The Public Equity Markets Are Open For Biotech
An initial Public Offering has for decades been the endgame for an aspiring biotech company. Thinking back just 10 years, an IPO was conceivable generally only once a company had successfully brought at least one lead therapeutic into late-stage clinical trials and the pipeline was robust. Today this has changed. An IPO today is often considered just one more option for capital raising, with its own set of advantages and disadvantages. Companies are able to go public much earlier, with IPOs of preclinical companies not being quite so rare any more.
The Evolution To Go Public
The private to public switch is associated with the need for a huge cultural shift in an organization, moving from the relative shelter of being private to the full transparency and compliance requirements associated with being public. CEOs of companies that have gone through the process are usually thrilled with their experience, the resulting access to capital both near-term and in the future and the liquidity that an IPO provides. However, they often lament the bureaucracy that an IPO brings; a focus on the very public numbers; the optics of every situation and the strategy suddenly being managed to meet near-term financial objectives, not longer-term upside. Indeed, not infrequently CEO changes are implemented either right before or right after an IPO, indeed such a change has also been associated with an increase in valuation (http://dx.doi.org/10.1002/smj.3197). However, despite all complexities, we are seeing more public offerings of companies that are much earlier in their development trajectory, both from a pipeline perspective but also as relates to build-out of corporate functions and infrastructure.
2020 Reality
Beyond the above more general trends, 2020 have provided for two key particular dynamics in addition. One is an over-proportionate growth in the cross-over market, where investors are allocating capital to pre-public companies with a strategy to follow through and participate in their IPO. Another one is the execution of public equity market transactions in a fully virtual environment. What previously were physical two-week roadshows are today packed into a single week over virtual meetings (back-to-back with no time lost on travel). The success of this year’s biotech IPOs, which collectively have to-date delivered an above 40% value growth, further reinforces investor interest in taking part.
The question is then: How might the new early IPOability impact partnering dynamics?
Drivers of “Early” Biotech IPOs
A number of factors have influenced the IPO market.
- Overall advancement in the sophistication of capital markets
- Specialist investors are better able to understand scientific and preclinical de-risking
- The search for high rates of return (“alpha”) necessitates even more risk-averse investors add new technology investments to their allocations
- VC rounds, even Series A rounds have grown larger
- Significant growth in crossover funding
Investors Today Have Greater Scientific And Medical Depth
As technology has advanced and therapeutic approaches become more personalized and targeted, more and more investment houses are incorporating deep sector expertise into their teams. These investors, equipped with advanced degrees and industry experience enable them and their organizations to perform deep scientific and clinical analysis in-house identifying the most promising technologies early. At the same time, the rationale of targeted or personalized therapies is easier to understand perhaps further facilitating investment.
The Search Is On For “Alpha”
Equity returns have dramatically declined over the past decade resulting not only from a generally lower interest rate environment (esp. in Europe) but also given increasing wealth globally rendering capital less scarce and competition for returns having intensified significantly. Against that context, even traditional fund managers feel almost a necessity to increase allocations of portions of their assets into less defensive investments – which place earlier development stage biopharma into the focus of such public market investor attention.
VC Rounds Have Grown Larger
Another consequence of the growing sector expertise, although clearly not the sole cause, is that successful companies are raising more capital, earlier. These large early rounds enable companies to invest more aggressively and earlier into building very robust and experienced management teams, doubling down on investments into technology platforms, building broad pipelines, or even to invest in dedicated manufacturing facilities in the case of some gene therapy or CAR-T players. Furthermore, such large investments enable companies to take clinical development further, enabling them to generate strong clinical proof of concept, in turn allowing their investors to retain a greater proportion of value upon exit. Companies that go down this route generate tremendous momentum, and it is this momentum that enables them to raise crossover funding and rapidly move to IPO.
Growth In Crossover Funding
The crossover market has seen significant growth in the last few years. Investors look at such pre-IPO opportunities as a great entry point into a company with a significant degree of maturity and a strong management team. Furthermore, since many crossover investors follow through and participate in the subsequent IPOs, those IPOs are often fully subscribed ensuring a robust post launch trading in the aftermarket.
An Observation – Balance Sheet Strength
Whilst there are exceptions and the market certainly is not “shut” for less capitalized companies as well, on average, biopharma companies that went public this year possessed significant cash reserves already pre the offering. Indeed, such position is a de-risking element for investors who come in at time of IPO. It also and more fundamentally suggests that investors are, in principle, prepared to wait longer for value creation milestones to happen – which we believe should to some extent mitigate near-term news flow pressures that often affect post-IPO trading.
The Role Of Partnering
When we look at companies that have followed the above trend of large early rounds, raising crossover funds quickly and then going public all the while still in relatively early development stages, it becomes evident that partnership continues to play a fundamental role in a companies’ strategy. There are many current examples of companies that established key partnerships prior to going public.
Partnerships provide validation of technology and will increase momentum in a company as it advances towards funding rounds or IPO. Not all public equity investors who want to grab a “piece of the pie” of early-stage IPOs will have the full internal capabilities to truly assess the promises of the new technologies being pursued. Hence, the signaling value of successfully interacting with large industry players, renders such activities a key priority for smaller companies. However, it also increases competition in the early interaction with large pharma, which has ripple effects on companies’ abilities to negotiate high-value transactions.
From a prospective partner’s perspective, this means the race to secure deals with early stage companies that are developing transformational technologies or therapeutics, is tougher. This is a direct consequence of innovative companies having, by virtue of enhanced capital markets access, possible alternative paths at hand which they did not have, or not to such an extent, previously.
What is certain though is that the pharma community today understands, as well as does the group of less specialist investors, that a particular set of very sophisticated investors who are known by name and reputation in the sector, conduct significant due diligence, in-field validation and market assessment before “backing” a company – so that there emerges a reciprocal mutual reliance and virtuous cycle.
Of course, the relative impact of supply, demand, and alternative options will be different in every individual case, and there is no overriding conclusion possible whether the one or the other force is more likely to drive the prospective outcome of a particular transaction at hand – from the perspective of the early-stage company as well as of its potential partners.
Lastly it has become a key factor being assessed by crossover and public equity investors, just how much a biopharma company’s path to success is predicated on ultimately being acquired by a larger pharma player. A proven ability to strike partnerships then is somewhat a bringing-forward of such dynamic, where the company has already evidenced it is making something that pharma cares about, whilst having retained its independence – ideally to build broader value to its investors.