Betting on Biotech

Stock market declines have taken their toll on established firms, but startup ventures still attract backing

Indeed, if one were to judge from stock market performance alone, it would appear that the biotech sector must be anything but attractive to investors nowadays. A run of grim news about stillborn efforts to create new pharmaceuticals and poor returns on investments has made it virtually impossible for companies to grow beyond the startup phase and parlay their fortunes by selling shares in an initial public offering. And it's not clear to analysts when the IPO window will open again; some predict that it won't happen until next year.

The really bad news began, analysts generally agree, in April 1992, when the United States Food and Drug Administration questioned the efficacy of Centoxin—a monoclonal antibody-based drug produced by Malvern, Pa.-based Centocor Inc.—and requested new clinical trials. At the time, the price of the stock fell by more than 70 percent. This was disturbing news, especially from a company whose stated goal was to be a "Merck of the year 2000" (Susan L-J Dickinson, The Scientist, May 14, 1990, page 1). The deadly blow for Centoxin came on January 18 of this year, when new clinical trials were called off after preliminary data showed `patients receiving the drug were dying at a slightly greater rate than those on placebo, according to Associated Press reports.

A more recent disappointment came from Boulder, Colo.-based Synergen Inc., which announced on February 22 of this year that its lead drug, Antril, was barely more effective in a clinical trial than a placebo was in preventing deaths from septic shock. Synergen's stock plunged about 68 percent on the same day. Then, on February 25, Amgen Inc. of Thousands Oaks, Calif., one of the most visible and respected biotech companies in the U.S., announced that its earnings would be far lower than expected. As of late March, Amgen stock, which once had been selling for as high as $78 per share, was trading at around $35.

The cumulative effect of such announcements has been to seriously depress the price of biotech stocks overall. BioWorld Financial Watch, a San Mateo, Calif., newsletter that tracks biotech financial issues, called the first 2 1/2 months of 1993 "a grim year so far for biotech stocks," noting that between January 1 and March 5, the AMEX Biotechnology Stock Index fell by 30 percent.

But despite the gloom and doom prevailing on Wall Street, the biotech sector is by no means moribund when it comes to startup opportunities. This is because companies at their early stages depend not on the stock market, but on venture capital firms and individual investors for their funding. And the feeling among these investors is definitely bullish, according to a variety of analysts; as a result, they say, biotech startups are continuing to spring up at a fairly regular pace.

"We believe in biotechnology," says a representative of E.M. Warburg, Pincus, & Co. Inc., a New-York-based venture capital company, speaking on condition of anonymity. "We are still actively starting up companies. I personally don't see any slackening in formation of what I'd call real companies."

By "real," the representative notes, he means those startups that can gain at least $5 million of private investment, an amount that will carry forward their work for the first 18 months to two years. In biotech's early days, by comparison, about $1 million in so-called seed money, spread over the same period, was typical. But today, with more than 1,000 biotech companies in existence, the financial demands have risen. Competition is more fierce, not just to get products to market, but to attract top `scientific talent, to license patents, and to aggressively pursue research.

The latest startup from Warburg, Pincus is Supragen, which was founded in December 1992 in Boulder, Colo. This company is developing therapies based on the knowledge of superantigens, which stimulate the immune system. Superantigens were discovered in 1989 by influential immunologist Philippa Marrack. Marrack will be serving as a scientific adviser to the company, while retaining her position as a Howard Hughes Medical Institute investigator at the National Jewish Center for Immunology and Respiratory Medicine in Denver. The Clinton Factor Arthur Klausner, director of research at Domain Associates, a venture capital firm based in Princeton, N.J., agrees that product development disappointments and a faltering public market for biotech stocks do not pose a threat to fledgling biotech firms; in his view, the venture capital firms still have plenty of money, and activity remains strong. However, he adds, startup activity could be adversely affected by what he refers to as "the uncertainties of the Clinton health care plan."

"I think any time there's uncertainty, that's going to chill entrepreneurial activity," he says.

One negative effect the weak stock market can have on start-up firms is to make private funding sources—the venture capitalists and wealthy individual investors—more insistent on striking the best possible deal for themselves, says Randy Scott, vice president of research and development at two-year-old Incyte Pharmaceuticals Inc. of Palo Alto, Calif., which is heavily involved in developing new drugs based on knowledge of DNA sequences.

"When the public markets dry up, the private markets start to take a vulture approach," Scott says, noting that investors are very nervous about liquidity right now. And he shares with Domain Associates' Klausner a concern about the new administration's impact. Scott perceives that there is considerable wariness among investors over what Clinton's future policy on pharmaceutical prices will do to the ability of a company to make a public stock offering, thus converting the venture capital investment back into dollars that can be invested in still other companies. "If `liquidity isn't going to be there, they want to buy your shares at a cheaper price," says Scott.

