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.
V
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,
16
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
27
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