates take over the asylum — but more often than not the teams fall apart or disperse, the programs get lost, ignored, or mismanaged in the portfolios of the acquiring companies. Innovation is stifled.

    Recall that all the notable free-standing biotechs — the ones we point to as totems of innovation in our industry — Genentech, Amgen, Biogen, Genzyme, et al. — grew up in a different time, a time in which the capital markets had a decidedly different structure. Even the companies that are today just crossing into the promised land — Vertex is perhaps the most notable example — also grew up in that era. Early in their evolution they were able to slip the bonds of venture capital and access capital from public markets, capital that was plentiful and cheap. That path is largely lost today and venture capital is unable to provide the ridiculous amounts of capital it takes to get a company to the point where it is self-sustaining. The only way out is M&A, which gobbles up our best and brightest. As a consequence, I don’t see where the next generation of free-standing innovative biotech companies is going to come from. Well, actually I do — from Asia. But I don’t see it happening here — and that’s a big problem for our industry and for this country.

    Off of my soapbox now and going back to work.

  • Agreed Michael.  In some cases the challenge becomes apparent even earlier than the drive for an exit and M&A.  In order to meet the ever present demands for limited financing for a developing company, and (let’s be honest) as few shots-on-goal as possible, the team that makes the key discovery (especially if it’s a small molecule therapeutic) often gets canned as the company moves to clinical trials, separating the truly sustaining part of the engine from the company.  By the time an M&A exit happens, there may be a company with a clinical story, but there’s often very little engine left.  Platform companies may get truly taken apart this way, and the platform simply doesn’t survive its own success.  There are many exceptions, of course, but a theme in biotech has been that the transition to the clinic kills the engine that got you there.  And if that one shot on goal is not a huge success, the company just implodes. This does contribute to reducing the number of sustainable companies out there.

  • The probability of exit and M&A success is probably directly proportional to the sum of the positive data.

    Or it could just be a more simple binomial distribution like plucking two given biotechs out of a pot, like this 🙂


  • RMEG

    How important is it to have another Amgen or Biogen?  What are the consequences of having cycles of companies being born, failing and disappearing or succeeding and being cashed out, and new companies being born.  If one believes that smaller companies are more efficient innovators, then one might also believe that there is no harm in having fewer people and financial resources tied up in bigger companies.

  • Pwoitach

    Is yesterday’s passing of the “Leahy-Smith America Invents Act ” which changes the US patent system from “First to Invent” to “First to File” going to further inhibit the ecosystem?    Impact on how small companies and academics operate or even form could be significant.

  • Bruce,

    Great article!  What are your thoughts on the influence that corporate venture capital is having on the industry in terms of the type of investments being made?  I’ve heard that the positive thing about CVC is that as R&D driven organizations, biopharma companies make for much better partners since they are fully informed as to what they are investing in.

    However, I’ve also heard they tend to subscribe to “the flavor of the month” in that phase III candidates will be all the rage, then 6 months later, they want phase I candidates.  Business need tends to drive their investment strategies vs. tradition VC firms who tend to focus on the return and time frame of the investment.


  • Kapilunique

    Probably one good reason of no new Amgen Genentech shaping up in recent time is rather simple – these biotechs were not started with a solely exit & PE multiples ….giving them much more breathing space

  • Anonymous

    Great discussion thread here – thanks for posting.

    A few themes jump out at me worth commenting on:

    1.  I don’t think there’s any problem with the “best and brightest” companies being bought by Pharma.  Not only does it channel good assets into the pipelines of large companies (who are really the only outfits equipped to do late development and marketing in most disease areas today), but  it also creates much needed liquidity in an otherwise illiquid market and recycles both capital and ideas back into new startups.  Most of the time, the star entrepreneurs don’t stay long with the Pharma acquirer and go back and do it again.  Peppi Prasit, for instance, has already started Amira 2.0 and BMS just bought them a month or so ago. 

    2. What I’m concerned about and voiced in the blog is that there’s just no alternative path to liquidity, which is required to recycle investors, reward risk-taking and innovation, and provide growth capital to scale companies.  IPOs and the credible threat of scaling a biotech in the public markets can also create an attractive parallel track for ‘price discovery’.  Big Pharma knows today that an early stage platform company can’t go public and that certainly dampens the ‘market price’ for the story.

    3. Its also worth noting that 20 years ago, when Big Pharma had an overwhelming “NIH” complex (Not Invented Here), acquisitions of venture-backed companies weren’t a common path to liquidity.  Biotech investors lived and died by the opening and closing of IPO markets.  Fortunately, when it was open, many investors would be sitting at 4-8x their invested capital at the pricing of the IPO (e.g., Gilead, Vertex, etc…), whereas today if they get public its often 1x or less.  Today we’ve got the opposite problem where M&A dominates as the most frequent liquidity path.  Fortunately, our sector’s M&A exits can often generate returns in the 4-8x range.  What we need is a balanced, healthy marketplace where the two alternatives are both viable, realistic paths for our maturing companies. 

    4.  I love RMEG’s question – why do we need another Amgen?  Its a great point.  If we believe (as I do) that innovative drug discovery cultures thrive better in smaller environments, then why should we fixate on create big companies?  One could argue that our ecosystem has enough big players today – so why should capital be invested to add more Phase 3/4 and marketing/sales capacity to an industry structure that is already in over-capacity.   I often ask that about why biotech’s want to vertically integrate today: why are they using expensive cost-of-capital funds to build infrastructure/organizations when there’s too much capacity in those parts of the pharma value chain already….

    5. What’s the right number of private and public biotechs?  These data above would suggest we have 240 companies >$50M mkt cap, probably an equal number in micro-cap/OTC valuations, and ~1000 private companies.  What’s the right number for a healthy ecosystem?  I’m not sure, but its fair to say that many of us scratch our heads and wonder how many of these small public and private companies ever get financed and survive (b/c they just don’t have compelling stories).  I guess a big reason there are so many companies is that we’re a sector where most companies are valued on promise (hope and hype), not performance (metrics like P/E multiples), and there’s always another investor around the corner willing to drink the Koolaid.

  • I think this is the critical point. It’s true that Wall Street wants more high-growth public companies, but is this the best mechanism for medical innovation? I find it maddening, for example, when large companies drop programs because they do not meet economic objectives. A third-to-market product, while perhaps not a blockbuster, may still help a lot of patients (especially if priced aggressively). I’d love to see some of this innovation unshackled via out-licensure or divestiture to smaller companies. Third to market, for example,  may be enough to generate returns for VCs, especially if the acquirer focuses on building the assets and not the companies. 

    Having said that, I understand the counterarguments about job creation and economic development.  The Amgens and Biogens of the world employee thousands of people who buy homes, buy cars, and eat at restaurants. They also create high-paying manufacturing jobs either for their employees or for the CDMOs who make the final products. 

    I think that as long as we have more innovation we’ll have more small companies as opposed to a few large ones. This will help drive both economic growth and increase the number of approved products available for patients. 

  • Statman

    Why will no one go to the heart of the matter? The FDA is not approving drugs. Their is no pot of gold at the end of the rainbow.  The FDA picks winners and losers. The industry has danced to their tune, but now they are running to Asia as fast as possible.

  • Igor Radovitskiy

    Very interesting, NOLs seem like a very real opportunity to create positive change. Seems to be working in NJ. Hopefully this is picked up more more states.

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