The US biotech sector has prospered in the past decade as venture funding has expanded, the IPO window has remained open, and post-IPO companies have been able to tap public markets to raise new capital (Exhibits 1 and 2). This capital influx has contributed to the sector, delivering world-changing breakthroughs—gene therapies, precision oncology therapeutics, and effective treatments for hepatitis C, for example.
The 2021–22 biotech public-market downturn was dramatic and sobering. As with prior public-market cycles in biotech and other sectors, the downturn offers a chance to reflect on what has changed and what the sector can do differently in the future. In the context of an incredibly robust innovation landscape and strength in biotech private markets,1 this article focuses on new approaches to operations, financing, and partnerships that together represent a survival kit for biotechs to emerge stronger from the downturn.
We looked at the cash situations of the cohort of biotechs that went public in the 2010s and the 2020–21 IPO boom (Exhibit 3). Half of the story is positive, with many biotechs buoyed by some of the largest-ever IPOs and follow-on public offerings; in this cohort, the median cash on hand is greater than $200 million. The other half of the story is challenging, with hundreds of biotechs having less than two years of cash on hand and looking for financing in a down market.
One of the first questions industry players ask is, “What will large biopharma do?” To date, the answer has been the disciplined execution of long-term strategies. The 20 largest biopharma companies made 11 acquisitions in the first half of 2022—exactly on trend with an average of 22 acquisitions a year over the past five years (Exhibit 4). These acquisitions featured assets that were derisked clinically or commercially and terms that were derisked where uncertainty remained. Licensing deals for preclinical and early clinical assets have remained high, continuing a long-term shift toward earlier-stage deal making. Large biopharma mergers and acquisitions will likely increase as the public-market downturn extends, but this will be a solution for only a handful of biotechs rather than hundreds. Companies lacking a clear exit opportunity because, for example, they’re unable to attract large biopharma interest at more than a 50 percent premium to their current share price must evaluate atypical financing and partnership options.
Meeting the challenge
Biotechs always need capital. Today, at a moment of sector-wide valuation challenges, more biotechs than ever need capital. A new era of streamlined and flexible operations, alternative financing solutions, and biotech-to-biotech business development and licensing (BD&L) may emerge.
Since the downturn began in 2021, most biotechs have reevaluated their development programs and either decided to stay the course or focus on fewer, higher-priority programs. Portfolio optimization is an ongoing activity that has taken on more urgency because of capital constraints and is being approached differently because of pipeline crowding in certain indications and modalities and new analytics applications. Management teams and boards can also consider broader shifts in the biotech ecosystem and the “beyond the pipeline” strategic options they present.
Streamlined operations with a sharper focus on value creation. One major shift over the past decade has been rising expense levels for a typical biotech company. General and administrative (G&A) expenses in a biotech’s first full year as a public company have grown steadily, rising from a median of $11 million for 2012 IPOs to $25 million for 2020 IPOs. The most notable feature of G&A expenses today is how much they vary, even after adjusting for a company’s stage (preclinical or clinical) of development. Preclinical biotech G&A expenses can range from $19 million to $30 million per annum, and clinical expenses from $15 million to $43 million (Exhibit 5).
The second shift in operations has come from hybrid work spurred by the COVID-19 pandemic. This has caused less disruption in biotech than in other sectors, since the lab work that constitutes the bulk of R&D is mostly done in person, but some management teams have adopted remote-working practices, leaving office spaces underused and raising questions about how biotechs should operate as they scale. We expect a third shift in how biotechs operate to come from the evolving role of outsourcing.
Like all companies, biotechs are only as good as their people, and we often hear from CEOs that their biggest challenge is attracting top talent given competition and the cost of living in major biotech clusters. These expenses and some others, such as public-company reporting costs, are unavoidable for a stand-alone biotech. Still, many operational costs are optional and should be evaluated on a case-by-case basis:
- real estate, including whether flexible office space or more sharing of office and lab space with other biotechs might be feasible
- travel and expenses, including the possibility of fully remote collaboration models for management and hybrid conference attendance
- resourcing, including the possibility of an optimized functional headcount to reduce near-term burn rate; building out management teams more slowly by, for example, partnering more closely with venture capitalists (VCs) to compensate; outsourcing resource-heavy R&D roles, including clinical operations; and leveraging partners and contractors for precommercial work and stand-up teams faster prior to launch
- salaries, including whether nonstandard compensation packages could reduce fixed costs
- supply, including, for example, switching contract manufacturing companies and contract development and manufacturing companies if new partners can lower costs (or increase the probability of success)
- commercialization, including the possibility of US launches being accomplished with leaner and more flexible resourcing models and earlier consideration of ex-US licensing deals (also a potential source of near-term capital)
Going forward, we expect greater scrutiny from investors on how capital is deployed beyond the pipeline. Successful biotechs will ensure a clear connection between capital allocation and value creation, especially in R&D but also in broader company operations. For example, precommercial companies with G&A expenses greater than 25 percent of total expenses (a benchmark for more efficient biotechs) may need to justify their choices.
