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Business of Biotech 7

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Business of Biotech 7

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  1. Constance McKee Yale MBA 1986 President & CEO, Manzanita Pharmaceuticals, Inc. Business of Biotech 7 Yale Biotechnology & Pharmaceutical Society 30 March – 2 April 2009

  2. Constance McKee Business of Biotech 7 The Business of Biotech 7 A Non-Credit Seminar for Yale & the Biohaven Community Week of 30 March – 2 April 2009 Yale School of Management 135 Prospect Street, New Haven Constance McKee Yale School of Management, MBA 1986 Manzanita Pharmaceuticals, Inc. www.manzanitapharmaceuticals.com 2995 Woodside Road Suite 400, PMB 309 Woodside, CA 94062 constance.mckee@comcast.net m 408.348.3191 v 408.872.1094

  3. Introduction Course approach – part quantitative concepts, part case studies First hour - basic concepts in start-ups Modular – hard copy fills in blanks if you miss a few evenings Second hour – micro case studies from entrepreneurs, investors & industry Speakers talk about making decisions – and how it *really* turned out Key questions What’s the opportunity? What’s the opportunity worth? How do we – founders & investors – make money? In the current environment, where *is* the money? Emphasis on biopharmaceuticals Business concepts apply to devices, tools & diagnostics companies But decision-making process similar for devices & tools Constance McKee Business of Biotech 7

  4. Course Goals Explain challenges of raising capital for life sciences start-ups No previous experience required From perspective of scientist Quantitative approach Skip the MBA….. Introduce basic concepts that drive the business of biotechnology Most good business decisions are driven by quantitative concepts Rules of the game How to play the game to increase the probability of success Develop network of Yale-centric entrepreneurs & investors Sources of information Sources of funding Career opportunities outside the lab Constance McKee Business of Biotech 7

  5. Course Outline & SpeakersCase Studies in Decision Making Monday, 30 March 2009 Sohini Chowdhury, Michael J. Fox Foundation (Parkinson’s disease) (New York) Robi Blumenstein, HighQ Foundation (Huntington’s disease) (New York) Tuesday, 31 March 2009 Jim Dolan, Executive VP, Purdue Pharma (Stamford) Dr. Roger Hill, Head, Global Licensing – Cardiovascular, Boehringer-Ingelheim (Ridgefield) Wednesday, 1 April 2009 Ron Burch, MD, CSO, Pacira (San Diego) (former CEO, AlgoRx) Jonathan Lewis MD, founder & CEO, ZioPharm Oncology (New York) Thursday, 2 April 2009 Scott Barry, Essex Woodlands Health Ventures (New York) Myles Greenberg, MD, CHL Medical Partners (Stamford) Constance McKee Business of Biotech 7

  6. Acknowledgments & Sources - 1 Matt Plunkett & Rob Weir, Oppenheimer & Co (Menlo Park) - M&A statistics Howard Palefsky, Montreux Equity Partners (Menlo Park) – MAKO case study Mark Edwards, Recombinant Capital www.recap.com & online publication “Signals” www.signalsmag.com Statistics on deals & deal trends Article on venture philanthropies Cynthia Robbins-Roth – books & columns From Alchemy to IPO Alternative Careers in Science BioWorld Today www.bioworld.com www.clinicaltrials.gov NIH database for clinical trials, current and closed Reference for trial design, numbers of patients www.nasdaq.com Pricing & valuations for many biotechnology, tools & diagnostics companies Constance McKee Business of Biotech 7

  7. Acknowledgments & Sources - 2 Online reading Fierce Biotech GEN (Genetic Engineering News) BioBrief, RPM Report In Vivo publications Roger Longman is one of industry’s longest-serving & most insightful analysts Patient advocacy organizations Statistics on patient populations Current news on experimental therapies, clinical trials NIH - information on diseases & disorders; SBIR & other grants programs Merck Online www.merck.com/mmpe/index.html Current information on diseases & disorders Standard-of-care drug therapy, mechanism of action of drugs SEC filings www.sec.gov Company websites for annual reports (10-Q), quarterly reports (10-K) Information on failed trials is usually buried in quarterly or interim (8-K) reports Constance McKee Business of Biotech 7

