On Financing Innovation

Financing innovation in our industry has historically been pursued through angel investors and venture capitalists. They provide the seed capital for a project or company so it can get to an early binary event, with additional infusions of capital needed to take the innovative therapeutic through the next hurdle in development. Eventually, the VC exit is either an M&A transaction or an IPO. An IPO doesn’t mean that the funding of the project is complete, it may merely signal that proof-of-concept has been successful and the company is ready to seek funding of the larger pivotal trials in the public markets. Over the years, there have been astronomical amounts of money (both private and public) raised to fund transformational therapeutics — Vertex Pharmaceuticals raised billions of dollars before the promise of their HCV antiviral reached its potential and the company turned a profit. In very rare cases, that can still be done today. But for most drug developers, the model is changing.

A new type of pharmaceutical company is now emerging and with it, a new model for funding innovation. The profile of these organizations is easily recognized – they have an approved pharmaceutical product (or perhaps multiple products) on the market for which they have commercial rights (at least in the U.S.); they have a very lean development organization (focused on later-stage development) with no discovery research; they have a very disciplined approach to financial management; and they are, or are close to being, profitable.

These companies pursue a goal of generating cash from their business in order to reinvest a portion of that cash in developing in-licensed/ acquired later-stage development products. They may continue to acquire commercial-stage products along the way; leveraging their commercial and corporate infrastructure, and generating more profits available for funding innovation. Importantly, this model allows for the consistent funding of innovation through the dry spells of the capital markets, as well as through the inevitable (many times temporary) setbacks of drug development. How many times have we seen companies hit a development ”speed bump” just at the moment that they need to raise capital? These end up as those ”ugly financings” that we read about. This new model holds the potential to create significant value for shareholders since it avoids the serial dilution (through serial capital raises) normally required in a noncommercial, development company. This value is created by companies using a portion of their cash inflows to develop innovative therapies

Celgene and Cephalon are two examples of this model. They have done well for their shareholders, and at a very large scale – building successful, cash-generating base businesses, and expanding their portfolios through the successful license or acquisition of innovative assets. The first companies that pursued this model did not start out with the model in mind. Rather, they hit difficulties in their discovery or development activities, and found it necessary to reinvent themselves in order to survive. Today, however, there are companies that are actively pursuing the model as an initial company strategy.

It is increasingly rare that a company is able to raise billions of dollars before turning a profit. With so many unmet medical needs in the world today, and so many exciting innovative therapies in development to treat them, we need new models for financing innovation in our industry. This may just be one whose time has come.

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