Dec 7, 2012
Back in January, Cambridge, MA, cancer therapeutic developer Verastem ($VSTM) made its initial public offering (IPO) and raised $55M in the process. It was not a monumental IPO success by biopharma standards, but what made the event noteworthy was that Verastem hadn’t yet filed an IND for its lead drug candidate, the first step in the FDA regulatory process towards a new drug approval. For those unfamiliar with the industry, the maneuver is akin to a software company launching an ad campaign for a product that hasn’t even gone through beta testing. Verastem’s IPO came on the heels of a November $20M Series C venture financing that raised their total venture investment to $68M over ~12 months. Guided by CEO Christoph Westphal, Verastem made the sometimes debilitating gap between venture funding and public adoption appear non-existent.
The traditional venture-backed biopharmaceutical start-up game is fairly simple. Raise as much venture capital as you can and then balance your spending between research that pushes your lead product through the regulatory pipeline and business development that finds you a partner or buyer for your company. For more than a decade small biotech companies have been following this formula: MicroMet, BioVex, and Pharmasset are some of the most recent acquisition champions with price tags of $1.6B, $1B, and $11B respectively. These generous valuations are effectively an endorsement of each company’s lead drug each of which was in Phase II clinical trials at the time of acquisition. But what’s a fledging young biotech to do if it’s unable to raise enough funds in the increasingly stringent venture capital market to get far enough down the clinical development path to find a partner or buyer?
Some, including Verastem, might answer: IPO. The young company, cofounded by MIT Professor Robert Weinberg in 2010, is developing drugs that target cancer stem cells, which some scientists hypothesize are the ultimate drivers of the disease. Other companies that have followed this route include InVivo Therapeutics ($NVIV, biopolymer scaffolds for spinal cord injury) and more recently Regulus Therapeutics ($RGLS, microRNA for cancer, sclerosis, fibrosis, etc.). Success of preclinical IPOs is partly driven by insider participation which can constitute anywhere from 20-40% of the offering (true for both early and late stage biopharma IPOs) and even then the initial asking price may fall. Insider participation is a strong signaling tool to attract the institutional investors that can carry an IPO. For example, Verastem got help from Longwood Founders Fund and Regulus sold ~80% of its voting stock to AstraZeneca concurrent to its IPO.
There is certainly value in shooting for an early IPO. Public markets allow a company more flexible financing options by simply issuing more public stock. Equity financing for private companies is generally limited to friends and family (not a viable solution for biotechnology companies given the dollar amounts required), angel investors (only slightly more viable for the same reason), or venture capital investors. These private sources of capital, while often better informed and able to contribute more than just money to a startup, can also be quite difficult to negotiate with and may demand a higher equity stake for their investment. Debt financing for early stage biotechnology companies looking to fund clinical trials usually isn’t a possibility since they lack sufficient collateral.
But money is never free, and early IPOs come with a cost. Public companies are out in the open and viewed under the microscopes of public scrutiny and SEC regulation. What price do they pay in operational effort to maintain this status? What opportunities have they given up with respect to implementation of alternative financial instruments? To what extent will the path the company goes down be driven by motivations to appease or placate public market responses rather than being driven by sound business strategy or scientific reasoning? It’s quite likely that after having gone public these companies will spend several millions of dollars each year to meet reporting and regulatory requirements. This will begin to dig into the capital raised during the IPO process. Furthermore, public investors and large financial institutions to which the company will now be reporting to are less likely to be understanding of the challenging path faced by any pharmaceutical R&D company, especially one that hasn’t yet begun clinical trials.
Investor naiveté is only part of the problem with preclinical IPOs. Fundamentally, even an expert in the relevant scientific and clinical fields would be hard pressed to accurately predict the relative probability of success at a stage of preclinical or clinical development. This is especially true in the case of Verastem, since the science of cancer stem cells is new and the mechanism of therapeutic action is unproven. It could take a decade or more for the companies to develop a working drug, but even then there is no guarantee of post-approval commercial success (see Dendreon’s Provenge, an interesting case study of market adoption challenges). In the case of the preclinical IPO, the stock price at offering and thereafter is merely a Drake equation for the likelihood of success in a given market: probability times market size divided by number of shares. But at the end of the day, even for a platform company, the outcome can be almost binary: if the drug is approved the stock price is undervalued and if it is rejected then the stock is worthless. And in the interim the price will fluctuate nauseatingly on every rumor and innuendo whether the pseudo-data is relevant or not.
For young therapeutic development companies with a few VC investors and merely preclinical results, the road to FDA approval can appear quite daunting. Moreover, the tolls along that road can amount to hundreds of millions of dollars. In the absence of continued VC reinvestment (hyperkalemia developer Relypsa has raised $193M to get through phase II clinical trials) or buy-in from major pharmaceutical partners (antibody platform company Micromet raised $14M upfront in a preclinical partnership with Amgen, only to be acquired a year later) a company might consider turning to the public markets. While such an approach can provide liquidity for early investors and with the right sales pitch can even raise significant capital, the fallout from this decision can have significant and long lasting financial and administrative impact. Sometimes, especially in a bear market, it’s better to stay the course and let your science do the talking.