Research Funding Grows Scarcer for Early-Stage Biotech Companies

Scarce funding for early-stage biotechnology companies that have yet to bring products to market is straining research budgets, even as overall capital raised by the industry increased, according to a report.

The top 20 percent of U.S. biotechnology companies raising money garnered 82.6 percent of funding in 2010, while the bottom 20 percent drew 0.4 percent, according to a report released today by London-based consulting firm Ernst & Young. Of the more than 270 publicly traded biotechs in the U.S., only about 40 -- such as Amgen Inc. (AMGN), Gilead Sciences Inc. and Biogen Idec Inc. (BIIB) -- are profitable, Bloomberg data show.

Biotechs in the U.S., Europe and Canada raised $25 billion last year compared with $23.2 billion in 2009. Much of the funding came as mature companies such as Thousand Oaks, California-based Amgen, took on debt to pay for stock buybacks or dividends, said Glen Giovannetti, of Ernst & Young’s global biotech unit. Younger, unprofitable companies in the U.S. that depend on funding from venture capital firms, stock sales and partnerships saw available capital decline 21 percent in 2010.

“We’re calling that ‘innovation capital,’” Giovannetti said in a telephone interview, referring to total capital raised by the industry, excluding debt financing. “That’s the bread and butter for pre-commercial companies. We’re still in a restrictive environment.”

Biotechnology companies in the U.S., Europe, Canada and Australia boosted profit 30 percent to $4.7 billion last year, and large companies were able to increase research spending, Giovannetti said. Companies without products on the market didn’t fare as well, decreasing research spending about 1 percent, he said.

Milestone Payments

The capital squeeze for smaller biotechs is compounded by a trend in payments from investors that are tied to meeting drug development goals, the researchers said. Venture capital firms have begun to use this approach to limit risk and maximize their return on investment, which starts tracking when money is paid out, Giovannetti said.

The use by venture capital firms of so-called contingency payments mirrors an established system in biotech partnerships and acquisitions. Sanofi (SAN), France’s largest drugmaker, used a contingent value right, or CVR, in its purchase of Genzyme Corp. earlier this year, giving shareholders of the Cambridge, Massachusetts-based biotech the possibility of receiving an extra $14 a share if certain milestones were met.

“The industry even has a term for it: biobucks,” Giovannetti and Gautam Jaggi, the report’s managing editor, wrote. That refers to the up-front payment and the total potential funding a company can receive upon reaching milestones.

Up-Front Fees

“The total potential value stayed pretty steady” in 2010 partnerships, Giovannetti said, at more than $40 billion. “The up-fronts, which is the real cash changing hands day one, have decreased pretty significantly.”

In the last five years, the average up-front payment received by a biotech company from a drug development partner declined 55 percent. In 2010, up-front payments dropped 37 percent to $3.1 billion.

While payments geared to milestones create an incentive for biotechnology companies to maintain focus on specific goals, the “drip feeding” of funds can lead smaller firms to cut corners in research and bear more risk in partnerships, Giovannetti said.

Funding pressure, compounded by increased regulatory scrutiny of new medicines, is forcing biotechnology companies to increase efficiency and prove their products provide unique benefit, Giovannetti said.

‘Market Awareness’ Required

“This environment is going to require some new competence in these companies,” he said. While the driver of success used to be mainly scientific, it’s now more important to have “market awareness of how a product fits into the competitive landscape, what payers are doing, and how the product might fit into the portfolio of a potential partner.”

Biotechnology companies may seek partnerships or mergers to reduce overhead costs and share intellectual property, according to the report. Still, the number of mergers and acquisitions involving European or U.S. biotechs fell to 45 deals in 2010 from 58 in 2009, the report showed.

“Investors are requiring more proof before parting with their money,” Giovannetti and Jaggi wrote. “While there is little that companies can do up-front to demonstrate the efficacy of their drug candidates, demonstrating that they understand the market realities for their product and have thought about the pharmacoeconomic issues will help increase the comfort level of investors.”

To contact the reporter on this story: Meg Tirrell in New York at mtirrell@bloomberg.net.

To contact the editor responsible for this story: Reg Gale at rgale5@bloomberg.net.

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