Meanwhile, at Domain Associates, progress on starting up companies continues despite stock market woes. This venture capital firm has helped form a number of companies, including Gensia Pharmaceuticals Inc. in San Diego. Most recently, Domain has funded a company called Trimeris Inc., based in Durham, N.C., which is tapping Duke University AIDS researcher Dani Bolognesi as a consulting scientist. Trimeris will initially focus its efforts on antiviral technologies, targeting HIV and related retroviruses. The president of Trimeris is Max Wallace, an attorney by training who, until recently, was director of Duke Management Co., which manages Duke University's assets.

"We have a venture commitment from Domain, and I'm its first employee," says Wallace, who has no formal business training. He's no neophyte to biotech startups, though, having previously been a cofounder of Sphinx Pharmaceuticals Inc., also in Durham, which specializes in signal transduction mechanisms. Sphinx went public in January 1992, before the stock market began to sour in the late spring, by selling stock on the NASDAQ exchange and raising about $75 million, he says. However, shares in the company, which sold for $15 at the initial offering, were trading at 4 1/2 last month. Role Reversal If an attorney can get wise in the ways of biotech, so, apparently, can scientists become adept in the financial community. One of a growing number of scientists who have become venture capitalists is Larry Bock, a partner in Avalon Ventures in La Jolla, Calif. In addition to his MBA, Bock has a bachelor's degree in biochemistry and was in on the early days of one of biotech's oldest companies, Genentech Inc. of South San Francisco, Calif. Such a science or medical background has become increasingly common at venture capital firms that specialize in biotech startups, he says, and notes that another partner at Avalon is immunologist Kevin Gorman, who has a Ph.D., with postdoctoral experience at New York's Rockefeller University.

For Bock, it's the successful pursuit of big deals on the cutting edge of science that really makes his work engaging. Says Bock: "When you're in on the cutting edge of a field, and no one is doing that, and you know about developments that are happening six months ahead of time, and these scientists have not been approached by anybody yet, that's exciting."

Bock says that after moving over to the business world, he worked for a traditional venture capital firm, but he was happy to make a move to Avalon, which is aggressively proactive in its endeavors to conceive of and launch companies. "This is in contrast to the traditional venture capital firm that passively responds to reams of ill-conceived ideas in the hope that a good one will pass over their desk," he says. Avalon, which has started seven biotech companies, such as Athena Neurosciences Inc., based in San Carlos, Calif., claims that it has never formed a company that failed—that all have advanced to the stage of going public.

Avalon made a big splash in the biotech startup world in March of last year, when it and other firms not only pulled together a top-notch team of scientists but also pulled off the largest seed financing in biotech history—$48 million from venture capital firms and wealthy individuals—for Ariad Pharmaceuticals Inc. Ariad, based in Cambridge, Mass., will specialize in developing drugs based on knowledge of signal transduction pathways.

The management team at Ariad includes CEO Harvey Berger, formerly the president of research and development at Centocor Inc. As vice president of R&D, Ariad tapped a well-known and highly cited researcher, molecular biologist Joan Brugge, who left her prestigious position as a Howard Hughes Medical Institute investigator at the University of Pennsylvania to become vice president of research and development.

Unusual Approach In putting together this blockbuster startup, Avalon broke with biotech tradition, which calls for increments of money to be meted out as certain developmental milestones are achieved. This new approach has met with some disapproval in the biotech financing community, coming from those who fear that if one company gets such a large block of money and then ultimately falls far short of expectations, the venture capital market could be soured.

Bock has ready answers for these critics. "Traditional venture capital groups would say it doesn't make much sense to give that amount of money to a start-up company," he says. "But we say good management can handle a lot of money."

The problem with the incremental approach to startup financing, `says Bock, is that management can get too mired in the pursuit of the next round of financing, rather than forging ahead with research, and with staying ahead of the competition.

Incyte's Scott agrees that the Ariad-style financing approach is "an interesting strategy," but says it remains unproven as to whether it is superior to the incremental approach. He contends that most of the companies that do this sort of financing find themselves needing money again fairly soon, anyway.

Like many of the ideas that have formed the basis of the companies Avalon has created, the Ariad concept was born out of a casual exchange between the venture capitalists and a prominent researcher. In this case it was Harvard University chemist Stuart Schreiber, who had been on the scientific advisory board of another company Avalon helped found, Vertex Pharmaceuticals Inc. of Cambridge, Mass. According to Bock, just 15 months prior to Ariad's founding, Schreiber told Avalon, "What you guys ought to be looking at is this black box of cell biology—signal transduction and protein trafficking."

