Bleak funding future forecast for biotech

C&I Issue 11, 2009

As the financial crisis deepens, securing funding is increasingly difficult and expensive for European biotechnology firms. Most of Europe’s small biopharma companies have only enough financial resources for up to 18 months of operation, over half feel under threat and one in five are at risk of bankruptcy by the end of the year, according to the European Biopharmacuetical Enterprises (EBE). That could mean the loss of 20,000 high-skill jobs and permanent damage to Europe’s research. With governments reluctant to step in, the outlook is gloomy for a shrinking industry that must find creative alternatives if it is to hold its own against the US.

 The market meltdown has meant that funding is down across the board. Overall capital raised by European biotechs fell from €5.5bn in 2007 to less than €2bn in 2008, according to Ernst & Young (E&Y).

 Typically, a biotech company is initially financed by angel investors, followed by entrepreneurs or seed investors, then funding rounds by venture capitalists (VCs), who subsequently realise a return, often through an initial public offering (IPO). However, IPOs are virtually non-existent in the current financial crisis; in Europe, the amount of capital raised in IPOs in 2008 plummeted by 89% to $111m. Unable to exit through IPOs, already risk-averse VCs are investing in even later stage projects or demanding significantly more equity for their money. As a result, E&Y says that VC financing of biotechs has fallen significantly, down 20% to €932m.

 Money raised from such financings as followon transactions, debt offerings and private placements, is also down 77% to $1.1bn, according to E&Y. ‘Many smaller companies face potential bankruptcy as traditional sources of funding – debt markets, public offerings, private placements and convertible bonds – are still largely closed for cash-burning firms,’ say analysts at Datamonitor.

 While it has always been relatively hard for biotech firms to attract investors, quality companies have managed to secure funding. But over the past year, the terms for funding – typically demanding a greater equity stake, or securing investment against the underlying intellectual property rights – have become more onerous, according to IP firm Marks & Clerk.

 Moreover, ‘There is a bigger divide between the have and have nots,’ says Ian Oliver, senior manager focusing on biotech at E&Y. ‘The haves had cash raised before the crisis hit, but the have nots must reduce their burn or raise cash [somehow].’

 With IPOs not expected to pick up for another 18 months, a private firm must now cast as wide a net as possible for funding options. And it is pharma companies that hold the lifeline, says Oliver.

 Although the total value of European strategic alliances fell 12% to €8.8bn, many deals have higher and higher potential values, with big pharma prepared to pay large upfront payments and milestones for promising technology, says Oliver. The symbiotic relationship between biotech and biotech pharma is expected to grow and develop, resulting in more alternative deal making, such as partnering earlier and for longer, or creatively dividing geographic rights.

 Merger and acquisition (M&A) transactions in Europe totalled €3.4bn in 2008 – one of the most active M&A years by value in the history of the European sector (after adjusting for megadeals), according to E&Y. And more consolidation of the biotech industry is expected as big pharma takes advantage of currently depressed valuations, shrinking the sector before the recession ends, according to Marks & Clerk.

 However, absorption of biotechs by big pharma may not be good for the future of the industry nor Europe. ‘On the one hand, consolidation and partnering will help speed route to market. On the other, a loss of independence could push the industry away from innovation towards conservative “me-too” products,’ says Mike Gilbert, partner at Marks & Clerk Solicitors.

 Dirk Carrez, director of industrial biotechnology at the European Association for Bioindustries (EuropaBio), agrees pointing out that big pharma are themselves merging and focusing more on their core businesses and less on new activities. Carrez says Europe will see the impact in about five years, as less research leads to empty pipelines and non-EU companies buying biotech patents.

 As well partnering or merging opportunities, Oliver says the challenge is for companies to be creative by leveraging all possible sources of traditional and non-traditional funds, including government contributions, charities and disease foundations.

 Meanwhile, European governments – many of whom are already cutting drug bills by spending less on branded products – have done little to help the sector recover. Only Norway’s government has provided a package of measures, worth around £300m, to rescue its biotechnology companies. And although the UK’s chancellor Alistair Darling committed £750m to a Strategic Investment Fund that will focus on emerging technologies, including biotechnology, the details about how the funding will be distributed to small and medium-sized enterprises (SMEs) are not yet available.

 Clive Dix, chair of the Bioindustry Association, recently criticised the UK government for failing to address the issue of access to finance and overlooking such recommendations as the establishment of an innovation fund, changes to R&D tax credits and Enterprise Investment and VC Trust schemes.

 The EBE has called on the European Commission to take urgent action, to ensure biotechnology remains a major component of Europe’s knowledge-based economy. ‘This is not just about saving jobs in the short term, it’s about protecting Europe’s capacity to drive medical innovation,’ says Carlo Incerti, EBE president. ‘Small biopharmaceutical companies represent a substantial part of the future of Europe’s health and competitiveness. If we do not support the sector, much of the innovation already created may be lost.’

 In an effort to help SMEs access finance, EuropaBio has established an SME Platform, bringing together SMEs, VCs, private banks, European institutions and national biotech associations. The Platform has come up with five main recommendations, although it is not yet clear how these will be implemented.

 The first is to make existing funding instruments more accessible. At the moment, for example, biotech companies are excluded from risksharing financing. The second recommendation is for European institutions, such as the European Investment Bank, to co-invest in, or with, VCs in biotech SMEs. Another is for EU member states to make maximum use of the European State Aid rules; many EU member states are unaware of the exemptions for State Aid for research, development and innovation, says Carrez.

 In the longer term, EuropaBio’s SME Platform suggests that measures – such as grants for translational research or grants for proof-ofconcept studies for biotech SMEs – should be developed so that Europe captures more of the value of its research. Moreover, it is hoped that the EU Framework Programme for Research will be made more attractive for biotech SMEs by, for instance, changing the criteria for applying for grants, and providing grants to fill the gap between ‘pre-competitive research’ and commercialisation.

 Meanwhile, the key to driving investor confidence in European biotechnology is to do a better job of advertising its product success, according to both Oliver and Carrez. With very limited analyst coverage on the public markets, biotech has little value within an investment portfolio and very little inherent advertising.

 As the funding crisis continues, more casualties and continued restructuring of the sector are expected. If something is not done soon to help SMEs access financing, Europe could lose out to a US biotech revival. Marks & Clerk points out that US President Barak Obama’s industry reforms, such as lifting of the stem cell funding ban, are expected to increase US dominance of the biotech industry, attracting talent and leaving Europe further behind.

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