Biotechs: Recent VC exit trends Will M&A transactions continue to be the exit of choice for biotechnology firms? James Gubbins (partner) and Louis van Aardt (senior associate) of the London office of law firm Morrison & Foerster examine recent exit trends and present their projections for 2007 and beyond.
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enture capital exits generally come in the form of initial public offerings or merger/acquisition transactions of portfolio companies. According to Ernst & Young’s annual report on the state of the venture capital industry (Transition: Global Venture Capital Insights Report 2006), the US and Israel have seen increasing M&A activity in recent years, while Europe has experienced an increase in IPOs. This trend has not, however, been seen to apply to biotechnology companies of late. Although IPOs have historically funded late stage trials and product launches, there appears to have been a recent decline in the number of VC-backed biotechs achieving an IPO exit both in the US and Europe. (Interestingly, Israeli biotech firms have been an exception to this trend with a spate of offerings taking place on the Tel Aviv Stock Exchange in the past two years. See: Life science firms trek to the TASE, IVCJ, March, 2007).
James Gubbins
Recent trends in the US Some commentators believe that the increased M&A activity in the biotech sector in the US during 2005 and 2006 will not diminish in 2007, and that there will be at least 30 biotech IPOs this year – a level last seen in 2004. This is despite the fact that there were only 18 IPOs in 2006 and 17 in 2005 – almost all of which were priced at or below the bottom end of their pricing range. Although Sirtris Pharmaceuticals successfully went public in March this year, other recently planned biotech IPOs, such as BioVex’s $45 million offering, have been shelved. Most recently, both Prestwick Pharmaceuticals and Voyager Pharmaceutical Corp. canceled planned offerings, citing poor market conditions. The increase in the minimum size requirement for an offering, compared to the late 1990s, and the increased cost and burden arising from Sarbanes-Oxley may be contributing factors to this depressed IPO trend. Nevertheless, it is anticipated that recent revisions to SarbanesOxley relating to small companies may help reverse this trend.
Louis van Aardt
Recent trends in the UK Despite the recent success of the AIM market generally, AIM cannot be considered a mature market for biotech. As of the end of April, 2007,
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there were only 43 biotechs from a total of 1,639 companies listed on AIM. Of these, 11 listed in 2005, 15 in 2006 and only 2 so far this year. European biotech portfolios may suffer more than their US-based counterparts, given that Europe has fewer large biotechs. In the current climate, it is only relatively mature companies – those with promising Phase II results or those in Phase III – that are likely to succeed in the public market. On the other hand, there appears to be a current trend toward a greater number of trade sales in the UK biotech market. Larger biotechs are increasingly looking to acquire smaller entities for new products to boost their development activities and global research infrastructure, while such transactions offer target companies access to wider distribution channels. Since December, 2005, there have been a number of biotechs that have taken the M&A rather than the IPO route, including KuDOS Pharmaceuticals and Arrow Therapeutics, which were acquired by AstraZeneca; Domantis Ltd., acquired by GlaxoSmithKline; Oxxon Therapeutics, acquired by Oxford BioMedica; and Paradigm Therapeutics, acquired by Takeda Pharmaceutical. The Domantis acquisition for £230 million in cash was one of the largest acquisitions in terms of size for a private biotech. The majority of small to mid-size biotechs are typically engaged in on-going R&D with one or more licensing agreements in place with larger pharma companies. This structure makes pre-IPO valuation difficult, with financial advisers typically implementing valuation metrics below the level that the VC investor anticipates or desires. Accordingly, public markets are increasingly perceived as a strategic financing source rather than an exit event – a potential alternative to a series C or D financing round – enabling the VC investor to keep the company progressing, while providing the potential to achieve a cash exit at a later date. The fact that biotech business imperatives are influencing the form of exit is borne out in Ernst & Young's 2006 Report, which highlighted the increase in the median time from initial investment to exit – three years in the mid-1990s to five years in 2006. In biotech investments, this period is now usually seven years or more. The impact of this longer investment period to exit creates a greater emphasis on capital efficiency, staged portfolio financings, milestones and the mitigation of risk. Such a changing exit timetable may also create a need for turnaround strategies and distressed exits. Continued on page 27
number of preferred shares layers as of valuation date: There is an obvious trend of a higher common/preferred ratio in younger companies.
models, in accordance with AICPA guidelines, will result in an unbiased result – saving time, money and frustration in a possible future exit event. ■
Biotechs: Recentstock VC exit trends ruin your exit Don’t let cheap valuations Continued page 16 20 Continuedfrom from page
Why the trend away from IPO exits?
It is unsurprising, therefore, that commentators have started to query whether public equity markets and biotechs are currently suited to one another. However, with the increasing globalization of the industry through licensing and M&A arrangements, it would seem that exit opportunities in global markets may increase.
