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:
Answers:
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:
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!
]]>Brenda Gavin, Partner at Quaker BioVentures, mentioned that there were only 20 M&A exits in 2009 from venture backed companies that would constitute a good return. She mentioned that there are 3,400 biotechs, all of whom are for sale at any given point. The exit ratio therefore isn’t so good, especially with effectively no IPOs taking place. As such, if a VC can pre-negotiate a “4x” as she mentioned, she would take that any day over an uncertain 10x.
Steven St. Peter from MPM commented on the MPM/Novartis strategic fund as well as other non-disclosed deals of a similar option nature with other pharma companies. He said their fund was doing these deals since 1996, but it wasn’t formalized until 2006 with Novartis. His interesting insight is that there is a real range of exit values for biotech M&A. Given the amount that generally needs to be invested to get there, there already is an effective cap on returns. There might be one outlier per year but you can’t set-up your fund expecting outliers. Given the effective cap on M&A returns, why not cap your return earlier to derisk the exit? This makes perfect sense to me and something that was mentioned in this blog half a year ago.
Pharma companies rely on biotechs for a supply of innovative assets to fill their pipeline. They need the VCs to make these risky investments to fund the early stage development. More companies will be asked by their board to find a partner prior to the next round of financing both to derisk the round as well as provide validation. This type of pre-negotiated exit arrangement I predict will become even more common going forward as VCs try to improve their returns.
]]>As follpw-up to the webinar, enclosed is a two-page overview on the results of our buy-side survey that we presented on what helps get a deal done. Feel free to pass this on to colleagues and let us know if you would like a copy of the full presentation.
All the best for a Happy Holiday and prosperous New Year!
]]>If entrepreneurs would be willing to cap their upside (albeit with downstream economics that can improve the final number) and pharma companies are interested in making this type of commitment, there has to be a way to attract funding. What investors in this market wouldn’t want a completely uncorrelated 2-3x return with potential longer term upside? My guess is that eventually the VC community will stubbornly come around and invest at least part of their portfolio with this concept.
The other answer is to start a fund whereby the top 5 pharma companies all agree to share these deals with a pre-negotiated exit with the new fund. The entire remit of the fund would be to fund these companies. While the upside for each individual investment might not be gigantic, the downside theoretically is much less given it has gone through “pharma diligence” rather than “VC diligence” which is arguably much more thorough and has a much higher success rate. Anyone willing to give me $300M to make this happen?
]]>Since this was well received, we plan to make this into a day-long course testing it again with the Wharton students. Our hope is to eventually make this course more broadly available in conjunction with either an eBook or published book on business development. If you’re curious to see the presentation that we gave, we’ll be posting it on this blog shortly. Email Geoff if you’d like a copy. If you have suggested topics for this eBook/book, please let me know.
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The licensing environment in 2009 is clearly a “buyer’s market”. Pharmaceutical business development professionals are being bombarded by biotechnology firms with offers to license or acquire programs. The noise level in the market is unprecedented. For biotech firms, this means that preparation for a licensing effort is more important than ever.
Evidence of Differentiation. In a competitive licensing environment, strong indications of differentiation are perhaps the most important factor in gaining a partner’s attention. Ideally, this would include randomized Phase 2 data versus standard of care. If resources are constrained, a validated, well-controlled pre-clinical model, can help strengthen the marketing package.
Sound Commercial Story. Telling the buyer it’s a $1 billion opportunity will gain little attraction. A licensor’s successful commercial case should include: 1) A solid understanding of the market conditions and trends and competitive landscape now, at launch and 5 years post-launch. This can be based on secondary data sources; 2) A target product profile (TPP) whose claims are justified by pre/clinical data, including active comparators; 3) Market feedback on the TPP from key opinion leaders (KOLs) in the relevant therapeutic area; and 4) a high level assessment of the commercial potential based on the previous factors. A $650 million opportunity that considers reality will gain more credibility than the “unsupported blockbuster”.
Getting to the Champions. This is a factor which often is mentioned but difficult to achieve. Depending on the development stage of the asset, any number of functions can be the internal champion for the licensor: Research, Clinical, Commercial and Senior Management. In licensing team, these groups weigh heavy on types/classes assets that are of most interest, due diligence go/no go factors, and deal terms that are deal breakers. Licensees’ Business Development are essential for completing a smooth process and maintaining opening communication, but it is rare that these individuals will serve as champions.
Willingness to be Creative. Deal terms have traditionally been the bellweather of measuring / validating the value that’s been created by the licensor - “more is better”. Even with a compelling asset, big bio/pharma licensees are increasingly P&L sensitive and seemingly taking a wait and see approach. This situation has led to a wide range of non-traditional structures, the range and impact of which should be considered before initiating a licensing process. Creative scenarios might include option-based deals with R&D funding; co-funding by a partner’s venture capital arm, etc.
]]>Follow-on investments in current portfolio companies might be throwing good money after bad (note: not all follow-ons are a waste of money and winners should be continued). The valuations of most current portfolio companies funded more than a year ago are overvalued given this environment. Short of recapping the company, insider rounds are only going to make the problem worse by increasing the valuation, generally at a flat price. Bruce Booth at Atlas Venture eloquently demonstrated in a Nature Biotech article that the intuitively obvious observation that more money invested and thus higher valuations leads to lower returns. LWP is about to unveil an analysis that says that much of the funding these days in existing companies, not surprisingly is insider rounds. Getting a deal done today with an external investor is extremely difficult for a host of reasons. Many of these outside investor deals where the new investor prices the round need to be done at a down valuation. There clearly are political implications of doing this. So, what is the answer?
Company formation is the only way to control the valuation, get founders shares in addition to preferred stock, control over the selection of the management team, control the venture syndicate and dictate the terms for the Series A round. While some venture funds have been successfully doing this for a while, others don’t think it is worth their time. I postulate that in this venture market, VCs should be working on funding more new companies with innovative technologies, not mee-too retreads further in development. Maybe VCs should even consider reallocating to start-ups some of the recently increased allocation they “reserve” for current portfolio companies. A recent webinar given by ReCap stated that they think that the shift among buyers (big pharma/biotech) will be from the late stage, which are very picked over, to collaborations earlier in the development cycle, including research and pre-clinical stage. Sounds to me like a great opportunity worth pursuing!
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