  8. MondayBasic Concepts in Start-up Business Infrastructure Patents How ownership arises (why Yale owns your ideas) How rights to patents get transferred to your start-up What is “unmet clinical need”? What is a “market”? What is a business model? What is a business plan? Constance McKee Business of Biotech 7

  9. Constance McKee Business of Biotech 7 Growing the Start-Up“First, you need a lawyer…..” 1. Incorporate. Set up a legal entity that (1) shields individuals from liability & (2) allows individuals and corporate entities to share ownership – but not always equally. Legal documents set up officers & Board members. 2. Patents. License in discoveries from a university, another company, or reduce your own ideas to practice. Employees assign rights of ownership of new patents to new company. 3. People. Legal agreements for employees, advisors & consultants, Board members, service providers – accounting, legal, patents. 4. Collaborators. Sponsored research agreements, Contract Research Organizations. 5. Financing. Cap chart, comparables, valuation.

  10. Patents What is a ‘patentable invention’? Patents are issued by US Patent & Trademark Office, European Patent Office and patent offices of respective countries Must show your idea is “novel and not obvious” & that it works (data) When issued, confers the right to sue if an infringer sells a product in the marketplace based on your idea What is intangible intellectual property that can be protected? Copyright – software, drawings Know-how – protocols for synthesis of a small molecule drugs Also known as trade secrets (“secret sauce”) Almost always key to real value in the product, never disclosed in a patent application Constance McKee Business of Biotech 7

  11. How Ownership ArisesWhy Yale Owns Your Ideas Under US law, the employer owns the ideas of employees Terms of Yale employment includes faculty, graduate students Yale Office of Cooperative Research http://www.yale.edu/ocr/ You can “consult” to your own start-up Most universities permit this, but your consulting agreement either continues to allow Yale to own your ideas while consulting, but licenses any discoveries to your start-up, or grants ownership of ideas generated during consulting period to the start-up Document who & where invention occurs Complicated with multiple academic collaborators Complicated by multiple granting sources Expect multiple co-inventors on patent application Constance McKee Business of Biotech 7

  12. Why Are Patents Important? Worthless unless a product made from it, sold & making $$ Does not keep others from stealing your ideas Just gives you the right to sue them if they do steal Formidable barrier to entry if you succeed In pharmaceuticals, can charge a premium price Confers exclusivity Means you’re the only one legally authorized to sell product Can be US only, EU only, ROW only or combination When patent expires for pharmaceuticals, generic drug makers take over & premium-priced drug revenues decline ~ 60% in one year post-expiry Strong patents are enormously valuable to pharma Constance McKee Business of Biotech 7

  13. Yale Licenses Rights To Start-UpHow Legal Rights Are Transferred License is a legal agreement Yale’s ownership gives it right to confer some or all of its rights, over time In exchange for grant of rights, Yale may get rights to % of future product value Future product value – milestones or % of sales (“royalties”) Important concept – transfers rights, not ownership If things go wrong, Yale still owns patents Start-up licensee usually pays for patent prosecution Start-up licensee usually obligated to use “best efforts” to develop Years before Yale (and you, the discoverer) makes any money Flexible concept May have low or no upfront fee May include milestones for key development steps May include royalties (% sales) when product launched Constance McKee Business of Biotech 7

  14. Constance McKee Business of Biotech 7 RoyaltiesPercentage of Cash from Products Sold • Wait years until product developed & finally sold • Industry standard – 2% of net revenues of Rx • Royalties increase as drug price increases, number of patients increases

