Book Review: Biopreneurs - The Molecular Millionaires

Book Review

Biopreneurs: The Molecular Millionaires

Ryan Baidya, PhD, MBA & Miyuki Shiratani, MBA California Takshila University Press, Santa Clara, CA, USA

Soft Cover, 280 Pages, 70 color images, tables and illustrations, US $35.50 First Edition, 2008, ISBN-10: 0-9822001-0-2, ISBN-13: 978-0-9822001-1-7

Bhaidya and Shiratani have attempted to interpret the diverse nature biotechnology industry and its relation with entrepreneurship by co-authoring a biotechnology guide mostly intended for venture capitalists, other investors, biotech executives and scientists with the special emphasis on how and why to invest in start-up and early-stage ventures. This book is based on the Bio-MBA lectures, invited seminar series organized by Japan’s External Trade Organization (JETRO) and hands-on experience by the authors in developing biotech businesses from academic to industry. The book is written keeping in mind the novice readers with or without the background in biotechnology or life sciences, thus keeping aside the dry hard facts of life science subjects and financial figures of the stock market.

The book contains 15 chapters divided into three broad areas which cover biotech entrepreneurship development, biotech drug development, and biotech business development (marketing, funding and valuation) along with four supplements of drug development section, attempting to address a quick-fix for the potential investors. The approach taken by the authors is not to describe specific companies (case studies) or specific industry sectors (value chain) but rather to discuss broader areas of entrepreneurship paths in biotechnology.

The book begins by explaining the basics of entrepreneurship in biotechnology by taking the readers through the traits of researchers and biopreneurs, to lessons to learn, and Dos and Don’ts (paths to success) as well. The chapters on biotech drug development provide in-depth analysis of pre-clinical and clinical development citing numerous figures and tables from the authors’ personal research and experience. The business of biotechnology section includes chapters on business plan, role of marketing, funding, fund raising and valuation for bio-ventures. The chapter on beginning a bioventure is a summarized version whereas; a larger section has been devoted to chapters on financing, investment and valuation which are explained in great detail (from idea to IPO and beyond). The role of marketing have been mostly concentrated on the differential strategy rather than on segmentation, targeting and positioning of biotech products.

In summary, this book reveals a lot of imagination that has gone into developing biotech companies, which is regarded as important. For those contemplating to set up a bioventure, there are lots of ideas that would be helpful for the first-time investors of bio-enterprises. Although, the authors have touched some of the important aspects of the science and business development, they did not really explain the implications of it. The book would have been still better, firstly, by including some relevant case studies in bio-entrepreneurship development, thus providing historical adventures by the early entrepreneurs and their bio-ventures. Secondly, the role of intellectual property, technology transfer and regulation of biotech products (drugs and diagnostics) in starting and managing biotech ventures would have been a great starter information for the students as well as potential investors of this industry. The audience for such a book is most definitely investors new to the biotech sector, to understand the underlying drivers and students enrolled for enterprise education, and unfamiliar to this sector.

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Licensing in the Business of Biotechnology

Business-wise, the biotechnology industry is divided into companies that create tools and technologies and companies that develop and commercialize products using these tools and technologies. The success of biotechnology companies largely depends on their licensing ability to transfer intellectual property rights of the tools or technologies for an appropriate value in either the consolidation agreements or partnering relationships. A license in biotechnology often arises in joint ventures and collaboration arrangements, while its value is determined by the rights granted by it. Considering the estimated costs of $1.2 billion to bring a drug to market, the licensing agreement remains the bridge between the companies to succeed with mutual benefit. Biotechnology companies at all stages of growth need capital and a robust product pipeline. As part of the survival strategy, the smaller biotechnology companies often provide a technology platform necessary for larger pharmaceutical companies to supplement their late-stage product pipeline. The innovations in the genomics-based drug discovery, target validation, diagnostics/ screening technologies have introduced numerous such licensing agreements between the larger-but-poor-pipeline and smaller-fund-deficient-but-innovative-technology companies in the biotechnology sector. To assess the potential value of the licensed technology or products, due diligence analysis becomes the most critical step of all licensing transactions while managing the IP portfolio of the companies. In biotechnology licensing agreements, the licensor and the licensee needs to include issues like the rights to make or sell, co-develop, manufacture, supply, transfer know-how, manufacturing know-how, sublicense to third-parties, IP rights, rights to second-generation products retained by the licensor and/or acquired by the licensee, and the access to the licensee's drug applications, etc.

