Biotech Start-Ups
Must a biotech entrepreneur travel a 'golden mile' to be successful?
By Arielle Emmett
Twenty years ago, venture capitalists knew little about biotechnology. The scientific community knew only a fraction more. "With respect to immune system hormones, not a single interleukin gene had been cloned by 1981. No cytokine had actually been purified to molecular homogeneity," writes Steven Gillis, chairman and CEO of Corixa Corp., a Seattle-based immunotherapeutics company.1 Gillis recollects that preclinical efficacy data in animals did not exist for the earliest recombinant technology, and investors had mostly naïve convictions about the likely outcome of commercial biotech ventures
"Naïvete was a wonderful catalyst for the birth of the biotechnology revolution," Gillis recalls in the same article. "Scientist entrepreneurs knew little of the technological pitfalls ... likewise, investors had little appreciation for the rigors of clinical trials, the politics of the Food and Drug Administration [FDA] advisory panels, and the massive impact these vagaries would play on their rate of return calculations."
By 1994, relaxed idealism in biotech had already given way to "frenetic cynicism," in Gillis' words, about nurturing many commercial prospects. The 1990s ushered in an era of cutthroat competition for money and resources and even greater realization of risk. As the industry toughened up on its perception of winners and losers, scientists began to dread the word "scale-up"--the protocols for purifying proteins on a lab bench were often useless for producing large quantities of substance for commercial lots.
Moreover, the timing of biotech successes had changed: Instead of one-product wonders promising blockbuster results fairly rapidly, multiplatform technologies--second and third products arising from an original discovery, acquisitions, or new academic research--with decade-long horizons became necessary. But on fickle Wall Street by the mid- to late 1990s, the Internet, telecom, and software companies were already luring away hoards of investors with better yields, faster turnaround, and much less risk.
Unlike infotech, "you can't make a drug in a garage and announce on the Internet that it's for sale," observes Gillis, whose biotech company, founded in 1994, has developed a melanoma vaccine, Melacine, approved for sale in Canada. "Drugs are expensive to design, test clinically, and to market," he continues. "Because of the regulatory process with the FDA, which is normally very capital intensive, it's extremely hard for a company to remain privately held."
Nightmare on Wall Street?
Biotech start-ups now follow an arc of development that was not fully anticipated a generation ago. The arc generally moves from independent discovery in a university lab to tech transfer and commercialization or from a tiny industrial park to the politics of big corporate boardrooms.
Some argue that the "golden mile" ends where it begins, with scientists moving out of, and then back into, big pharmaceutical firms. Though sparked by entrepreneurial vigor and original ideas, many tiny start-ups find they must be gobbled up, or enter joint partnerships, to survive. Once an idea is proven viable, it may win initial rounds of private financing and venture capital, followed by more struggle, public offerings, mergers or acquisitions, and finally absorption by a bigger fish. Most entrepreneurs acknowledge that the successful approval and marketing of a biotech product today requires the global reach and regulatory and advertising support of Big Pharma.
David Holveck
For these reasons, a new venture's late early-stage development can be the toughest, draining finances and entrepreneurial verve, experts contend. "The operative word we've always struggled with is sustainability," says David Holveck, company group chairman of Centocor, a successful Pennsylvania biotech/pharmaceutical company that merged with Johnson & Johnson in October 1999 for $4.9 billion. Though many of the entrepreneurial business models are based on a technology platform, Holveck explains, applying that platform to a product and then a series of products dilutes people's energy and a company's financial resources. "Not only is it very costly to develop and commercialize a product, but generally you have to form some sort of strategic alliance to get the first commercial product under your wing." In Holveck's view, that's a double-edged sword. "You don't get full value with a [marketing] partnership; once you have a joint relationship, you end up splitting profits, and that dilutes your return."
It gets even tougher for biotech companies to bring out a second or third product while commercializing the first, Holveck contends. Even with the advent of going public, "if you start to forward-integrate the areas of manufacturing with new R&D and marketing, the organizational complexity gets a lot bigger. It takes more people and lots of infrastructure. It mounts up."
When Centocor, for example, developed its first therapeutic product, Centoxin, it established a sales and marketing infrastructure, and entered a partnership with Eli Lilly and Co. to market the new drug. But Centoxin did not win regulatory approval and tanked Centocor stock on Wall Street; the stock plummeted from $60 to $6 on announcement of the first drug failure. Fortunately, the company had enough capital and research on a second product, ReoPro, an anticlotting agent, to recover. ReoPro successfully came on the market in 1994-1995 under a joint profit-splitting agreement with Lilly, "and that worked out well," Holveck says, enabling Centocor to sustain work on another product, Remicade, for Crohn's disease and rheumatoid arthritis. The company then purchased a separate cardiovascular drug called Retavase from Roche Healthcare Ltd.
