Building It Up, Biotech Style

DOING BUSINESS VIRTUALLY

The virtual model is really nothing new to biotech or venture capital, says Michael Lytton, a general partner in Boston-based Oxford Bioscience Partners. What is new, he adds, is Big Pharma's increasing willingness to out-license clinical development candidates to cut costs. "Biotech companies seeking in-licenses are the beneficiaries of the pharma company distress," Lytton says. "The in-licensed compounds can then be developed via the 'virtual' model."

While it has the important advantage of allowing a company to stay flexible, operating virtually has its own risks says Peter Kolchinsky, a portfolio manager for Boston-based hedge fund RA Capital and the author of The Entrepreneur's Guide to a Biotech Startup.

"Management of virtual companies still need to be able to manage the relationships with all their consultants and CROs [contract research organizations] and maybe even hire a liaison that will supervise what the CRO is doing," Kolchinsky says. "This can be as challenging and sometimes even more expensive than hiring your own people to do the work, just as in the long run it is more expensive to rent an apartment than to buy it."

And companies operating virtually will still need to bring new people into a project as it progresses from one stage of R&D to the next, Kolchinsky adds.

While outsourcing clinical trials can work if a company has its own chief medical officer and a CRO liaison keeping a close eye on things, it's generally a mistake to try to outsource research and discovery, according to Kolchinsky. "Research and discovery are best done either in the university or, if you insist on doing it, in your own labs," he says. "Virtual companies that hire CROs to do discovery research are frustrated by the slow pace and poor quality of the work done by those CROs, who can hardly be expected to care since they get paid no matter what."

Morrie Ruffin, executive vice president for capital formation and business development at the Biotechnology Industry Organization in Washington, DC, says young biotech companies should focus on keeping their infrastructure costs under control by outsourcing as much as they can while concentrating on their technology and keeping control of their intellectual property.

"Managers have to be frugal because capital is precious and should be treated as such," Kolchinsky agrees. "Praecis and Human Genome Sciences are examples of companies that probably overin-vested in building really nice headquarters (instead of just renting office space) because they believed their own hype during the genomics bubble," he adds. "Their current pipelines certainly aren't as nice as their offices. Both companies are now worth a fraction of their valuation during the bubble."

Investors are keeping a closer eye than ever on build-out, given the current overcapacity in biotech infrastructure, says Perseus-Soros' Purcell. "They like to see companies keeping things as lean as possible."

Purcell adds, "If you're product ends up working and it looks good, you have the option to go full steam ahead. But you don't want to do that before you know if the product actually works or not."

MONEY IN THE BANK

As a rule of thumb, a company should have one to three years of cash on hand, says Kolchinsky. "A good company will always try to raise money before it goes below 12 months of cash."

This requires some contingency planning, perhaps a plan B for stretching 12 months of cash over 18 months if it turns out to be difficult to raise money. "Unfortunately, some companies let their cash dwindle down to like three months, and it's very difficult to stretch three months in any meaningful way," says Kolchinsky. "We see lots of cases of public companies where the management team lets their cash run down and they're desperately trying to save money and they're coming up with ridiculous deals."

Not only might a business wind up selling its soul to an investor to raise money, lack of funds can also stop research in its track, for example requiring a company to put a clinical trial on hold. If that delay goes on for too long, the shelf-life of the drug could expire.

Another important strategy for smaller companies hoping to grow is partnering with larger companies, says Jay Paap, who has worked as a consultant with companies on entrepreneurial issues for 30 years. But as with the pipeline, partnerships should never involve putting too many eggs in one basket. Paap points to Alza Pharmaceuticals as a company that used its partnerships wisely. In its early days, he explains, the company had a conscious policy of building close working relationships with major pharma companies, but not depending too heavily on any single firm.

"It is very tempting to continue to get support from the same large pharma company, because you know you can work together and you know you can trust them," Paap, president of Waban, Mass.-based Paap Associates, adds. But once that company accounts for 70% to 80% of your business, "you now are a slave, and you've reduced significantly your options for moving in other directions," he says. "Partner with multiple players so that you're not beholden to anybody; so that you're not a pawn in their fortunes."

The fact is that many of today's biotech firms are started with the express purpose of being sold to big pharmaceutical companies down the road – just make sure this is your plan, not an accident.

KEEP AN EYE ON THE COMPETITION

Planning for a company's future also means keeping an eye on the market and anticipating competition years out – something Purcell says many entrepreneurs don't do. "They don't really see the big picture out there – yes, your product looks good, but by the way there's four people ahead of you," he says.

Kolchinsky cites Dyax as an example of a company that kept its eye on the market and changed course as needed. The firm had planned to launch a drug called DX-88 for hereditary angioedema in an infusion formulation, which would require hospitalization. When they saw competitors were developing a subcutaneous formulation patients could self-administer, they changed direction and began making their own subQ DX-88 formulation.

"Making the switch mid-development is costly in terms of time and money, but at least Dyax won't waste its time commercializing an inferior product that few patients will want to use," he says. Peptimmune has managed to maintain its independence, with Genzyme owning less than 10% of the company, and it's never operated virtually. It has been able to move ahead by changing its focus – while staying focused. "Not one company that I know of, or have been associated with – and I've been in this business since 1991 – no company today is reflective of what they started out to be," says Mathers. "The best laid plans in this business always change."