Any molecule early in development is not yet an asset, but it is already a "cash burner". Of course, that molecule may become an asset later on, once utility in humans is first demonstrated in an appropriate clinical trial) - let’s call it the “proof of concept ” moment, or “POC” – that the ugly little duckling will become, against the odds, a beautiful swan.
Sadly, in our business only a very small percentage of ugly little ducklings become beautiful swans. Understanding this high intrinsic risk of early stage molecules the knee-jerk reaction is to start several programs in parallel. Risk reduction theory tells us that the "assets" must be diversified, so that, at any point, one asset can be replaced by another whose chance of success is unrelated. That's the key word: unrelated, uncorrelated, diversified, different. Taking the same risk over and over is not diversification – quite the opposite: its gearing your returns.
Worse still, attempting risk mitigation through diversification within each early-stage company may have some perverse effects that end up enhancing risk, instead of reducing it. Having a full early stage pipeline demands real infrastructure, like a big management team, with human resources and G&A support and a host of other expensive functions inside the company (as opposed to being outsourced). And that means they need large and regular infusions of cash.
This has two consequences: it means the capital at risk is high before you even begin along the path to de-risk the asset and it means the team will focus on raising larger chunks of cash, covering multiple milestones on different assets. Which, in turn, means that if one (or more) of those assets fail the money is in the company anyway, where it might be used for any activity the management can think of, irrespective of quality. Both these factors reduce the capital productivity.
Things are very different in a company with a single product candidate. Financing of the project is tightly, and exclusively, linked to achieving the very next milestone: only the amount strictly necessary to pass the next value inflection point is put at risk. The risk: reward profile for each investment is easier to calculate, with a gradation from small amounts of capital at risk in the early days when the risk of failure is sky high through to higher amounts of capital as the technology is de-risked, and the magical POC moment is approached. Best of all, capital efficiency is maximized because nothing was spent on anything other than achieving the next step-up in value.
We don't suggest that its never right to build a company, with all the necessary infrastructure. But we see a tendency in the industry to build infrastructure way too early. And many of these “early build-out” companies end up as “silver medalists” (as David Grainger calls them in his post, see link….): above-average companies, that have survived long enough to find reasons to survive a bit longer, and grow a bit more, and that may even end up delivering some returns to the stakeholders. But those returns are seldom good enough to make the industry as a whole exciting for investors. And because these fully-formed companies are so capital-hungry, they lock up a disproportionately large fraction of the capital invested in biotech, and before long their disappointing returns become the de facto returns of the sector as a whole.
One area where this doesn't apply are companies that are formed to explore major new biology areas revealed by sudden breakthroughs at the frontier of unmet medical needs: it is difficult to imagine how these companies can be developed without major upfront investments and long terms commitments by investors and management teams. We certainly believe that returns from unraveling the secrets of major new areas of medicine (like monoclonal antibodies in the past, and stem cells or gene therapy or small RNA therapeutics in the future) will be important value drivers for investors and all stakeholders. These companies would never survive in the ethereal, virtual world of the “asset-centric” company.
There is another advantage to the “asset-centric” company model: it leverages the power of opportunity cost to hone the performance of the decision makers. Without other projects to hide behind, management is forced to face up to new data showing their product opportunity is failing. And instead of vainly hoping to prolong the gravy train, they can see their upside has disappeared completely. Its time to move on to the next thing, benefiting management and investors alike by forcing early “killer experiments” and realistic assessments of the data as they emerge.
Quite simply, a single asset environment counters the normal human tendency of delaying tough decisions: in a pipeline play, the cash needed to keep trying the famous “last few experiments” in a bid to save a dying asset is already in the company bank account - and hence more easily accessible without having to do too much convincing on investors and directors. The single asset model shifts the emphasis from the "absence of red flags" to the "presence of green flags" to justify keeping any program alive.
A single molecule company is altogether a healthier environment for early stage R&D. But how do you run these investments in practice? Over the years, starting with our first such experiment, PanGenetics, sold to Abbot in November 2009, (see the blogpost by KJ) we have assembled a platform of trusted and successful scientific entrepreneurs with extensive industry experience that, for simplicity, we refer to as "Index Drug Developers (IDD)". The IDDs identify attractive-looking projects in academic labs, in centers of translational medicine, in industrial research centers, including biotechnology and pharmaceutical companies, These IDDs use their experience and knowledge of what makes a good “asset-centric” play to sniff our the best opportunities, knowing that each of them can handle only one or two – its not like advising an investor (when you might “like” a lot of what you see); here it’s about them finding the best, not merely the good, because they will live with that project.
Sometimes we will pass on potentially good opportunities or maybe stop certain projects too quickly, before they are given the chance to bloom, but on a fund level we must be more robust against false positives than false negatives. Failing early (even if it was a ‘false’ negative) is cheap, and we can have many such early opportunities in play. Failing late (on a ‘false’ positive) is expensive.
The perfect IDD is clearly a hybrid figure between a pure entrepreneur and a venture capitalist: over the last 5 years pursuing this strategy, we have seen this model directly benefiting the scientists and innovators that are the origins of the molecules: their invention or discovery will remain the only focus of the Index-backed company, till the project stops. And the manifold benefits should translate into superior returns for the investors, too.
The biotech industry does not have the same luxury as in the technology sector: indulging in the pleasure of creating companies, starting large with a vision to take over the world has no place in early-stage drug development. The path is too long, and the process far too capital-intensive. Given the massive unmet needs that clearly persist into the 21st Century, there is a strong rationale for investing in early stage R&D. But delivering returns that match, or exceed, other sectors requires us to adapt the investment model in our industry.
The solution is not, in our opinion, just drifting away and investing in late stage drug candidates instead, as many have done, but to be brave enough to forgo the comforting chocolate-taste that masks the poison of diversification within each company, and instead focus on focus – and leave the diversification where it properly belongs: at the level of the VC’s portfolio. Only that way can we cure the ailing investment returns of early-stage biotech – one asset at a time.