Raising Capital for Early Stage Biotech Start-ups in the Age of COVID-19

Dr Peter Devine, CEO, Uniseed And Dr John Kurek, Investment Manager, Uniseed

Dr Peter Devine, CEO, Uniseed

Since publishing an article on raising capital for early stage biotech start-up companies last year, we could not have imagined how the world would change over the next nine months. The global COVID-19 pandemic has impacted all facets of life and the economy. No sector was left unaffected, including start-ups that depend on venture capital (VC) funding. We have been invited back to share our experience on raising capital for biotech start-ups and we have updated last years’ article to also share our insight on the impact of the COVID-19 pandemic on biotech companies.

Raising money for early stage biotech companies, especially those that come out of universities and research organizsations is tough. And even when you do raise funds, the odds are stacked against you. Doing it during a black swan event like a global pandemic and subsequent economic downturn adds another level of complexity.

Developing new drugs is a long hard road and there is a high failure rate. There are many reports and publications that talk about the probability of successfully developing a new drug, with statistics cited of 1 in 10,000 molecules making it through from discovery, through clinical development, regulatory approval, and market launch.

Even after a lead drug is selected, the probability of completing the subsequent stages of development is also low with a cumulative probability of approval from phase 1 of around nine percent.

To further complicate this, attrition rates vary depending on the clinical indication (e.g. 100 percent failure at phase 3 for Alzheimer’s Disease drugs in the clinic (not withstanding Biogen’s aducanumab which is before the FDA but with mixed clinical results); and a 5 percent success for oncology drugs entering the clinic), so it is not surprising investors tread warily.

The COVID-19 pandemic has now thrown a different set of challenges for VC investing and we have seen all the biotech companies in the Uniseed portfolio impacted to varying degrees by COVID-19

Unfortunately, most drug development projects arising from research organizations such as universities are not at the clinical development stage, so the chances of success and corresponding chance of raising venture funding are even lower.

In early 2020, the innovation sector has sustained a major setback with COVID-19, and this will arguably be of even greater impact than the 2008 GFC. With an unforeseeable end to the COVID-19 crisis, this pandemic is going to be with us for a long time, and we have to prepare for an unknown future. Generally, sectors on the decline will continue to be so, differentiation will become minimal and pressure on budgets will get tighter. The demand for evidence will be greater and the quality of the evidence will need to be higher.

Just as occurred after the GFC, capital markets have contracted, new investment funds will not be formed as frequently, and existing funds will focus investment on supporting their existing portfolio at the expense of new investments.

Dr John Kurek, Investment Manager, Uniseed

There has also been a flow on effect to universities, which generate new intellectual property for start-ups. In Australia, there has been a significant negative impact on university budgets due to the loss of international student revenue, and this will take a number of years to recover as students may not return immediately when travel restrictions are finally lifted. In some cases, budget holes as large as 600 million dollars have been reported.

The COVID-19 pandemic has now thrown a different set of challenges for VC investing and we have seen all the biotech companies in the Uniseed portfolio impacted to varying degrees by COVID-19. These impacts have included;

• Clinical trials postponed or put on hold;
• International sales impacted;
• Some research programs at partner laboratories delayed or on hold;
• Delays in the progress of commercial discussions;
• Delays in the supply of components for products; and
• Delays of subsequent capital raisings.

However, start-up companies need to be agile and adapt to changing circumstances and develop response strategies to the new conditions. Looking at the Uniseed portfolio, this has included:

• Reviewing cash flow and modifying R&D programs to focus on the key value adding activities;
• Imposing temporary salary cuts for CEO and staff;
• Reducing operating costs, including board size, travel budgets, and discretionary expenditure that is not directly related to R&D programs; and
• Accessing government support packages where available.

However, it has not been all negative as COVID has created opportunities in the digital health space. We are now observing digital health companies responding by repositioning themselves and accelerating marketing and rolling out of their products and on boarding materials as medical professionals have had to transition to delivering health services remotely. This has been aided by reimbursement codes for telehealth being opened up by governments.

Companies working on treatments for respiratory infections have also seen renewed interest in regard to COVID-19.

