At the end of the day, biotech venture capital is a business and driving returns is the ultimate metric.
For twenty years, to deliver on that, I’ve embraced what I call the “first principle” of early stage biotech investing: if we can positively impact the lives of patients by discovering and developing an innovative new medicine, the system will reward that risk-taking with superlative investment returns.” I stand by this today, even with the turmoil and uncertainty raised from the policy chaos on drug pricing.
Beyond great science and wonderful people, the third big ingredient required to deliver on this first principle is capital – which brings us to the business of biotech. This is the third post in my blog trifecta reflecting on the last two decades.
In this section, I’ll cover a range of topics around corporate development (like BD and fundraising), board governance, and investor syndication. This only scratches the surface of these topics… thankfully, there are over 400 prior blogs on this site for those that want to dig into these and other topics!
Here are a few business-related observations.
Corporate Development
- The cliché is true: BD deals are never done until the ink is dry. I’ve seen too many deals fall apart at literally the 11th hour. 11:59 in fact. Press releases agreed, champagne on ice… only to have a wonderful pharma “partner of choice” change their mind. Getting that phone call is a gut punch. It’s so painful, and often hurts the morale of executive teams and damages the cohesion of a Board… the blame game ensues out of the deal wreckage and there are usually casualties. You really can’t count your chickens until they’re hatched. The other axiom is BD is that “time kills deals” which is also certainly true. Don’t let minor non-critical, non-business issues drag on too long. Lawyers get paid to redline and “add value” by fighting to win every point during contracting, but it can come at the cost of time. BD fatigue is real and partners can and do walk because of it. If there’s an impasse in the deal dialogue (either at term sheet or in contracting), don’t let it fester – escalate it quickly to the right senior business principal (often the Head of R&D or BD, or in some cases the CEO) to get it resolved. Don’t be shy about doing that (see Opener vs. Closer CEO point in the People blog). Where needed, leverage your investors’ relationships to help – I’ve made that call to senior Pharma executives countless times to facilitate getting a deal done.
- Companies are bought not sold – but with caveats. The gravity of Big Pharma’s balance sheets is too big for most emerging biotechs to escape over the long run, which is why M&A is a fairly common exit, at some point, for those firms developing or commercializing high impact new medicines. But putting a “for sale” sign up in front of an emerging biotech is generally not a great way fetch an attractive acquisition offer. Instead, planning for the long-term and executing on the business plan is frequently what attracts M&A interest. But, obviously, you can put yourself into the position of being an acquisition target by proactively engaging Pharma around BD discussions. Bankers will frequently acknowledge that 80% of M&A deals start as partnering/licensing discussions, and then flip into M&A through the deal dialogue. If you didn’t engage in any BD discussions at all, M&A likely wouldn’t happen (especially not for earlier stage companies) – so there is a subtle balance in most deals. Sure, you aren’t selling yourself, but you are helping potential buyers appreciate the great things you have going on in your pipeline. Add into the mix a good set of strategic deal advisors and the boundary between getting bought vs getting sold blurs even more.
- Going public really isn’t for everyone. Being CEO of a company that successfully priced an IPO has for years seemed like the brass ring to grab on the biotech carousel. It makes for a great career milestone, so everyone seems to want to go public. The bell-ringing NASDAQ photo with the confetti is awesome. There are, of course, legitimate reasons to go public – the primary one being to access the “lower” cost of capital funding from the huge pools of public equity investors, including both generalists and healthcare specialists alike. It’s almost always easier and faster to raise money as a public company. Rather than a six-month endoscopic dataroom-dive in the private markets, as a public company a good data catalyst can trigger an overnight offering, which can fill up the coffers nicely. But it’s not always easier, and in tough times it can be brutal to be public. As a “going concern” you need one year of cash to be public (versus the all too common situation of running it down to weeks of cash in the private setting). It’s also expensive: banker fees, D&O insurance, legal and audit costs, quarterly reporting, etc… It’s not unusual to burn $50M over the first few years as just the cost of becoming/being a public company. Being public can be a total drag: countless IR meetings, annoying investors, analyst management, short sellers to deal with, and so many other headaches. All of the public market focus can easily distract a leadership team from strategy and execution. Not to mention having your entire organization staring at a stock price every day (and your Board… I’m guilty!). It can feel like every move is somehow a measure of their success (or failure). It’s not, obviously. But the truth is one should only go public if you really can’t fund yourself as a private company through the important data inflection points. I’ve heard plenty of regrets from CEOs who got beaten up in the public markets, who went out too early… and I’ve shared those regrets as an underwater investor on several painful occasions. Stay private as long as you can continue to access capital.
