Faced with patent shortages to replace flagship products, Big Pharma is increasing investments in smaller biotech companies to capture innovations early.
Most new companies wither and die if they run out of initial funds before they’re profitable. In biotech, companies may strive to hit goals such as proving that a technology works as intended, developing prototypes, moving technologies to human models, or the familiar transitions to later stages of clinical trials. Any of these milestones can trigger infusion of additional capital.
Hitting any of these goals creates something valuable that another larger company may want to buy, and if a biotech company develops technology that enables or leads to a medical treatment, pharmaceutical companies are usually the interested buyers.
However, in contrast to industries where market needs are identified from consumers, biotech startups must keep an eye on the needs of potential buyers and net a profit for investors. The opposite trend has recently emerged, with buyers starting to sow their own seeds well in advance.
Biotech blogs have been buzzing with coverage of major pharmaceutical players entering the venture capital space to directly invest in startups, including Pfizer, Roche and Merck. Last year, one of America’s largest venture capital firms, Flagship Ventures, teamed up with Merck’s Global Health Innovation group to invest up to $250 million in new ventures, bringing Merck’s venture capital involvement up to $500 million.
Merck and Flagship Venture’s entry is comparable in size to another fund dedicated to biotechnology created by Sofinnova Ventures last year, weighing in the $440 million range.
At first glance, these seem like good changes for aspiring biotech entrepreneurs.
The upside of having Big Pharma funding discovery companies are obvious: biotech profits are reinvested into new biotech ventures; demand is created for the biotech industry and people within it; and the use of discoveries funded by the public increases. Small organizations are more nimble and can adapt to solve problems quicker than larger, more established firms. Ventures backed by large pharmaceuticals may also have access to technologies only available in larger companies. This supportive environment can provide a company with very strong incentives to succeed.
All funding, comes with a catch, and I haven’t seen any drawbacks discussed that might come with pharma backing.
For instance, one common feature investors may ask for is right of first refusal over technology developed within the venture. In essence, the larger pharma company gets to choose whether to buy the smaller company (or its technology) before any competitors have a chance to do so.
If all goes well with the new venture, this is isn’t a significant impediment.
However, a right of first refusal can restrict a company from freely approaching other buyers or from acquiring subsequent investors. In essence, it shrinks the market for that startup and potentially keeps it from realizing a valuation that it could have otherwise.
What could happen if the initial investor isn’t interested in the technology anymore but a competitor is? Would the startup company be bought out and shut down to keep its technology away from another pharmaceutical giant? Despite being a poor idea for society, this kind of defensive strategy is common: take Microsoft, who had such control over Nvidia, maker of graphics chips for the Xbox, for most of the 2000’s.
So although Big Pharma seems to be opening its wallet and embracing startups, those involved in smaller research companies should be aware that this doesn’t make navigating the field any easier: strings come attached with the benefit of having a major sponsor for your work.
Paul Krzyzanowski
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