Patent license agreements can be divided into in-licenses and out-licenses. In-licensing refers to agreements by which a party acquires the rights to use a patent, whereas out-licensing refers to agreements in which a patent holder grants a third party the right to use a patent. In biotechnology, in-licensing is important for large pharmaceutical companies to develop new or improved products. Because in-licensing is a way to avoid expensive and time-consuming research and development, such companies are committed to in-licensing development compounds. Companies often find it necessary to develop biotechnology products for which patented enabling technology exists (e.g., patented genetic engineering techniques). And, out-licensing is useful when a company is unable to commercially export technology. It allows a licensee to perform basic research and development during the risky development stage. Patented starting materials and processes can be out-licensed to maximize the value of technology, even by licensing basic enabling technology to multiple users. Applications of the same patented core technology are also divisible by out-licensing; e.g., by diagnostic and therapeutic market (field-of-use restrictions). This provides multiple royalty incomes from single-core technology. It is also possible to extract multiple royalties by out-licensing a single biotechnology product. Patent rights to a gene can be licensed to a number of companies. Those rights may include, for example, manufacturing a specific protein from the gene, developing diagnostics and/or therapeutics using the gene, and developing a gene-specific delivery system.

IP transfer agreements can be further categorized into confidentiality agreements, material transfer agreements, de¬velopment (the licensee assumes all responsibility for further development), co-development agreements (two parties collaborate on continued development), and distribution agreements. In confidentiality or nondisclosure agreements, the development of a drug candidate involves the use of confidential informa¬tion such as source, research findings, methods of production, technology used, and business in¬formation and thus all informa¬tion need to be protected. The materials transfer agreements are made when a licensor provides the drug samples or information pertaining to it to a potential licensee who wants to evaluate a new product or process. Even after acquiring new IP from a public institution, it is not always possible or feasible for a single private company to carry out all stages of production and marketing. The company may need to collaborate with others in order to complete prod¬uct evaluation (preclinical toxicity tests, clinical trials, and so on). Besides, high-quality, good manu¬facturing practice (GMP) production facilities are needed to develop products for the mar¬ket. The licensee can either pay other agencies to perform some of the tasks or collaborate on mutual beneficial licensing terms with them. In return, the partnering company may request a share of the IP rights or a portion of the revenue generated by product sales. Technology licensing agreements allow one company to use the proprietary materials or know-how of others. Such an agreement clearly defines the validity of the license, the kind of license (ex¬clusive or nonexclusive), the territory in which the license is valid, the market in which the product will be released (public sector or open market), whether or not the product can be sublicensed, the amount of money to be paid up front, and the royalties that the licensor will receive. The territory is the geo¬graphic region in which the licensee is permitted to sell the product. Sometimes, nonexclusive licenses are awarded to licensees in order to promote competition between them. Or an exclusive license may be granted to market an expensive product within a limited market—un¬less such market exclusivity is guaranteed, no one may be willing to manufacture it. The guiding principle for deciding whether to grant exclusive licenses of nonexclusive licenses should be that while it is most important to bring new products to market at affordable prices. Health-related products can lead to liabilities; especially susceptible products, such as vaccines, are tested on healthy volunteers. Often, compa¬nies are unwilling to market a product because of potential liabilities. The licensing agreement for a health-related technology must define the cases in which the investigators will, and will not, be held responsible (for example, such cases might involve bad or inferior product, improper storage and use, administration of the wrong dosage) and the licensee must take out an appropriate amount of insurance before starting trials. The clinical tri¬al agreement should also describe how, and how much, an individual who is harmed by a health product should be compensated.