  15. Constance McKee Business of Biotech 7 Unmet Clinical NeedNumber of Patients X Cost of Undertreatment • Example: 25 million Americans with chronic pain • No drug of choice – many classes of Rx prescribed, but only 30% effective • Direct cost - $1,000 per patient per year • Rx relatively inexpensive, but patients keep going back to the doctor • US Army - $340 BN total cost of treating pain in returning veterans from Operation Enduring Freedom, Operating Iraqi Freedom

  16. Constance McKee Business of Biotech 7 What is a Market?Can Describe Both Place & Total Value Sold • Place = pharmacy, stock exchange, flea market, souk, eBay • Total value = number of units sold X price per unit • Drug market = number of scrip written X price paid by patient • Example: Exubera (inhaled insulin developed by Nektar, marketed by Pfizer) • Exubera sold $14 million after it was launched • Merck sells Januvia for $4.86 per tablet (100 mg 1X 7 days) x (22,475+48,685) = $2 million per week, $125 million per year just weeks after launch • Pfizer pulled Exubera from the market in October 2007 • Depends on who can afford Rx, who actually takes their meds • Doesn’t quantify potential Rx with better effectiveness that addresses unmet need http://seekingalpha.com/article/50788-pfizer-four-lessons-from-the-exubera-failure

  17. Constance McKee Business of Biotech 7 What is a Business Model?Lemonade Stand Revenue Model, Price & Customers • Are you selling the end product? Or intermediates? • What is the cost of the materials in your product? • What is the price per unit, less the cost of materials per unit? • How much $$ does it take to develop your product & launch it? • How much $$ does it take to keep your business going?

  18. Constance McKee Business of Biotech 7 What is a Business Model?Life Sciences Sector Overview • Key risk is time & money until you get to product revenue • Trade-offs between make-it-yourself and license-it-out models • Best scenario – shortest time & money, biggest payoff • Venture capital now only rarely funding drug development

  19. What is a Business Plan? Proxy for future value Estimates for market size & market opportunity Estimates risk (amount of $ to product vs amount of potential revenue) Patents How much can you expect to sell vs competitors’ products? Proxy for reality Has team done *it* before? (developed this kind of product) Have other companies tried to address this problem before? Did they fail? Have other investors made money in this sector? With this business model? What are the “comparables” (value of deals done in this sector)? What are the “comparable exits” (value of deals in this sector that were acquired by other companies, or went public) Constance McKee Business of Biotech 7

  20. Biotech IPOs – Canaries in Capital Markets?the venture capital industry is not investing…. Constance McKee Business of Biotech 7

  21. Constance McKee Business of Biotech 7 Early-Stage Funding Gap Source: Signals Mag; Alzheimer’s Drug Discovery Foundation www.alzdiscovery.org

  22. Opportunity for Philanthropic CapitalHint: go where the money is….. Constance McKee Business of Biotech 7

  23. TuesdayManaging Risk in Clinical Development: Focus on Pharma What is the FDA-driven development path? What is a decision tree? What is the decision tree for clinical development? What are key strategies to manage development risk? Constance McKee Business of Biotech 7

  24. Constance McKee Business of Biotech 7 Clinical Development7.5 Years - $750 Million Clinical Trials $250M Research $500M Gene “HIT” Library Medicinal Chemistry Rationale Drug Design Compound identification Preclinicals/IND 1: 10,000 (.01%) Phase III/IV - 40% FDA Approval 50% Marketed Phase II - 50% Phase I - 50% Lead Candidate Cell-based assays In vitro - primary culture In vivo - non-mammalian In vivo - knockout In vivo - clinically predictive In vivo - not clinically predictive Safety Pilot - Effectiveness Effectiveness $$$

  25. Constance McKee Business of Biotech 7 What risks, over what period of time?What kind of risks do your investors understand? Financial risk Regulatory risk Market risk Science risk Clinical risk Lead Candidate Cell-based assays In vitro - primary culture In vivo - non-mammalian In vivo - knockout In vivo - clinically predictive? IND application FDA Approval Sales Phase 1 Safety Phase 2 Pilot - Effectiveness Phase 3-4 Effectiveness

