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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  • Persuasive plead to academics to channel their innovations through the startup ecosystem for translation.

    Not so effective in establishing value of equity to them: in reality, this ecosystem often wipes the initial innovation owner (academic lab) through dilution, while protecting the investors and management through anti-dilution, liquidation preferences, and option grants.
    An interesting alternative would be if academics are rewarded through a combination of upfront cash and downstream royalties, while all the equity accrues to the investors and enterpreneuers.

    As a VC, would you back-up your defense of equity by licensing innovations for cash/royalties, keeping 100% of the equity for yourself and the management? My hunch is that you wouldn’t: it is profitable to exploit the general ignorance of academics on matters of dilution, liquidation prefs, management re-ups, etc… Hope I am wrong.

  • Suleman

    If I’ve understood your very insightful article correctly part of the value of the equity would come from that specific entrepreneur’s reputation. It would be interesting to see the reaction of other investors if he/she decided to start work on a risky project that could endanger that reputation.
    Also I think companies frequently seem to end up in the position of having to get rid of the founding scientist because their interests are no longer aligned. That presumably would be more difficult to do if they have substantial equity.

  • Bruce,
    I noted with some degree of nostalgia and satisfaction that one of the new models for translational R&D is the integration of Pharma and academia, You point out that this has been tried in the past and resulted in lackluster relationships. I think we have come full circle.

    I’m reminded of some not so lackluster relationships of the early days of biopharmaceutical development when pharmacokinetics and pharmaceutics were just coming into their own in the 60s and 70s. That may seem like ancient history today, but that a hugely prolific time and generated a ton of pharmaceutical lore. It also generated a ton of technology that went directly from the academic labs into the Pharma R&D groups and revolutionize the way scientists viewed development.

    In those days, luminaries like Jens Carstensen, Taq Higuchi and Mario Garibaldi were defining pharmaceutics and pharmacokinetics in their academic labs and Pharma was implementing their new knowledge as quickly as they could. Back then, Pharma was flush with cash and the industry was in its growth period. Pharma could well afford to support these scientists and did so with a variety of programs. Pharma provided rich consulting retainer contracts with no specific deliverables other than to share their learning with the Pharma R&D groups. Pharma also generously provided fellowships and grants to promising scientists in graduate school, again with no specific required outcomes.

    These early luminaries were entrepreneurs in their own right. You make a good point that equity is a driver for today’s entrepreneurs and scientists in large firms don’t have access to equity rewards. I would posit that academic scientists are rewarded by their own accomplishments and don’t necessarily need an equity stake to drive them to breakthroughs. The breakthrough is reward enough for them.

    There is something to be said about the approach taken today which is to provide academic support with focused intent for the funding. However, there is also something to be learned from our past history where unfettered academic support generated some very fruitful relationships with a lot of luster.


  • Agree. You have to have skin in the game to make it all work. Treating biotech product development as a job or as a pathway to tenure leads to inefficiencies. Your last paragraph is very important. Working weekends is fine, but that equity-laden entrepreneur has to clearly see an exit, just as his/her investors do.

  • That’s a really interesting idea, but I don’t think VCs (and their LP masters) would ever go for that. Plus, there’s the university that will want their cut…and that won’t be a small one!

  • I agree that these alternative models are lacking pieces that lead to entrepreneurial risk taking. However, I wonder if it is more about protection from the downside (walking away from failure) than participation in the upside (equity turned to cash).

  • John

    I think that academics are presumably great for basic research (caveat, there are reports of 70% failure rates for “breakthrough” academic publications), but since 90% of research projects fail in pharma, which hires the best and the brightest and turns them into experienced professionals, what makes anyone think that academics can be good at actual drug discovery and development. If you have not seen dozens of projects fail for the various idiosyncratic or more generalizable reasons, how can you systematically judge if you are on a valid path to compound selection.

    I feel that many billions of NIH, VC and Pharma money have been/will be lost on this latest run to the academic labs for drug discovery. I think it best to let them go back to their pursuit of breakthroughs for academic glory/academic satisfaction and leave most drug discovery to the professionals.

    The central issue for Big Pharma would seem to be that bigness is bad, that big data can suck the juice/excitement out of research (trees vs forest) and that poor leadership can kill any endeavor. Uncertainty re the next layoff also prevents creativity.

  • jack

    I’ve never worked in Pharma but I imagine the amount of wasted institutional knowledge and potential is off the charts. I would think something along the lines of Google’s “Founder’s Award” would be useful, but that would force these companies to allow their employees some freedom to spend their time where they best see fit. Allowing starry-eyed scientists to manage their own time and resources with the incentive being a large, IPO-like monetary reward would be very interesting to see.

  • A Marshall

    Late to the party again! If we want to turn innovation into products, entrepreneurial route is definitely the way to go, even if its does screw founders occasionally (and let it be said many academics have done well enough out of this model). NCATS and Pfizer’s CTIs etc are all worthwhile, but they are just a drop in the ocean in terms of tapping the potential of academic labs and the amount invested. I share Bruce’s skepticism that they will result in many products; they can’t be taken seriously for all the reasons stated in the post and comments. Let’s also hope the current vogue among funders for translational research doesn’t end up stifling blue sky research. But this is all navel gazing anyway unless new sources of funding for entrepreneurial innovation can be found. At the moment, there simply are not enough VC funds investing in early stage science. With an increasing number of mid-to-large cap biotechs succeeding in launching their initial products on the market, perhaps they are the answer. If these companies could be persuaded of the merits of creating corporate venture capital funds, there might be a steady and growing source of funding. The problem is most of them have been rather half-hearted in this respect, preferring instead to buyback shares and behave in other pharma-like franchise expanding activities rather than set up corporate venturing arms. One would have thought that the biotech sector would have been more open to supporting this. So Bruce why don’t more biotech companies do this in a more meaningful way?