- Raising venture capital funding is never easy. Or maybe better said: raising capital at a “good” price is never easy. Our definition of what “good” is depends on where we are in the financial cycle. When times are tough and money is tight, it’s common to hear the refrain: “flat is the new up” so we’re just happy to get the money. I’ve seen multiple time periods like this since 2005. But in more bubblicious go-go times, “good” begins to require a healthy step-up in value or the fundraise will disappoint. Getting that step-up might not be easy. I’ve seen this euphoric part of the cycle a number of times, too, in particular in the pandemic bubble. But regardless of where we are in the cycle, one of the best ways to make a private biotech fundraise “easier” is to focus on the highest probability potential investors. Simply put, these are the ones that previously bought into a deal that looks like yours and made money from it. For instance, if they’ve never done an investment in a single asset biotech, you probably won’t be their first. In contrast, if they made money off of a deal like that recently, they will be looking to do it again. In general, investors like to draw lines from limited data points, sometimes just one point. This worked, it will work again. Or the opposite. This type of pattern recognition behavior is very evident in raising capital, and focusing on this during a fundraise is helpful prioritization. I’ve seen teams spin their wheels chasing low probability folks; most of the time, it’s just not worth it. The other reality affecting the pain or ease of fundraising: it’s a relationship business and connections matter. If no one in your current syndicate or team knows anyone very well at a potential investor’s firm, it’s not a high probability conversation. Relationships build trust. Trust makes fundraising easier.
- Investment fatigue is real and can lead to loss of equipoise. Investments that become particularly long in the tooth can grind down the patience of even long-term investors, causing value-destroying decisions. Sometimes this fatigue is just a case of needing more electrolytes and stamina – convincing yourself to stay in because the thesis is still intact and it can still deliver positive returns. I think about Prestwick in 2008, where we sold it for a little more than our money back right after finally getting Xenazine approved, in part because the syndicate was tired after three CRLs from the FDA. We left a ton a value on the table. But other times the fatigue means it’s time to pack up and go home, and not throwing good money after bad. I’ve walked from several, and it’s painful after a decade of investing. Undoubtedly it’s very hard to walk away from a big loss rather than chasing it, but you have to fold up on occasion. Further complicating the decision, sunk costs shouldn’t matter in theory, until they do (in a closed end fun) based on marginal returns. Unfortunately, it’s hard to make this call and whether or not you made the right or wrong bet is only known with hindsight. To me, the key as a long term investor is to know you’re fatigued, be candid with your partnership, and try to get a fresh look at whether you should be more bullish (or even more bearish). And CEOs should try to spot a fatigued insider and offer to spend more time with their team, if salvageable.
Board governance
- Boards shouldn’t just be quarterly cheerleaders. Being supportive of the executive team and appreciative of their effort is certainly important, but Boards should know their role isn’t to just rubber stamp what the CEO wants. Good boards challenge their teams to be better – on overall strategy as well as the plan to execute against it. But Directors also need to do their work – be prepared, be helpful, engage productively outside of Board meetings, among other things (see blog here on high performing boards). Too many Directors (even some “celebrity” Directors!) are simply box-checkers who show up quarterly to pontificate; it’s particularly annoying if they simply cheer the CEO’s greatness all the time, when a more critical view might help the company. I could provide examples, but I’ll protect the innocent. As an aside, this point extends to Scientific Advisory Boards as well; SAB members should challenge and push the team, not just cheerlead. On Boards, the Chair and CEO should work together to ensure the right dynamic is at work in the boardroom – from the quality of the agenda topics and discussion framework, to the engagement level of the Directors themselves.