However, with three products and a substantial cardiology/immunology platform in various stages of research, testing, and marketing, "we couldn't bring a sizable investment down to the bottom line, and therefore we weren't one of the more attractive stocks on Wall Street," he recalls. There's the double-edged sword: "If you do it on your own, or use a contract sales force, or you go with a partner, it doesn't leave you the type of return on investment that Wall Street wants to see. On the other hand, if you're dropping it all to the bottom line to satisfy Wall Street, it doesn't leave you enough to invest back into your company." Holveck sees going public as inevitable to finance multiproduct development. "Once you've [built the business] and let the genie out of the bottle, the remedy is that you eventually marry into a large corporation," he concludes. That may end financial woes, but it also returns entrepreneurs back to the bosom of Big Pharma--something most wanted to break away from initially.
Pennies from Heaven
"In biotech, you're far better off paying pennies on the dollar for a venture already well established than starting a new one. That's because no one has been able to raise [substantial] money for biotech deals for a long time," claims Tom Churchwell, CEO of Arch Development Corp., a wholly owned commercial subsidiary of the University of Chicago. Established 15 years ago to license and commercialize university research, Arch Development has 20 start-ups to its credit and more than 200 technology licenses. But times are still tough, Churchwell contends; a brief 1999 resurgence of biotech venture capital has "faded," and aggressive dealmaking and licensing are still necessary to help new ideas out of the starting gate.
"A lot of the [lack of enthusiasm] had to do with the bad experiences of investors--putting a huge amount of money into projects and not getting it back," he says. "These days, instead of raising $15 or $20 million at the outset, we start with small amounts of money and use a lot of SBIRs [Small Business Innovation Research grants from the U.S. Department of Defense] to flesh out the risks of a venture and test against milestones [established in the business plan]. It's far better to get a project to a point where you have a tangible product with good clinical evidence than to license or sell a very early-stage product," he continues. "Big Pharma is just overwhelmed with products in early stages and underwhelmed by products they can take out into the marketplace."
Further, "biotech has become very geographically specific," Churchwell adds. "In Silicon Valley and on the East Coast, there's a huge venture capital infrastructure. At Stanford University and surrounding areas, for example, they have a plethora of venture capitalists skilled in the art of starting companies." The Midwest, by comparison, has a dearth of venture capital firms and financing, and hence fewer biotech firms. "The deals need to be made in one's own backyard, because they're volatile," Churchwell contends. "That's why we're in the process of raising a venture fund--we hope $100 million--to finance new projects."
Geographic specificity for venture capital has not always corresponded with the depth of research talent in a particular city or region, suggests Lou Berneman, managing director of the Center for Technology Transfer, University of Pennsylvania. For example, Penn research (along with that of nearby medical centers such as Thomas Jefferson University and Fox Chase Cancer Center) drives the lion's share of biotech activities in the Philadelphia region. Yet venture capital is still comparatively scarce. "We are certainly the research engine for the biotech industry," he argues. "Of $1.5 billion in federal funding for basic research in the region in [fiscal year] 1998, Penn received more than $400 million, and in the biomedical field, we are by far the largest." But even with 250 new invention disclosures each year to Berneman's office, as well as 40 active commercial start-ups arising from Penn research, the Philadelphia region is still considered up and coming--second tier--behind the high-tech capitals of Boston, San Francisco and Silicon Valley, San Diego, Seattle, Research Triangle Park, and New York.
"It's harder to get biotech deals done today because investors are increasingly wary of the dot-coms," Berneman says. He denies, however, that there is an overall downturn of interest in biotech: "With the increased globalization of pharmaceutical companies, most are interested in late-stage discoveries to fill their revenue top lines. They're less interested in the embryonic technology we have to offer."
Tech transfer offices associated with universities have had to become more proactive in commercializing discoveries. They have had to work out consulting arrangements and resolve faculty conflict-of-interest issues. In some instances, they become aggressive dealmakers. "Our role specifically is to create [new biotech companies]," Berneman declares. "Each of the 250 disclosures we get each year is assessed against a set of criteria. If we choose to go forward with them, whether it's product or invention, we go through the processing of licensing and marketing. If we see something as a platform technology, we develop a feasibility study, then prepare an opportunity package and start talking to folks to generate investor interest. We then engage a search firm to designate a CEO, and our office, in concert with the entrepreneurs, creates a business plan."
Jeffrey Labovitz, director of the office of technology licensing and industry-sponsored research at Harvard Medical School, says the rules for setting up high-tech firms are becoming tighter. "Although there may have been a blip with the influx of investor cash in the first quarter of 2000, entrepreneurial opportunities have declined over the years because of the stringency of intellectual property rights meeting requirements of investors," he says. To keep a deal alive, "We'll consider any reasonable business relationship that will meet the litmus test of our policies and doesn't conflict with our primary obligation as a teaching and research institution," Labovitz says.
"Equity these days gets a lot of attention in new deals, but it's just a business tool," he continues. "We structure [licensing] deals such that payback to the university and inventors is sometimes pay as you go, or uses equity as part of the equation [rather than strict royalties or up-front cash]. There are other components of a deal providing income back to the university; if the company is successful, for example, the royalties for an invention or new drug may far outstrip any equity [the university] may have taken [in the start-up]."
