In recessionary times, many companies act quickly to reduce inventories, scale back head count, and reduce non-core projects in a race to conserve cash to weather the storm. In the Biotechnology and Pharmaceutical industries, where your supply chain possibly keeps patients alive, reducing inventories is difficult. This causes a deeper culling in non-core research and development, and layoffs. In an industry where intellectual property is a ticking time bomb for a product’s sales, the next drugs in your pipeline mean everything to future revenues. If companies focus only on what they consider core development (read: ‘blockbuster’ drugs), they leave themselves more open to catastrophic late stage regulatory failures and missed opportunities. For giant companies with large and fully stocked war chests, the recession has afforded them the opportunity to snatch up competitors with tougher cash positions or fire sale stock prices, but promising pipelines. Nearly $200 billion in acquisitions of public companies by Big Pharma have occurred during the economic downturn (Table 1). The potential fallout from this comes from there being fewer companies that will be looking to fund, partner with, or acquire earlier-stage companies. And as we are also seeing, there is less money flowing into these companies in venture investments.
Venture capital (VC) investment, the lifeblood of a capital intensive industry like Biotechnology, has been hit hard by the economic downturn. This April, the National Venture Capital Association (NVCA) reported that in the first quarter of 2009 the Life Sciences sector (Biotechnology and Medical Devices combined) experienced a 40 percent decline in terms of dollars and a 31 percent drop in deals with $989 million spread across 133 rounds. Investment in Biotechnology fell 46 percent to $577 million in the quarter, while Medical Device investments fell 27 percent to $412 million. Investments in Life Sciences companies represented 33 percent of all investment dollars and 24 percent of all deals in the first quarter, which follows normative distributions from the past decade. Valuations for early stage companies took a dramatic plunge as a result of the downturn (Figure 1), meaning entrepreneurs and inventors have to give up a larger stake of their companies to VCs to get them started and to keep them going. The IPO market has evaporated for Biotech, and a poll of VCs recently reported that the IPO market won’t thaw until 2010 (Martino, 2008). With both the volume and size of deals contracting at an alarming rate, VCs are retrenching their portfolios. Biotech startups have to tighten their belts and stretch their current tranches as far as they can go. If new capital is definitely needed, companies better get out there and start fundraising sooner rather than later. In this environment, state and federal grants are more valuable than ever before—but are there enough dollars to go around?
The American Recovery and Reinvestment Act of 2009 (ARRA) was an unprecedented bill aimed at pumping massive funds into the U.S. economy across nearly all sectors and industries. The National Institutes of Health was awarded up to $10 billion in appropriations in the ARRA, with $8.2 billion in extramural scientific research across current programs and new proposals such as Signature Initiatives, Challenge Grants, Grand Opportunities (“Go” grants), and talent recruitment for faculty and internship programs. These monies will eventually flow into academic research, but is restricted from small businesses. Come again? That’s right, the NIH’s Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs don’t get a dime. When a researcher takes the leap and forms a company around their invention’s intellectual property, the SBIR and STTR programs are one of the main sources to facilitate this transition. The program, which has doled out over $26 billion across nearly 18,000 projects in its 25 years, is one of few sources of funding available to budding Biotech companies, but was left out of the ARRA entirely (Viscarolosaga 2009). And competition for SBIRs is often steep. Even small VC-backed companies are usually not eligible, and a reauthorization for the SBIR to include VC-backed companies has stalled in Congress. Moreover, the divide is widening. Small businesses receive only 4.3% of federal research dollars, yet the percentage of scientists and engineers employed by small companies grew to 38% in 2007 (Girard, 2009). As the debate over reauthorization drags on, Congress and the Obama Administration have to do some serious thinking about how their policies will affect entrepreneurial Biotechnology and drug development as a whole.The Obama Administration has spoken loudly on the future of healthcare in the United States. Leaving the broader debate over nationalization and its effects aside, the intended sweeping healthcare reforms will undoubtedly have major impacts on the Biotechnology industry. In a public call for increased generic competition for biologic drugs, Obama opened a black box that could return to haunt him (USAToday, 2009). Biologic drugs, substances derived from living cells as opposed to chemical synthesis, are incredibly difficult to isolate, develop, manufacture, stabilize, and store. Far from the pill bottles in our medicine cabinets, biologics consist of specially designed sugars, proteins (often antibodies or interleukins), genes or vaccines made from recombinant DNA or other means, produced in scale, isolated, and stabilized in many type of matrices. It is incredibly expensive to develop and manufacture these complex three-dimensional proteins or other substances, and one false move can turn a million-dollar batch of drugs into a useless vat of bacteria. Errors gone unnoticed can lead to patient deaths—recall the tainted Heparin from China last year (Harris, 2008). Biotechnology has generated big profits from biologics, and patients pay a premium for these amazing medicines. In a push to reduce costs to patients, the first place politicians look to is generics. But whereas many pharmaceutical generics are simply bulk compounds available from large pharmaceutical manufacturers often simply pressed or encapsulated and shipped off, biologic drugs are proving very difficult to reverse engineer. Building a viable recombinant protein is no light task. If generic biologics are pushed through all the regulatory red tape and onto the market, the incentive for drug development takes a big hit. This stifles innovation and hurts patients in the long run. Obama needs to tread lightly on biologic drugs—especially imported generics—if he pushes forward with this. Revenues aside, the danger to patients is real.
The fear and concern caused by the economic crisis is wreaking havoc on the Biotechnology industry. There has to be efforts made to spur private investment in the industry, such as Obama’s proposal to eliminate capital gains taxes on qualified small business stock held 5 years or more (Small Company Lawyer, 2009). Congress must address the SBIR program, and come to some agreement on the role of small, venture-backed firms. It is a big problem that a publicly traded company with 499 employees can get SBIR funding, but a startup with 10 employees and only $3-5 million in VC money is not eligible. Something has to give. Innovation and entrepreneurship are the cornerstones of this country. Their neglect will have dire consequences on our future.
(This post is a paper I turned in for Prof. Keith Hazelton's "Money and Capital Markets" MBA class at Oklahoma City University. References are hyperlinked.)
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