Alternative financing solutions. A complex and dynamic financing landscape has emerged as public markets have soured over the past 12 months. Some commercial-stage biotechs with favorable valuations have achieved successful follow-ons, and many biotechs across stages have secured funding from existing investors, often through private investments in public equity, but these options are unattractive or unobtainable for many companies given current valuations. How can hundreds of public biotechs gain financing through the downturn?
We see a patchwork of alternative options linked to recent shifts in biotech financing, including the growth of royalty deals, the emergence of structured financing for clinical trials, an expanded role for private equity, and debt financing.
Royalty deals used to be reserved for marketed assets, but they have now become an option for late-stage development and have spiked in number and value. Royalty monetization was more than $10 billion over the past five years (Exhibit 6). It could grow further if it extends to midstage pipeline assets and helps to boost companies that cannot be financed in public markets. Royalty financing carries low risk and a moderate cost of capital. It may be a good fit for multi-asset biotechs because the royalties would apply to the entire future business.
Another nontraditional form of financing could come from private equity. In recent years, many private-equity investors based in Europe and the United States have added capabilities to enable clinical-trial financing; they have acquired or made investments in venture capital, blurring the lines between private equity and VC. There has also been an uptick in healthcare private-equity fundraising in the first half of this year, matching VC raises (Exhibit 6). We anticipate that a broader group of biotechs will partner with well-capitalized private-equity investors while on the journey toward an improved public market or toward proof points that derisk investment for large biopharmas. More private-equity-led buyouts are also a possibility.
Debt financing has seldom been used, but market challenges have led to an uptick among clinical- and commercial-stage companies. Multiple biotechs have recently taken on debt in isolation or as part of broader financing packages. Debt-financing vehicles are best explored by extensive analysis of the long-term implications, such as the ability to service convertible notes, in the context of all plausible future scenarios for the company considering trial outcomes, commercial performance, stock price, operating expenses, and other potential investment needs.
Biotechs should consider the characteristics and long-term implications of debt and other financing options (Exhibit 7). Finally, we note that the core objective of the biotech ecosystem is to deliver on the promise of innovative biotechnologies and the highest-potential assets in the pipeline. Undifferentiated assets and platforms will struggle to find capital that may be better deployed elsewhere.
Biotech-to-biotech BD&L to realize benefits of scale. Large biopharma companies have long been the default partner for early-stage licensing and acquisitions once clinical or commercial proof points have been demonstrated. They will probably remain so, but biotechs in search of partners or acquirers now have additional options in the form of commercial-stage biotechs and biotech asset aggregators.
Biotechs are independent for good reasons; it allows the formation of a team of scientists and executives with bespoke capabilities, a laser focus on developing and maximizing a core platform, and incentives to reach transformative long-term impact. These benefits may continue as an asset portfolio or platform matures, but they often become less compelling. The biotech downturn has shone a harsh light on the inefficiencies of single-asset companies. Capital-constrained companies—as well as some with plentiful capital—could create value by merging with or acquiring other biotechs and realizing the benefits of greater scale.
Eighty biotechs launched new products between 2017 and 2021 and transitioned from R&D-only to fully integrated biotech companies. Forty-one percent of the 273 new molecular entities launched in this period came from companies launching their first product or following up on a first-time launch in the prior five years (Exhibit 8), up from 19 percent in prior years. This rise was driven by readily available capital, limited acquisition interest from large biopharma companies, and potential for value creation in independent companies developing specialty medicines. Prior analysis has shown that valuations for biotechs with marketed assets have been less damaged during the downturn. In a down market, biotechs that have recently launched their first product could be natural licensees or acquirers if they have a strong cash position and a desire to grow their portfolios.
In recent years, we’ve also seen the maturing of new approaches to building portfolios, with several asset aggregators showing that you don’t need to be a large biopharma to finance and manage multiple assets. These companies have their own valuations challenges, but they represent another newer category of acquirers or licensees of clinical-stage assets that other biotechs could engage.
Clinical and preclinical biotechs have not typically partnered or merged, but the dual threat of cash constraints and valuation challenges could lead to creative deal making. Such combination therapy for biotechs could take multiple forms:
- Immediate capital synergy: a capitalized biotech with a relatively weak pipeline could combine with a cash-constrained biotech with a stronger pipeline.
- Efficient value creation: complementary platforms and portfolios can be more valuable when combined. For example, data, technology, or intellectual property (IP) assets could enhance differentiation and the probability of success. Also, certain assets and programs could be managed more effectively together than alone if companies had complementary technical and management expertise.
- Near-term capital synergy: certain combinations could reduce or eliminate near-term capital needs, for instance, for building out a cell-therapy biotech’s manufacturing or a late-stage asset developer’s commercial infrastructure.
Delivering on the promise of the biotech pipeline
The strategies selected will depend on company context, the willingness of management teams and boards to pursue more unusual strategy options, and companies’ ability to execute. The successful implementation of new strategies may require detailed road maps and efficient management of processes such as postmerger integration; proactive syndication with investors explaining how practical and bold actions today could bridge to the next inflection point and future aspirations; and robust change and talent management.