Besides talking to researchers and reading the scientific literature, Avalon uses citation analysis as a means of identifying the cutting-edge areas of research. For example, the researcher whose scientific expertise Avalon tapped for its next company, Neurocrine Biosciences Inc., is Wylie Vale. This Salk Institute neuroscientist, according to the Philadelphia-based Institute for Scientific Information's Science Citation Index, is the eighth most cited scientist in 1981-90; his name appeared on nearly 350 papers in this period, which amassed a total of well over 16,000 citations. In founding Neurocrine, Avalon is once again going for big money up front, this time gathering between $30 million and $40 million in a private placement, meaning that it will bring together money not only from venture capital firms but also from wealthy individual investors.

Corporate Partners Another financing approach that appears to be gaining popularity is to bring in, up front, a corporate partner for a start-up company instead of using the traditional tactic of waiting until product development has advanced to clinical trials.

Hal Brodersen, a partner at the venture capital firm Hillman Medical Ventures Inc. of Horsham, Pa., says that GenVec Inc., to be located near the National Institutes of Health's campus in Rockville, Md., is a joint effort between his group and biotech giant Genentech. Gen-Vec will be developing simple, easy methods of delivering gene therapies. Genentech will have rights to proprietary technology as a result of the joint financing.

"It's common, down the road, for a biotech company to bring in a corporate partner, but it's uncommon for a corporate partner to be in on the founding," says Brodersen. Genentech is supplying $17 million, while Hillman is putting together an $8.5 million initial investment round for GenVec, he says.

Hillman Medical Ventures' style of making direct contact with the scientists and their ideas is similar to the proactive approach that Avalon prefers. But GenVec, the result of a serendipitous encounter, was a special case. Both Brodersen and an official with Genentech were invited to speak at a meeting at the University of Pennsylvania. After the meeting, the two got together for a beer and found that both companies were looking to start a gene therapy company. And both said they were interested in tapping the same highly cited researcher, medical pulmonologist Ronald Crystal. Crystal, who pioneered the use of viral vectors to administer gene therapy to the lung tissue of cystic fibrosis patients, is among the top 100 cited scientists for 1981-90. He is leaving his post as chief of the pulmonary branch at the National Heart, Lung and Blood Institute to move to Cornell Medical Center in New York City and to be chief scientific adviser to GenVec.

Brodersen is another venture capitalist with a science background. He has a medical degree, with a subsequent residency at the University of Pennsylvania. Halfway into this residency, "I realized I wanted to combine business and medical interests in some way," he says. The Wharton School of the University of Pennsylvania, a highly regarded business school, was right across the street, and so it was there he ended up taking his MBA.

Like many scientifically trained venture capitalists, Brodersen finds that dwelling in both worlds is uplifting.

"What's exciting to me is, every day is different. I learn more medicine being a venture capitalist than practicing medicine. I'm exposed to leading scientists in every specialty," he says.

Another startup taking advantage of an up-front corporate alliance is Glyco Tech Corp., which, like GenVec, is setting up shop near NIH. In this case, says company president John Magnani, Glyco Tech is capitalizing on access to the abundant financial and scientific resources of Swiss pharmaceutical giant Ciba-Geigy AG.

Glyco Tech, which aims to develop novel immunotherapy drugs, is so new that Magnani, when reached via cellular phone last month, told The Scientist, "I'm in the middle of construction dust"; workers, he explained, were constructing laboratories for the startup in an industrial park adjacent to NIH.

Magnani formerly was a research scientist with BioCarb USA, a division of a Swedish biotech firm that failed after its sole investor went bankrupt. Following that debacle, Magnani paid a visit to Ciba-Geigy Corp.'s pharmaceuticals division facility in Summit, N.J., where the company was interested in hiring him as an employee. He told them, however, that what he really wanted to do was form his own company.

Word of Magnani's entrepreneurial ardor filtered back to Ciba-Geigy's biotechnology division in Basel, Switzerland, which had expressed some interest in BioCarb when it had been seeking a corporate partnership as a financial survival tactic just prior to its bankruptcy. Magnani was invited to deliver a lecture, which led to a corporate alliance/startup deal and the founding of Glyco Tech. He finds the arrangement advantageous, and not just for the $6 million, to be spread over five years, that it is supplying.

Says Magnani: "Not only do I get the financial resources to start the company, I also get a lot of [Ciba-Geigy's] guidance, not just in business matters but also in science." Magnani, who left what he felt were the stifling bureaucratic confines of NIH about three years ago to enter the biotech startups fray, says, "What's exciting to me is to build something and watch it grow. At NIH, you're almost prohibited from growing. It has its sleepless nights, but I find it very invigorating."