The move away from IPO exits appears to be driven by general conditions in the markets in which the entities operate. Traditionally, biotechs are perceived as struggling. Costs associated with R&D and compliance with drug regulations and safety protocols are rising, while margins are shrinking. As drug patents expire, competition Outlook for 2007 and beyond from generic manufacturers is growing. The biotech industry is currently engaged in a Many factors in the current environment make healthy M&A cycle, with many companies being IPOs an unlikely exit strategy, including: able to achieve far better valuations from larger • market fashion and sentiment, which tradi- pharmaceutical companies seeking to bolster thin Industry analysis shows that most industries As more layers of preferred share and financing tionally influence IPO markets and cannot be pipelines than from public investors via IPOs. It is are characterized by a wide spread in the rounds accumulate, chances increase to arrive at a relied upon for an objective view of a firm’s likely that M&A transactions in the UK, as with the common/preferred ratio. It is also interesting to lower ratio. It should be noted that this chart does potential US, will continue to drive the general exit strategy note that the median result does not differ signifi- not include companies with an IPO scenario. • the lengthy timetable involved in taking a for VC investors in small biotech companies, not When implementing IPO scenarios in mature cantly among the various industries. company to market because IPO exit strategies are failing, but because companies, where such is feasible, the resulting • high legal and regulatory approval costs in IPO consolidation in the industry is a necessary part of ratio can surge depending on assumptions. Common / preferred value preparation growth. With such consolidation, the European In conclusion, quick methodologies used in the ratio by round • the relatively substantial size and scale of a public markets in particular may support biotech The following chart describes the distribution past are no longer relevant. Only a thorough business that is required before it becomes in the future more than they do at present. This, in of the common/preferred ratio according to the process of cheap stock valuation using custom attractive to the market turn, may heighten the financial viability of an IPO number of preferred shares layers as of valuation models, in accordance with AICPA guidelines, will • the ongoing costs and regulatory requirements, exit. ■ result in an unbiased result – saving time, money date: particularly in the US, associated with operThere is an obvious trend of a higher and frustration in a possible future exit event. ■ ating a public company The information provided herein may not be applicommon/preferred ratio in younger companies. • the necessity for continued growth and “good cable in all situations and should not be acted upon news” that public markets require to avoid without specific legal advice based on particular situaBiotechs: Recent VC exit trends tions. The views expressed in this article are those of the stock illiquidity Continued from pagefor 16 VC shareholders to enter into authors only, are intended to be general in nature, and • the necessity lock-up periods (typically 6-12 months) leaving are not attributable to Morrison & Foerster LLP or any It is unsurprising, therefore, that commentators Why the trend away from them vulnerable to adverse price movements of its clients. have started to query whether public equity IPO exits? and less control over the business during this The move away from IPO exits appears to be markets and biotechs are currently suited to one period of potential volatility driven by general conditions in the markets in another. However, with the increasing globalthe industry through licensing and M&A which the entities operate. Traditionally, “Published in the June 2007 edition of IVCJ - biotechs Israel Ventureization Capital of & Private Equity Journal - EXITS: Which Way Out” are perceived as struggling. Costs associated with arrangements, it would seem that exit opportuR&D and compliance with drug regulations and nities in global markets may increase. safety protocols are rising, while margins are shrinking. As drug patents expire, competition Outlook for 2007 and beyond from generic manufacturers is growing. The biotech industry is currently engaged in a Many factors in the current environment make healthy M&A cycle, with many companies being IPOs an unlikely exit strategy, including: able to achieve far better valuations from larger • market fashion and sentiment, which tradi- pharmaceutical companies seeking to bolster thin tionally influence IPO markets and cannot be pipelines than from public investors via IPOs. It is relied upon for an objective view of a firm’s likely that M&A transactions in the UK, as with the potential US, will continue to drive the general exit strategy • the lengthy timetable involved in taking a for VC investors in small biotech companies, not company to market because IPO exit strategies are failing, but because • high legal and regulatory approval costs in IPO consolidation in the industry is a necessary part of preparation growth. With such consolidation, the European • the relatively substantial size and scale of a public markets in particular may support biotech business that is required before it becomes in the future more than they do at present. This, in attractive to the market turn, may heighten the financial viability of an IPO • the ongoing costs and regulatory requirements, exit. ■ particularly in the US, associated with operating a public company The information provided herein may not be appli• the necessity for continued growth and “good cable in all situations and should not be acted upon news” that public markets require to avoid without specific legal advice based on particular situastock illiquidity tions. The views expressed in this article are those of the • the necessity for VC shareholders to enter into authors only, are intended to be general in nature, and lock-up periods (typically 6-12 months) leaving are not attributable to Morrison & Foerster LLP or any them vulnerable to adverse price movements of its clients. and less control over the business during this period of potential volatility
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