- Owner-Directors are critical voices in the Board. One of the major problems in many public company boards, big and small, is that long-term Owner-Directors (like VCs or public investors) are often absent. A boardroom full of “independent” Directors without any real skin in the game, clipping their quarterly paycheck and option grants, not rocking the boat since they are largely serving at the discretion of the CEO… is not a recipe for stellar stewardship of current shareholders’ interests. Board composition should certainly evolve over time, but at no point, in my opinion, should a few big Owner-Directors be absent. Early stage investors can rotate out as companies have line of sight to commercialization, but it’s critical to replace them with later stage downstream investors (e.g., Avoro, Baker, BVF, Deerfield, EcoR1, Orbimed, Perceptive etc all serve on Boards of many of their public biotech investments). I’ve worked with many of them over time and they are committed, highly engaged Board members. When you have real ownership stakes in the boardroom, they share an important and often different perspective that’s invaluable to the dialogue.
- Get independent viewpoints on Boards early in the life of a startup. By the same token, independent voices are also important – and valuable to have as early as Series A stage companies. These independents should bring different perspectives (e.g., sitting/former CEOs, mix of R&D vs BD vs Commercial experience, etc) – but they should also be good at challenging teams, and challenging their fellow Board members, including the owner-directors in the room. Independents that just “say yes” to what the CEO wants aren’t helpful, and the same goes for those that just go along with the lead investor in the room. Good “independents” bring real independent thinking and perspective to the discussion, and I’ve worked with many who are exceptional contributors.
- Compensation philosophy and execution is a core responsibility of the Board. In order to benchmark cash and long-term incentive compensation, every company uses compensation consultants. They are almost always hired by the CFO or HR head, and typically behave like that’s who they are working for. But this isn’t the case: Comp consultants work for the Board, and specifically the Compensation Committee (CC) of the Board. Having a clear understanding of this relationship is important, and they should have a direct line of communication to the chair of the CC. The never-ending escalator upwards of cash and stock compensation is in part driven by the Lake Wobegon benchmarking process: every biotech thinks they are above-average or above-median. “Exceptional performance” is actually quite common in biotech, based on my compensation discussions. I hate being Debbie Downer, but median performance is what is common – by mathematical definition. Further, what’s rarely included in the compensation metrics and discussion is the underlying median tenure/experience/value in the role. For instance, should a first-time CEO be at the median for compensation? If we’re intellectually honest, only if the “typical” CEO in the data sample is also a first-time CEO. But, alas, no one wants to be hired below the median. So everything marches upwards. Evergreen option reloads used to be 3% annually after IPOs… then 4%… and during the bubble moved to 5%. Why? Because benchmarking is largely devoid of market context and almost never goes backward. This why the overall compensation math feels like it’s forever rising even as the market cycles cools… Boards generally feel bad pushing back on these topics, and its uncomfortable, but it’s a core responsibility.
- Resource allocation is how strategy gets implemented and must be a key part of good Board governance. Having a detailed understanding of the cash burn is also a core function of the Board, and weighing tradeoffs between what, where, and how much to spend is critical. Scenario planning around future buy-ups (or no-go’s) helps provide resolution on the timeline to key decisions. Fully allocating all the company costs to the programs themselves is also important so that Boards know truly how much is being spent per program. This visibility helps evaluate the tradeoffs: are we spending too much on Program #3 vs our Lead Program? Why is G&A 30% of our spend rather than 15-20%? In particular, understanding fixed cost infrastructure, like leases (!@#@!) or expansive internal FTE hiring plans, isn’t something to gloss over as a board. I have recommended detailed financial transparency for Boards in the past (see an old 2012 post here); these data can help Boards understand where the money is going. When markets are hot and the cost of capital is relatively low, companies often get out over their skis… we’ve all been there. But you pay the price later because the Board didn’t push back on over-committing or over-building. As noted in the People blog, RIFs are often the painful hangover of partying too hard in the fast times. In short, though most executives might not like the sense of being “micro-managed”, I’d rather see a Board err on the side of being too deep into the weedy details of a spending plan than not deep enough.
