Out of Whack: Biotech Business Development Compensation

Biotech business development is out of whack!  Something needs to be done fast or the best, brightest, and most experienced will leave their companies.  Below is an example of what is wrong with biotech BD and what can be done to fix it.

Suppose senior investment bankers get paid a small base, say $200K, and a bonus usually with an extra zero on it.  Biotech Chief Business Officers (CBO) likely receive anywhere from $200-300K in base salary and possibly 25% in bonus compensation with a ~2% equity kicker vested over 4 years (not counting re-vesting for re-greening).  How can two people who both are arguably transaction professionals doing largely the same thing (yes I know there are differences) get paid in such radically different ways?

Three questions that you should think about:

• Which person is more financially motivated based on these structures?
• Who does more deals? and
• Which person has more variability in compensation?

Answers:

• Banker
• Banker
• CBO (yes it’s true, I’ll get to it in a second)

A senior banker is basically paid a percentage of revenue, which is directly related to closing deals.  He/she might work on 10-20 deals a year and close 2 or 3 if not more.  Let’s say the average success fee is $5M.  That’s $10-15M in revenue, of which maybe 10% gets paid out to the lead banker equating to $1-1.5M.  The $200K base plus $1-1.5M in bonus is $1.2-1.7M in annual compensation.

The CBO gets his/her $250-350K in cash compensation including bonus and depending on the type of company, might be involved in one deal every year or every other year (they might not do any deals if the technology fails or they company needs more data).  What if, though, that deal is not an exit, and there are no more deals to be done at the company?  It doesn’t make sense to stick around anymore waiting for the equity to vest and hoping for an M&A.  Let’s say this BD deal happens two years into your four year vesting cycle.  The CBO only earned 1% of the company and hasn’t realized any value from that equity.  He/she now has to make a decision whether or not to buy those shares, not knowing if they will ever be worth anything (for private companies only).  How many biotech companies exit for large sums?  In 2009, 19 private venture backed companies exited out of thousands potentially for sale.  A BD exec would be lucky to get one good one in a career.  Two is like getting hit by lightening.  A typical “homerun” of $300M x 2% = $6M if you’re there at exit and assuming all VC preferences have been washed away.  $300M x 1% is $3M, but more often than not, you will be heavily diluted after leaving the company and after they raise more capital.  Your 1% might end up as 0.5% or 0.25%.  On a $300M exit that is worth $1.5M or $0.75K.  That equates to $750K or $375K in “bonus” per year.  What if you only have one of those in a 20 year career?  Many companies don’t ever get a deal or an exit.  That is <$100K in “bonus” per year and is highly variable.  Bankers’ bonuses have much lower variability (much higher risk adjusted value) compared to M&A exists for biotech BD execs.

What does all of this math mean?  Bankers have a much better deal financially and one of three things needs to happen:

• Biotech companies with one or two products need to hire bank (who need to learn how to do business develpoment, not just M&A)
• They need to hire Locust Walk Partners (sorry for the self serving commercial), or most likely
• They need to compensate their business development professionally in a radically different way to properly incent these professionals financially.

Equity options in a company and success fees that could be paid for a transaction can and often have little correlation in economic value, especially in private companies.  I suspect that if this paradigm doesn’t change, either the best BD professionals will start competing shops to Locust Walk Partners or they will leave the industry entirely where their skills will be more highly valued (like in banking).

This was not mean to be a white paper in favor of Locust Walk but rather to illustrate a point that CEOs and VCs might not have the right mix on how to extract the maximum value from their important business development professionals.  Let’s see if they can figure it out!

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