  26. Constance McKee Business of Biotech 7 Decision Tree for Clinical Development 50% FDA approval (launch - $50M for ramp-up) 40% Complete Phase III/IV (invest - $50M) Don’t market (competition) 50% Complete Phase II (invest - $25M) Failure (50%) 50% Complete Phase I (invest - $25M) Failure (60%) Complete preclinicals (invest - $20M) .01% Failure (50%) Develop 20 compounds (invest -$500M) Restructure R&D (invest - $200M) Failure (50%) Divest division (sell + $50M) Do not develop PhRMA; (Brealey & Myers)

  27. Constance McKee Business of Biotech 7 Spread Portfolio RiskVenture Investors & Pharma Measure Success as “IRR” • IRR = internal rate of return (complex calculation for both cash invested and time until investment pays off) • ROI = return on investment (used interchangeably to express increase in value of original investment, adjusted by time) • For pharma & VCs alike, “shots on goal” - home runs make up for strike-outs • For pharma – known mechanism of action; clinically relevant models shortens development time & lowers risk

  28. Constance McKee Business of Biotech 7 Potential Market Value Drives Decisions$120M Market Is Minimum To Justify Beginning Development • If 10% of drug candidates reach the market, you need 10 drugs to complete preclinical studies to ‘guarantee’ a successful drug • But costs $500 million per drug candidate through to Phase 1 • Big pharma needs $1.2 BN market opportunity to justify development ($120M x 10, assumes stop development at milestone failures)

  29. Constance McKee Business of Biotech 7 What is a Business Model?Lemonade Stand Revenue Model, Price & Customers • Are you selling the end product? Or intermediates? • What is the cost of the materials in your product? • What is the price per unit, less the cost of materials per unit? • How much $$ does it take to develop your product & launch it? • How much $$ does it take to keep your business going?

  30. Constance McKee Business of Biotech 7 What is ‘Venture Fundable’?Venture Investors Seek Least Risk, Highest Upside • Start-ups usually begin after discovery completed in universities • So VCs focus on the $250M cost of development • Big pharma addresses large, chronic conditions • VCs focus on smaller markets, clear clinical endpoints

  31. Constance McKee Business of Biotech 7 Affymetrix (AFFX)Business Model Example: Research Tools

  32. Constance McKee Business of Biotech 7 Affymax (AFFY)Business Model Example: Emerging Biotech

  33. Constance McKee Business of Biotech 7 Pain Therapeutics (PTIE)Business Model Example: Small cap biopharma

  34. Constance McKee Business of Biotech 7 Medtronic (MDT)Business Model: Medical Devices

  35. Constance McKee Business of Biotech 7 Amgen (AMGN)Business Model: Biotherapeutics

  36. WednesdayValuations What is a valuation? Why is this important to founders? How are valuations determined in the private (venture) market and in the public markets? To what quantitative factors are valuation models sensitive? Founders make money when…. Founders lose money when…. Constance McKee Business of Biotech 7

  37. Constance McKee Business of Biotech 7 Valuation Determined by (1) Value of Latest Round of Financing & (2) Market Conditions • If 25% is worth $1 million, then 100% is worth $4 million • ($1 divided by 25% = 4) 25% valued at $1 million

  38. Constance McKee Business of Biotech 7 Pricing RoundsVenture Valuations Affect Founders’ Ownership (“Dilution”) • Begins with pre-money valuation • Pre-money valuation driven by • (1) absolute amount of cash needed and • (2) target post-money valuation • New price-per-share calculated as (valuation/new $$ required = price/sh) • New price/sh calculate as (# new shs issued = % owned) = “dilution”

  39. Constance McKee Business of Biotech 7 ValuationsMarket Drives Pre-Money Valuations • Model sensitive to time to exit (acquisition, IPO, product launch) • Model sensitive to cash required for each milestone • Pre-money valuation is whatever investors believe & insist on • Pre-money valuation + funds in = post-money valuation • Next round of investors want a “step up” (assumes you meet your milestones & your technology is now worth more)