Investor syndication
- Big syndicates are like herding cats – a big headache. The bigger the syndicate of investors, the harder it is to manage so many elements of running a biotech. For instance, the chore of getting all inside investors on the same page for the next financing or whether or not to do a BD transaction. Big syndicates are also challenging in part because of the greater potential for misalignment: e.g., different liquidation preferences create seniority (vs pari passu), which leads to divergent views on downside protection vs swinging for the fences. Different stock price entry points mean different views on the target exit value. In addition, hiring/firing decisions around key executives, especially the CEO, are more difficult with big syndicates, especially if there are multiple investors on the Board with divergent viewpoints. In most cases, you only get to really unwieldy syndicates if things have taken far longer and cost much more than originally anticipated (e.g., the Series E round might asymptote towards maximal dysfunction). You often need a lot of co-investors to build biotechs, but too many lead or co-lead investors is where the havoc starts. Having been there before, especially in the 2007-2010 timeframe, we try to avoid that outcome. It’s also true that bad co-investor behavior – often revealing itself in these unwieldy syndicates – has populated our “blackball” lists for those VCs not to be invited into future deals.
- Which venture firm certainly matters, but which Partner matters more. VC firms have reputations and styles for how they like to invest. But in a boardroom, you have a person as a Director, not a firm. Whether you’re the CEO, or one of the lead investors, make sure you know (and like) that individual. Different partners at the same firm often have different styles and reputations. Collectively, they all, of course, represent the firm but working with different partners is a different experience. So choose wisely: when raising capital or trying to syndicate a deal, pick the one you “fit” with most and ask them to lead the deal. It’s certainly important that the individual partner or deal sponsor can “represent” their firm in the Boardroom (rather than running back to the “boss” for approval), but in my experience the firm is typically less important day-to-day versus the value of the individual partner – so long as they are with a firm with the ability to invest capital over time. I’ve often sought out specific individual partners, even as they hopscotched around different firms in the past two decades.
- There is no place for free-riders in early stage biotech venture investing. Nearly two decades ago one of my VC mentors (Kyle Lefkoff) told me that you have to be there at the end of the evening in order to hear your number called if you want to win prizes in the biotech raffle. In short, you have to have staying power to be there at the end – by investing in essentially all the future private rounds of the company. This is very different than tech investing, where “seed” funds don’t always participate or follow-on in future rounds. Biotech doesn’t have that dynamic. All existing investors are expected to do their pro rata of the insider portion of those future rounds, especially in tough markets. If a firm doesn’t want to participate (or can’t due to lack of funds), and new external demand is soft, terms like “pay to play” clauses will dramatically reduce their equity position in punishing ways (e.g., 10 to 1 conversion to common). The reason is simple: in tough markets, future investments often bail out past investments, so one can’t expect to free-ride on that new capital (and goodwill). As an investor, we make sure we have adequate reserves to support deals we have conviction in, and we expect the same from our co-investors. There are, of course, special situations that require special accommodations – but in general, a private biotech deal is like Hotel California… you can never leave. We’re all in this adventure together.
And that final note – that deals stick with you longer than you likely imagine at the time of original investment – brings me to the “full circle” moment for this blog post trifecta. Invest in strong science, good people, and be diligent about supporting companies through every stage of discovery and development.
In light of the science, people, and business complexity we all face, I’ve embraced a simple motivational phrase when working with teams: D.F.I.U. I suspect most of the CEOs I’ve ever worked with have heard this from me over the years… mostly joking, of course. But when (not if) we do stumble and mess something up, let’s hope its from an original mistake that we can learn from!
I’ve loved the past two decades of this journey. It’s been full of great people, incredible science, and exciting business. Hopefully I’ll have better reflections in 2045 if I’m fortunate enough to celebrate by 40th anniversary at Atlas.
Onward and upward!