The Uniseed commercialization/venture fund operating in Australia typically invests at the lead selection/optimizsation stage, with 3 notable successes:

- Fibrotech, with an initial investment round in 2008 at the lead selection and optimization stage, went on to complete a phase 1 study of its lead kidney fibrosis drug FT-011, and then did a deal with Shire plc in 2014 for USD 75 million up-front and around USD 500 million in milestone payments.

– Spinifex, with an initial investment round in 2005 at the lead selection and optimization stage, went on to complete a phase 2 trial of its lead drug EMA-100 in neuropathic pain, which led to a deal with Novartis in 2015 for USD 200 million up-front and around USD 500 million in milestone payments.

– Hatchtech, with an initial investment round in 2001 at ‘hit to lead’ stage, went on to complete a full clinical program and submitted an NDA to the US FDA, which led to a deal with Dr Reddy’s Laboratories in 2015 for USD 200 million combined up-front and milestone payments. The novel human headlice treatment that kills both adult lice and eggs received FDA approval in July 2020.

These deals highlighted the time needed to get from early stage investment to deal, with eight to 14 years in the above examples. As VCs generally have 10-year closed funds, only doing new investments in the first three to five years, this highlights that investing at the lead optimization stage of development is not a viable proposition, and therefore most university generated technologies are too early and too risky for many VC funds.

However, it should be noted that the model for most venture investors is not to take the drug to the market but rather do a deal with a pharmaceutical company at the end of phase 1 or phase 2 clinical trials. This improves the equation a little.

Unfortunately, this means that many drug discovery projects at research organizations will not receive VC investment. This does not mean that it is not excellent science, but rather that the technology is too early and risky to justify an investment. To receive investment, a project must have the potential for large returns due to the large number of failures and that generally means meeting an unmet medical need in a growing, large, and definable market that a pharma partner will want to enter. For a project to receive VC funding a lot of things need to line up— it is not just about the science.

As investors, we often see a disconnect with when academic scientists consider a discovery to be venture ready compared to when an investor sees it as being ready for investment. Whereas academic scientists may consider a project to be investment ready at the target identification or the drug design/ chemistry stage, investors such as Uniseed want to see a putative novel lead molecule with a patent filed for the composition of matter, supporting in vivo data in a relevant disease model and some information on the drug exposure and dose response (i.e. pharmacokinetics and pharmacodynamics). In addition, an understanding of the mechanism of action is also important; that is an understanding of the target engagement. Most early stage programs we see have gaps in the data, which is not unexpected in an academic program, and in most cases, we provide funding to close these gaps. However, at a minimum, investors will want to see initial proof of concept data (in vitro and in vivo).

In our experience, repurposing drugs is also difficult (i.e. finding a new use for an existing drug, as obtaining a strong commercially defensible patent position is quite difficult). There may be a few exceptions in a niche or orphan indication, but as a general rule they make difficult venture investments. Platform technologies are also difficult, as you need a specific application (e.g. drug delivery).

In terms of raising venture funding for a start-up, here are some other tips for researchers. These are more relevant now as there is a downturn in the economy. While VC funds and private investors are still investing in biotech, they may apply a higher level of scrutiny when undertaking diligence, and some may defer investment altogether in opportunities that they consider too early stage or too risky:

- Know your investor audience. Study their other investments to determine at what stage they typically invest and what types of disease indications they have invested in. This can vary between funds.

- Be realistic about your role—are you a CEO, CTO or scientific advisor? Being a CEO requires a different skill set to that of a scientist.

- Sell the science and technology —don’t over-explain it—avoid too many data slides in the initial pitch

- R&D is about risk management, so have a clear sense of the first major de-risking (=value uplift) point

- Focus on value-critical milestones— getting to a value inflexion point with minimal investment; think about what is “needed to know” versus “nice to know”.

- Have a credible development and finance plan. Get external expert input (most budgets we see are 100% underestimated)

- Have realistic valuation expectations (≠ research spend). Cash is now king so be prepared to be flexibleon valuation as investment capital is even more valuable now (i.e. the ‘cost’ of money has increased).

- Make sure your proposed team has relevant experience

- Be open to feedback and donot take rejection personally

- During an economic downturn, fundraising will most likely take longer, so you need to plan for this and be patient.

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