This blog was written by Ron Renaud, CEO of RaNA Therapeutics, as part of the From The Trenches feature of LifeSciVC.
Much of the discussion I have had had with my colleagues in publicly traded biotech companies over the last five to six months has included the requisite “I bet you are glad you are not in the public markets!” The apparent weariness of the BTK down over 25% in the last twelve months starting to show and as @LifeSciVC reported last month – most biotech IPOs since 2013 are below their issue prices. It would seem that with RaNA’s series B closed last summer and a healthy balance sheet, that we should be counting our lucky stars.
Not so fast. We know that the public biotechnology market is inextricably linked to the private side. In fact, we have seen some public disclosure of institutional investors in private companies marking down valuations on private biotech investments. With some of this public biotech melancholy persisting, there is a similar dialogue among many of us in the private company side of our sector. A common discussion with many of my colleagues in privately held biotech and life science companies is focused on what the next round of financing is going to look like for many of our respective companies. I assume that many of the common questions within private biotech boards of directors thinking about the next round of financing probably share a common thread – is the biotech IPO window closed? What are the criteria for a successful IPO in 2016/early 2017? Why would a biotech want to go public in this climate? How should we be thinking about our next round?
While private biotech investment has been strong to start 2016, with 39% of the $5.6 billion raised through March 10 in private biotechs according to BioWorld, we cannot be certain about how the rest of 2016 and 2017 will look. This is an election year with all of the candidates taking aim on drug pricing and M&A-related (inversion) tax reform. Other headwinds include the usual concerns around earnings growth, pivotal trial failures and slowdown in M&A activity. Feedback from investors to private companies is to hunker down and focus on the most efficient use of resources to extend our cash runways (we should be doing this anyway!). Without a public currency though, many private biotechs need to create as many options and contingencies for raising capital as possible. In a public market where the appetite for biotech IPOs might be very small, private options may be as straightforward as doing another private round or a mezzanine round. Other, more complicated options may include bridge loans, upfront payments for collaborations or a strategic sale of assets.
One additional option that is a consequence of a bull biotech market followed by a downturn is the reverse merger. In its most simple form, a reverse merger involves a privately held company becoming public by acquiring a controlling interest in a publicly listed company with limited operations (failed programs or platform) or limited assets (out of cash). Mechanically, the private company exchanges its shares for the shares of the public entity based on a valuation-derived ratio with the private investors owning the majority of the public company. In most reverse mergers, the operations of the previously private company are assumed by the public company with the board of directors, executive management and much of the staff of the private company assuming the same roles in the public company. So, as long as there are “shell” companies for private companies to reverse merge into, there is another path for private companies to get public. A parallel capital raising process during the reverse merger process is common. It is important to note that a reverse merger should not be confused with a Form 10 filing which is another path to public markets and could be another blog topic on its own.
The reason I highlight the reverse merger is because we are getting many calls from bankers working on behalf of public companies looking for reverse merger candidates and gauging our interest. Some of these public companies are IPOs from the last few years with programs that have stumbled or rapidly dwindling balance sheets. Some of these companies have been public for many years and have raised significant amounts of capital but are now at the ends of their pipelines and in search of a new direction. In many cases, these public companies are trading at negative enterprise values. Given the strength of the biotech bull market from 2010 – 2015, it is not surprising to see so many public biotechs looking for reverse merger opportunities with private companies.
My general and admittedly shallow disposition toward reverse mergers has historically been negative. If a private biotechnology company, or any company for that fact, was ready for the public market – why not take the IPO route like Amgen, Genentech, Biogen, Genzyme and all of the industry greats did in their humble beginnings. Yes, it is more laborious, more expensive and success is uncertain but it gives the opportunity to showcase your company. If the story is strong, you can attract investors who want to own a piece of your company. Some of my views on reverse mergers were formed during my career as a sell-side analyst, where I remember reverse mergers of companies into names like EasyWeb, HeavenlyDoor, and Two Moons Kachinas. I also wondered why shareholders who invested in a specific company would be interested in letting a completely different, private company, come in and acquire the public company and basically take it over. What kind of shareholders would they be after the merger? I also could not recall many reverse mergers that resulted in long-term success prior to this last bull market. Cougar Biotechnology, Infinity Pharmaceuticals and Micromet come to mind as standouts. Since 2010, we have seen some successful reverse mergers such as Synageva into Trimeris, which was acquired by Alexion for more than $8 billion. Puma Biotechnology also reverse merged into a shell company and retains a $1.6 billion market capitalization and traded at a nearly $6 billion valuation at the end of 2014. Unfortunately, these are exceptions as most reverse mergers have suffered from significant losses in market capitalization post-merger.
Ironically, the cool market environment for biotech IPOs following many years of somewhat stronger public biotechnology company formation may create some very compelling opportunities for great private companies to get public through the reverse merger process. As a result of the number of inquiries and generally being curious about reverse mergers, I started to ask around for viewpoints. Soliciting opinions from investors, board members and trusted strategic advisors has yielded a wide range of perspectives on reverse mergers from very negative to supportive. Much of the negative sentiment was aligned with my previous thinking. That said, there was an area of agreement among most everyone I have talked with on the subject. Basically, if a private biotechnology company with a strong private investor base does make the decision to pursue a reverse merger it should set a very high bar for itself given the lack of success with most reverse mergers in biotech.
A few of the key things I have heard:
- At a minimum, the target public entity should have the following:
- A meaningful cash balance (or concurrent capital raise) that can be deployed post-merger with no debt; or
- A complementary technology platform that will have an immediate, value-enhancing benefit; or
- Key employees (e.g. CMO or team with domain expertise) that could bring critical mass to combined entity.
- Very straightforward capital structure
- No debt
- No warrants
- Strong support and agreement from private (acquiring) and public (selling) investors on what the Newco will look like
- Acquiring company will assume control of Newco
- Immediate transition to a public board of directors
- R&D investment
- Executive team and staff
- Absolutely no pre-existing liabilities from public company
- No ongoing litigation
- No contract disputes
- No long-term financial obligations that will not benefit Newco
- Established infrastructure to maintain a public company
- Financial reporting
- Investor relations
- Commitment by Newco management to meeting with broad investor base that you miss by not doing IPO
Finally and perhaps most importantly, the acquiring private company must have a good answer to the question of why it needs (not wants) to be publicly traded. As a private biotech CEO, CFO or board member, ask yourself many times how the company that you are considering a reverse merger with – got to this point. It is ok to admit that some companies simply go public too early. Do you want to be in the same situation? Talk to small public biotech executives and ask them ifthe grass is really greener. If you get to the end of all this analysis with confidence that you have rigidly adhered to the above screening criteria and introspection, the list of good reverse merger candidates is likely to be quite short. Once you get to that short list, valuation will be the obvious key driver to both the public entity and the private acquirer. My assumption is that if a private biotechnology company can affirmatively check all of these boxes, the chances of success for a reverse merger is increased and may be a good idea. I also assume that is probably an increased number of private companies chasing a limited number of public reverse merger opportunities and the likelihood of finding that pearl seems quite low.
My view on reverse mergers has certainly changed given the higher quality of public candidates but timing is everything. If the market for IPOs gains strength and there is strong investor support for an IPO then it seems like a straightforward decision for a private biotechnology company. On the other hand, if the IPO window really does close and there is a strong requirement to have a public currency, finding that pearl to reverse merge into might be an acceptable option.
Just remember to double-check the rearview mirror a few times before backing up.