Always an Exception
Despite a generally dampened atmosphere for investment, the industry continues to support many surprises. The large publicly traded success stories are the standouts of yesteryear, but many today are partially or wholly owned by other big companies or participate in joint partnerships. Smaller entrepreneurships may still hold the key to next-generation technology. For example, the Association of University Technology Managers, which collects data on licensing activities from academic institutions, claims that 17,088 licenses and options were active for FY 1998. This implies "that the licensee was still actively evaluating or developing the invention or selling product, up 11 percent from 15,328 in FY 1997."2
Because venture capital is geographically specific, successful upstarts must sometimes begin by bootstrapping operations with private capital--often the inventors' and business partners' capital, says Lance Fors, CEO and chairman of Third Wave Technologies Inc., a company in Madison, Wis., that provides DNA analysis products for research and clinical applications. Fors, a former graduate student and postdoc at California Institute of Technology and protégé of Lee Hood, began his company on a casual visit to colleagues Jim Dahlberg and Lloyd Smith in Madison. "An initial observation on DNA enzymology was made at the University of Wisconsin," Fors recalls. "But it was just an observation, there wasn't a technology at the time--just three guys who had an idea."
The notion of developing a cutting-edge, non-PCR DNA analysis technique was born, and the company subsequently developed The Invader assay technology, now hailed as a next-generation method for more accurately detecting and quantitating DNA and RNA sequences, including genetic variations known as single nucleotide polymorphisms (SNPs). The company says the Invader will replace the less accurate and more costly PCR method and "has the potential to make DNA analysis practical on a broad basis and fundamentally alter drug development and the practice of medicine."
Since its inception in 1993, Third Wave has collaborated with major genetics research institutes, including the Sanger Center, Cambridge University, and the Stanford Genome Center. By July 1999, the company had raised $38 million in private equity financing (investors include Wellcome Trust, SR One, and Schroder Ventures International Life Sciences Fund II); it had also signed an agreement with Warner-Lambert to provide a portfolio of Invader assays for testing in genotyping and gene expression applications.
"At the start, we thought maybe the three of us were willing to put up the money to get this thing going, and then it was a matter of scale," Fors says. He and the two associates wrote personal checks for "tens of thousands of dollars," began developing a business plan and milestones for the high-throughput genetic assay research, and started work.
"The question becomes, 'how interested are you in being an entrepreneur who chases a dream and runs with it?'" Fors says. "So we established our milestones, made observations, funded it ourselves, and then got one or two patent applications, and we became Third Wave Technologies. After that, we went to step two, which is, 'how are you going to get that real seed financing which allows you to figure out where you are?'" That step, getting the first $5 million for the company, "took a lot longer than anyone thought .... Had we been located in San Francisco or Boston, instead of Wisconsin, we would have raised the money in a fifth of the time."
Fors got the first $4 million in funding not from venture capital, but from SBIR grants. The money permitted Third Wave to continue testing and refining its patented genetic profiling technology--and to develop a "story to take to corporate investors. It happened somewhere between two and four years since getting the research grants," he says.
"We had to prove to ourselves that it would work and make the story clear to potential customers. We needed additional funding and more people--basically the ability to go out and create excitement about what we were trying to do." This happened, by biotech standards, relatively quickly. "We had enabling technology, and we talked to every major player in the research and diagnostic market about it," Fors said.
Meetings with PE Biosystems, Foster City, Calif., took place in the summer of 1999; a merger announcement came in January 2000, with both partners declaring the benefits of complementary strengths. By June 2000, however, Third Wave's course shifted again. As if to emphasize that the path to successful entrepreneurship is never straightforward, Third Wave and PE Biosystems decided to terminate their merger due to the frustratingly slow and increasingly uncertain regulatory review by the U.S. Department of Justice. The department was evaluating the merger for potential monopoly problems and needed to sign off on the deal before it could take effect. Third Wave, which was widely considered one of the premier initial public offering (IPO) candidates prior to entering the merger, may again be a leading IPO candidate. Company officials believe their technology is emerging as the standard for DNA analysis for research and clinical applications.
Eternal Optimists
What's around the bend for biotech companies in general? Biotech veteran Gillis is excited about the prospects for the future, even though he decries the "herd" instinct on Wall Street and believes that the investor community needs better education about biotech. "It's easier to be an academic-entrepreneur than it was 20 years ago," he says. "When we started Immunex in 1981, it was viewed as heretical that academic institutions would collaborate with industry, even though that had been done for decades in chemistry and physics. In biology it was rare, and only now are we catching up."
Holveck believes that entrepreneurs can still maintain their drive even after they've caught the big fish. "The best days are ahead of us," he says. "Finally we're able to focus on the development of technology and not be distracted as much by Wall Street issues. I'm energized because of what we can do." S
Arielle Emmett (arielleem@snip.net) is a contributing editor for The Scientist.
References
1. S. Gillis, "Factors for success in biotechnology: then and now," Nature Biotechnology, Vol. 16, Suppl. 1998, page 9.
2. FY 98 Licensing Survey Executive Summary, Association of University Technology Managers: http://www.autm.net/pubs/survey/1998/execsumm.html.