  40. Constance McKee Business of Biotech 7 How Expected Exits Drive Valuations Solve for “x” – exit value must be at least $50M • Constant – capital needed to bring Rx to market • Constant – time needed to bring Rx to market • Constant – return VCs seek at each capital raise • Variable – IPOs & comparables • “Solve for x” – what your company is worth now ~ current round VC pricing (x+5) + (3x+5) + (2x+10) + (2x+30) = 100 Your idea - $70M for novel Rx Milestone – IPO or trade sale Milestone – in vivo POC $5M Milestone – preclinicals/IND $5M Milestone – “clinical proof” $10M Milestone – FDA approval $40M Time: 6 - 8 yrs for novel Rx

  41. Constance McKee Business of Biotech 7 Notion of ‘Expected Future Earnings’Public Company Valuations Fluctuate with Price • For public companies, investors buy on future expected value of earnings • Torcetrapib failed in Phase 3 • Pfizer spent $850M to develop the drug to that point • Conducted trials in 20,000 patients • On 4 December 2006, stock price dropped from $27.88 per share to $23.00 per share (x 7.2 billion shares, from $201 BN to $166 BN total company value) • Means investors removed value of future earnings from stock price

  42. Constance McKee Business of Biotech 7 What’s a Valuation ‘Comparable’?Similar business model, similar products • Valuations of venture-backed companies • Subscription-services • (1) Venture One • (2) The Venture Capital Analyst • (3) your lawyers (without naming companies….”we’re seeing deals like this right now at valuations of etc”) • (4) your friends • Small cap public companies • Valuations may be affected by major investors’ portfolio concerns, may be unrelated to company’s future – or inside information? (PTIE) • Valuations may be affected by global market conditions (MAKO) • Similar class of drugs progressing through clinical trials • Pfizer torcetrapib failure

  43. Constance McKee Business of Biotech 7 What Happened to 2007 IPO Debuts?Public valuations ~ VC valuations Market cap as of 16 Mar 2009 MIPI = Molecular Insight ($64M) SNTA = Synta ($62M) OPTR = Optimer ($328M) ROSG = Rosetta Genomics ($30M) VRUS = Pharmasset ($241M)

  44. Constance McKee Business of Biotech 7 What happened on October 7?Venture investors Montreux & Skyline do $60M PIPE on October 29, 2008 at $6.25 per share* Montreux bid $6 per share in 2006 in a venture round before MAKO went public, but were outbid by hedge funds. MAKO later went public at $10 per share, has received FDA approval and started marketing its products. Montreux invests later in the company’s development with minimum science, clinical and market risk in a PIPE (Private Investment in Public Entity)…but what is VC doing investing in public companies….?

  45. Constance McKee Business of Biotech 7 What happened to PTIE on March 2?Largest investor Eastbourne sells 1M (of 11M) shares

  46. Constance McKee Business of Biotech 7 Founders Make Money When…Valuations Are High & Keep Ratcheting Up to Exit

  47. Constance McKee Business of Biotech 7 Founders Lose Money When…Valuations Remain Low & Exit Is Low

  48. Change the Math for Early-Stage Investment Shorten Time to Market & Minimize VC Equity Constance McKee Business of Biotech 7 $60 Million ROI = 9% ROI = (6%) Capital ROI = 24% $20 Million Time in Years ROI = 24%

  49. Change the Math for Early-Stage Investment Strategies to Accelerate Exit & Minimize Dilution Constance McKee Business of Biotech 7

  50. ThursdaySources of Equity & Non-Equity Capital Founders make money when… Angel investors & venture capital Pharmaceutical industry alliances Federal grants NIH - SBIR, STTR (TIP) Department of Defense - US Army, DARPA Venture philanthropies & foundations Ex-US Constance McKee Business of Biotech 7