Generally, the licensing payments are determined by the type of the technology, patent portfolio, drug regulations, stage of development, market size, and exclusivity (exclusive, sole, or nonexclusive and/or restricted by field of use, territory or time), etc. The licensing fee includes signing-up fees or up-front payments, milestone payments and royalties. The signing fees allow a licensor to compensate money spent on developing technology or drug delivery platform. These fees are usually modest for basic or undeveloped technology and nonexclusive licensing. Many biotechnology inventions require substantial development or must be combined with other technologies to create a product (e.g. delivery devices). Therefore, a common strategy is to keep the signing fee modest but allow other fees to increase as the technology becomes more promising. Milestone or benchmark payments are used to compensate the licensor when an invention demonstrates value that was not yet proven at the time of licensing. Milestone payments are tied to such contingencies as filing an investigational new drug application (IND) and beginning phase I, II, and III clinical trials as well as to stages that indicate a potential for success —such as when filing a new drug or product license application (NDA or PLA) or receiving approval to market. They can offset non-reimbursed costs that remain with the license and are usually back-end loaded. Milestone payments are critical revenue generators and are likely to be high for early-stage molecules and more for later-stage molecules. It is extremely difficult to estimate royalty rates for biotechnology inventions because the final product is often unknown at the time of licensing. In general, a therapeutic compound carries a higher royalty than a research tool such as a screening assay. Royalty payments are only made as a percentage of net sales of the therapeutic or technology to develop the molecules.

For example, a company can acquire a product for a modest up-front fee, conduct preliminary tests till phase 2 trials for the target indication, and reach an attractive financial position rapidly and relatively inexpensively. Reaching this stage costs more, and takes longer, for a startup. Nevertheless, building organizations is something that venture capitalists are good at, making it a fairly low-risk activity. Although the cost of any component can be debated, it is clear that in-licensing is a cheaper, faster way to start a biopharmaceutical company than building one around a new technology and venture capitalists too favor certain business model over others when evaluating new plans. Thus, licensing becomes an inherent part in the business model of biotechnology companies to achieve near-term or long-term strategic goals. This issue is more relevant from the perspectives of developing countries that either do not have expertise to deal with such complex IP licensing issues or the government officials are ignorant and/or lack expertise which discourages private companies that might be interested in collaborations. To make any comments or suggestions, please write to virenkonde at gmail dot com. Thanks!
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The Art & Science of Valuation in the Biotechnology Marketplace

A company’s value lies in its potential to generate a stream of profits in the future and it is the criteria that matters most to the investors. Almost all valuation exercises are thus based on assumptions or educated guesses as to what a company’s future would be down the line meaning what important milestones to be achieved and what timely strategic decisions to be taken. These assumptions are grounded by three fundamental factors: first, the state of the market targeted by the company; second, the principle elements of a company’s science and technology; and third, the ability of management to deliver on the business plan.

Valuation is essential for the most crucial steps of a biotechnology company. The value of biotechnology companies is driven by anticipated future product and revenue streams, or by the impact that a technology platform is expected to have on the value of assets. The amount of money at stake justifies and requires a careful and thorough valuation. Biotechnology companies face the need for valuation at various stages: fund raising, license contracts, initial public offerings, and mergers and acquisitions. Quantitative financial evaluation of biotechnology investments is not an easy task. Biotechnology companies are typically dealing with innovative yet uncertain technologies and drug development candidates. The applications and the impact of a technology are often not clearly defined, and new drug development targets are not validated. However, financial evaluation and risk analysis are essential for investors as financial indicators and definite value propositions to fund biotechnology operations, and to the senior management of biotechnology companies needs to understand the risk and expected financial impact of their projects for prioritization and maximization of company value and while establishing technology partnerships and licensing agreements, the involved parties need to understand the financial value generated by a deal, and to ensure market-conformity and fair deal terms. The determinants of value in the biotechnology industry are expected cash inflows from marketed assets, R&D and market uncertainty, cost and speed of development, and strategic opportunities arising from technologies and projects.

