During my career, I have been on the both sides of the financial partnership table. I have led ‘due diligence’ process together with my drug & business development teams at pharma. Currently, I represent the third party capital providers assessing development risks for various pharmaceutical assets. Since this is an area of interest for many of my blog readers, this article will explain the basics of the investments and partnerships models for pharma and biotech companies. Considering that there are fundamental differences between the pharma and biotech organizations and how they manage their portfolio strategies, the article is split into two parts:
- Part 1 will cover the basics of the large pharma partnering models with third-party capital providers
- Part 2 will focus on partnering models for different types of biotech companies
PART 1: Partnering models between large pharma and third-party capital providers
- Partnership with third-party capital providers (investors)
Any collaboration between a biopharmaceutical company and capital provider is initiated only after a robust verification process known as a “due diligence.” It includes a review of various documents and data: pre-clinical, clinical, clinical pharmacology, medical, CMC, safety, regulatory, patent, payer, commercial, etc. The cross-functional inputs are gathered by the potential partner to assess the business risks and potential gains. The quality of information provided may decide about positive or negative outcomes and final decisions. The due diligence process may apply to commercialized products or those still in development.
On the separate note, similar parameters are used by pharma organizations in internal portfolio assessments, for prioritization and optimizations decision. Further, those criteria are used to decide for which assets development will be pursued, which will be sold out, out-licensed or even dropped from a pipeline. This article will not touch on pharma portfolio management, rather will explain the thought process for the third-party capital providers when the investment portfolio is formed.
Since investing in the pharmaceutical sector is risky, it is essential to prepare the due diligence inputs of the highest quality to allow the best assessment. Pharmaceutical business development (BD) teams run the proper preparations, meetings, and finalization of the term sheet. BD teams collaborate extensively with the selected product leaders for which partnership & investments are planned.
Investors decide to partner with a particular pharmaceutical or biopharmaceutical company either on an individual asset or multiple assets with the intention to create the portfolio effect and to mitigate the investment risks. The assumption is that portfolio (usually an accumulation of 3+ products), will increase the chances of success of a capital return.
Independently whether we deal with pharma or biotech, below two parameters are the most critical in guiding the go/no-go decision of the investors:
- Significance of the investment risk (one asset vs. portfolio, early vs. late development; the latter comes with less risk)
- Agreeability of the return structure (the way how the investor will be paid back: this may include royalties, milestone payments, equity, etc.). Return structures will be dependent on the actual risks. As a rule, one can expect that the greater is the risk, the more upside/return is expected by the investor
For larger portfolios, the pharma company may need to seek additional sources of the capital due to pre-existing capital groups boundaries, which limit the investment size to the pre-defined % of the total fund available. Syndication comes with its risks and logistical difficulties (timing, conflict of interest between investors, resource involvement in due diligence, etc.). Thus many pharma companies prefer to select few smaller investors on the top of the primary third-party capital provider and run due diligence same time, minimizing the risk of complications.
- Partnership with biotechnology companies (in/out-licensing and co-development)
Another model is collaborations with biotech companies. Part 2 of the article will cover this topic in more details. The primary objective of those collaborations is filling up the productivity and innovation gaps at large pharma. For same reasons pharma partners with academic institutions.
- Strategic partnership with another pharma (strategic co-development and co-commercialization alliances)
All strategic partnerships begin with a due diligence process. The primary goal of the strategic alliance is to leverage the strengths of the partners to co-develop or/and co-commercialize the product(s) with advantageous sharing of the costs and optimizing the planned revenues. The alliances can be very complex and operationally challenging. However, growing number of pharma companies enters partnerships as the benefits outweigh the risks.
Alliance partnerships are managed by alliance managers and via single or multiple governance bodies and committees. Since the business landscape and needs of the partners evolve pretty rapidly, it is common to see the necessity of the partnership agreements to be renegotiated and amended over time.
PART 2: Partnering models for different types of biotech companies
Biotechnology companies are falling into few categories, based on their development stage:
Type 1: focused on the discovery, with no infrastructure or cash to advance assets to the clinic. The solution is partnering with larger companies to advance assets to the clinic and commercialize them, or sold/out-license them out. The costs of the partnership are meaningful; biotech may expect to lose a significant part of the future potential asset value, as the vast of it is retained by the bigger partner, who takes over the development costs and risks.
Type 2: experienced in advancing molecules to the clinic. Comparing to Type 1, more credible due to the existing track record of achieving PoC or established partnerships with pharma. Companies of this kind search for financing deals where they can retain more value for their assets.
Type 3: acts similarly to pharma, with proven internal expertise on advancing assets to a clinic and their commercialization.
The majority of type 2 and 3 biotech wish to retain as much of the control over the assets as possible (IP), while sharing the risks, development costs with the partner and taking advantage of the operational infrastructure. When targeting a qualified partner by public biotech, financial reporting needs (GAAP in the USA) are also considered. Cash needs may be covered by a partnership with big pharma, financial institutions, mutual funds, VC, or through IPO, royalties, monetization, etc. Operational needs may be secured through either partnership with CRO or big pharma. Selecting the right partner for biotech companies allows them to strengthen their development expertise and retain intellectual property. Few of the partnering possibilities are described below.
- Biotech partnership with third-party capital providers
Many investors are not very eager to invest in the single product, or even in the basket of a portfolio with only early-stage development assets. Because the majority of biotech companies own only early development (Ph I/II) assets up to proof-of-concept, the investors usually form a strategic portfolio of products to mitigate the financial risks. A real portfolio approach, however, requires from the biotech to have a pretty robust early pipeline with various targets.
Another problem with securing the additional funds are the pre-existing partnerships with pharma, which further dilute the value of the investment deal. Also, for phase I/II, it is harder to define the milestones and successes criteria. Due-diligence costs are higher due to various experts needed for assessment of the early products forming the investment portfolio. Exit strategy (e.g. out-licensing, selling the asset) for all the products must exist and be acceptable to all partners (pharma, VC, etc.).
Recommended financing strategy for the type 1 or 2 biotech may be the direct equity investment (DEI). Direct investment provides capital funding (e.g. CRO) in exchange for an equity interest without the purchase of regular shares of a company’s stock. The partnership with CROs is covered in the section below.
- Biotech partnership with CRO
As mentioned above, partnering with CRO, which can be both service and capital provider comes with the upside for the biotech company.
CRO can provide operational expertise and infrastructures, which the biotech is lacking, at preferred rates. Also, allows the biotech company to retain their intellectual property without the transfer that may be required for other types of partnership deals for desired sponsor’s accounting treatment.
- Biotech partnership with large pharma (alliances or joint ventures)
The primary goal of the collaboration is to provide the required cash needed to build infrastructures and lead development until proof-of-concept is achieved and then, transfer the development to big pharma leveraging their late development and commercialization expertise. The return structure is usually based on royalties, milestone payments, and options. That model is favorable to biotech from accounting perspective by deferring R&D expenses.
References: Optimization of Pharmaceutical R&D Programs and Portfolios: Design and Investment Strategy 2015th Edition by Zoran Antonijevic (Editor)