Unleashing Biotech Innovation With The Currency of Entrepreneurship

Posted December 5th, 2012 in Biotech financing, Biotech startup advice, Capital efficiency, General Venture Capital

The translation of cutting-edge science into new clinically-relevant therapeutics is the ultimate goal of many academic investigators, industry researchers, and investors.  This stage of R&D is the most challenging, and typically frought with scientific and technical risks: taking a new approach or biological target, discovering a lead drug candidate to interact with the target in the right way, tuning the drug-like properties around pharmacology, safety, and PK/ADME to find the ideal Development Candidate, and then ultimately testing the hypothesis in clinical studies to show if it delivers the desired outcome to patients.

There are many possible modes of failure in this process, and all of us involved in this part of the ecosystem spend a lot of time thinking through how to derisk projects, reduce those costly false positives, and channel capital towards the right innovations.  The ingredients of success are multiple – sound science, titration of capital, clear early development path, the right exploratory markers, etc…

Form follows function, and to integrate all these things many “forms” of early stage translational R&D have emerged.  Academics have tried to develop projects on their own, through new translational R&D centers; the jury is still out on how these will do.  Pharma has tried to integrate projects directly out of academic labs through licensing arrangements, though once inside Pharma’s research behemoths these projects often lose momentum.  To avoid this, Pharma has more recently also tried to incubate projects within academia through large scale direct-to-academia deals.  It will be interesting to see how those play out, and if they will be different from the lackluster relationships of the past.  The NIH is also taking a shot at translational work through a shift in its emphasis and the NCATS effort.  These are all important efforts.

But they are likely to fail to deliver.

Fundamentally, these “forms” don’t embrace at their core the quintessential nature of this early R&D: it requires real risk-taking.  And risk-taking requires entrepreneurship.  Venture capitalists take risks with their capital, but ultimately the real risk-takers are those who dedicate their time, the scarcest resource of all, to these projects.  These are the entrepreneurs who help create new biotechs, throw themselves at them 24-7, and relentlessly drive them forward.  They don’t want to waste their time on the false positives – those drug projects that advance, consume resources, but fail to prove out in the clinic.  It’s not the existence of a job that they are worried about.  They are just as aligned as investors to want to kill projects early that don’t work.  Great entrepreneurs are totally aligned with other shareholders around wanting the capital efficient discharge of risk from their project or portfolio.  And lastly, all of these entrepreneurs tend to be motivated with the concept of “doing well by doing good” – create great medicines and the financial rewards will follow.

So why can’t the other “forms” of translational R&D work as well?  As my partner Jean-Francois Formela likes to say, it’s because they lack the fundamental currency of entrepreneurship: equity ownership in the startup.  This is the unit that rewards the successful entrepreneur and binds them together with the academic founders, key advisors, and the broader shareholders.  It’s this currency that creates the mutual ownership that drives teams and success.  Those small, focused startups that we call “biotech” are the only “form” of translational R&D enterprise that harnesses this currency effectively.

It’s the very nature of this equity currency that enables impact.  A great chemist in a drug discovery startup can personally change the trajectory of the equity of the startup with a new lead series.  Working over the weekend actually might change the outcome of a startup.  When a superbly crafted development plan, developed by a few individuals in a startup, achieves clinical PoC, it can create huge equity appreciation potential.  It’s also how scientific founders are rewarded: they are real owners of the translation of their work through their startups, and can play an active role in shaping it over time.

Unfortunately, the other “forms” of translational R&D don’t have this level of alignment or impact.  A great drug discovery researcher at Merck has no real ability to alter Merck’s stock price.  An academic investigator that excited partners his work with Pharma for some lab funding often regrets it later when they see their project get buried in a portfolio of 100s of discovery-stage efforts.

As the entrepreneur’s currency, equity provides a clarity of focus and transparency around value that few other measures can.  Equity is the only currency that rewards risk-takers.  Like other currencies, there’s a market out there that prices it on a daily, monthly, or quarterly basis.  Early stage investors help price the equity initially, but importantly so do downstream pharma partners, later stage investors, and eventually traders on the more liquid capital markets.

In early stage biotech, it’s easy to argue pricing of this currency isn’t very efficient: there are too few buyers of equity to enable a marketplace.  This is undoubtedly true in part.  But it’s also true that if the pricing was systemically too low, then the asset class’ returns would be far higher and it would equilibrate.  The sad reality is that venture returns, across all sectors, haven’t been great for a decade, so at a macro level its fair to say that on average the pricing of equity, or risk, hasn’t been too low.

Equity is also priced by entrepreneurs, not just by those with cash.  Entrepreneurs effectively value their equity as the price for their scarce time.  If there’s not enough equity at Biotech ABC, I’ll spend my time elsewhere.  This gets at the importance of biotech hubs.  Boston excels in large part becauase the pricing of startup equity is more efficient here than elsewhere.  More choices for entrepreneurs, more choices for capital providers – creates a more efficient (not fully efficient) market for the value of biotech startup equity.

Importantly, all currencies are based on some underlying value.  As a currency for entrepreneurship in early stage biotech, it’s fundamentally based on data: has the entrepreneur and her startup been able to generate a compelling data package around a platform or product that supports the appreciation of the underlying value of the equity.  This data package, coupled with the intellectual property that enables appropriate time-delimited monopoly pricing to extract returns over time, is what creates the futures market for their currency.

As with most marketable currencies, equity in a biotech can suffer from deviations from this underlying data-supported value, which can result in over-pricing of assets that lack the intrinsic quality or robustness.  Entrepreneurs often try to maximize the value of their currency by pushing their biotech’s stories beyond where the data supports.  But this is self-defeating in the end.  Over-promotion leads to reputational consequences and in the long-term bubbles in an entrepreneur’s equity get efficiently repriced.  More often, great entrepreneurs recognize that their time is the ultimate asset, and spending it on opportunities with better promise is the way to maximize one’s potential.

If other “forms” of translational R&D are going to work, they need to figure out how to inject the currency of entrepreneurship into their models.  Encourage and reward real risk-taking.  Cultivate a culture of rule-breakers not rule-takers.  Move the career-ist phenotype out of management role to liberate the entrepreneur within.  This can’t just be “fiat currency” either; it needs to be meaningfully grounded in external market value and provide the significant startup-equity-like financial incentives for those that succeed. This will be a huge challenge culturally, and may cause atrial fibrillation in most HR departments or academic hierarchies, but it’s the best way to unleash the entrepreneurial spirit required to for successful translational research.

The other alternative, of course, is figuring out how to leverage the existing currency of biotech equity to facilitate early stage translational efforts, and this is happening with increasing frequency: Pharma-Venture collaborations, open source externalization of R&D portfolios, pre-competitive equity-based collaborations like Enlight, Academic-Pharma alliances that involve creating startups or partnering with biotechs, etc…  At their core, all of these involve liberating the entrepreneurial culture that is so adept at challenging the status quo, advancing new innovation, and testing new translational hypotheses.

Lastly, markets function best when rewards manifest over appropriate periods of time to free up existing resources.  To do this effectively, a viable futures market for this currency of entrepreneurship must exist.  Whether through M&A or IPOs, equity realizations in this market are critical to unleashing this entrepreneurial currency and recycle the time, talent, and capital into the next wave of new ideas.

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