Although, a company can have as many values as the number of different people evaluating it, every valuation starts with a systematic and rigorous testing of a company’s artistic hypotheses such as economic, technological and managerial abilities in combination with the following three scientific approaches:

Discounted Cash Flow or Net Present Value

The most common approach to primary valuation is the discounted cash flow (DCF) method, whereby a company is valued at the present value of the future cash flows it will be able to generate. The same approach is also called as net present value (NPV), or risk-adjusted net present value (rNPV) or expected net present value (eNPV). The idea underlying this method is to compare revenues and costs. If income exceeds expenses, then the project is profitable and the company should start or continue the project. But if, different cash flows do not occur at the same time or have the same likelihood, then adjust the cash flows for their time difference by discounting them and for their likelihood by multiplying with their probability to occur.

These methods are conceptually robust but can prove difficult to implement in high uncertainty environments, such as those of early-stage biotechnology firms. Typical problems include highly uncertain and distant positive cash flows, a business model based on many assumptions and a difficult risk profile of the company. Therefore, in principle, what is needed is to estimate the expected future cash flows of the business and to discount back to the present all these future cash flows, using a discount rate consistent with the level of risk in the project. In practical terms, there are some difficulties in implementing this approach as to projecting performance for several years into the future is a process considered as too speculative to be useful, then selecting a forecast for the future cash flows is purely arbitrary and questions the residual value of the business at the end of it, and obtaining an appropriate discount rate for an early-stage, privately held company presents difficulties too.

Comparable market data valuation

The comparable method is also known as a ‘secondary’ valuation method because it uses the market value of comparable companies or transactions as reference points. The method relies on available key figures, such as earnings, sales, number of employees, and R&D expenditures, etc to estimate value. In a sense, secondary valuation makes the assumption that these comparable companies have been properly valued, and can serve as benchmarks when assessing a company.

A comparable valuation for a biotechnology company of interest is based upon a financial investment into a comparable company. Based on the information, the ratios such as price/revenue, price/employee and price/R&D can be calculated and used to estimate the value of the company of interest. These ratios are used because they have a direct or indirect impact on the valuation. It makes more sense to use earnings or cash flows as the ultimate basis of comparisons across firms. Unfortunately, most early-stage companies, as development entities, tend to burn more cash than they generate, and usually have negative earnings as well. Comparing losses or cash burns would obviously lead to speculative valuations. The amount spent on R&D, the number of employees for a company and the level of revenues that can be generated are seen as better indicators of future performance.

Real Options Pricing Model

Real options valuation is primarily based on the investments and financial options. An option is the right but not the obligation to buy or sell an asset at a prefixed price until a certain expiry date. Some investments can be modeled as options. For example, a company with Phase III trial compounds, where the results are expected in 30 months. If the results are positive, the company has the option to file a new drug application (NDA) and then launch the product. However, the company will do so only if the expected sales exceed the costs necessary to bring the drug to market. The costs of clinical Phase III correspond to the purchase of this option. Equally, with the costs of clinical Phase II the company buys the option to acquire the above-mentioned option after a successful trial. The investment for clinical Phase I is then the price for an option on an option on an option. In finance, these options on options are called iterated compound options, nested options or multi-stage options. The companies exercise the options only if the necessary investments (the costs of the subsequent phase or the launch costs) are less than the value the company gets in return. The launch costs are the option fee to launch the drug. In return, the company gets the sales revenues of the drug.

“Price is what you pay. Value is what you get.” -- Warren Buffett