Thursday, May 05, 2011

At Allicense, VCs Avoid The Creep

If Tuesday’s discussions at Deloitte Recap’s Allicense conference focused on how VCs are putting their money into new biotech companies, Wednesday’s sessions dealt largely with the challenges they face in getting their money out – and what they’re doing about it. Privately-held start-ups are continually struggling with structured buy-out deals that delay full liquidity. Those few companies that can go public must debate internally whether to partner their assets beforehand, a variable that may not be as validating as once thought. And some have even looked for liquidity through creative asset-based financing arrangements that provide returns without an M&A deal or a public listing.

As Cooley LLP life sciences partner Barbara Kosacz pointed out during an afternoon panel, the weighting of earn-out deals has shifted heavily toward milestone-based biobucks, a trend she doesn’t see turning around anytime soon. “It used to be the icing, not the cake,” she said, postulating that a $500 million upfront deal with a $100 million earn-out is largely a thing of the past. Now, she says, “we have creep” – a series of incremental shifts that have devalued upfronts and placed more weight on contingencies that may never materialize.

In tandem with the shift have come more complicating factors, as various panelists noted: retention of original management, earn-outs booked as liabilities, and diligence clauses that can lead to potential conflicts over whether the buyer did its best with its acquired assets. Former Calistoga Pharmaceuticals chief business officer Cliff Stocks, whose company sold to Gilead for an impressive $375 million upfront in February, even suggested that sales royalties could increasingly come into play as an earn-out component, with shell companies being set up to collect royalties and redistribute them to selling stakeholders. It'd be yet another way M&A deals will continue to take cues from licensing arrangements, as they have for some time.

Though the IPO market has been difficult for years, another afternoon session zeroed in on the companies that can get reach the public markets – and whether their partnerships have been a boon or a liability. Moderator Michael Brinkman explained that where partnerships were once seen as validation, more current prevailing wisdom is that a good asset is worth holding onto completely. Indeed, just two IPOs since the beginning of 2010 had significant partnerships – Ironwood's multiple geographic carve-outs for linaclotide and Zealand with Sanofi – with the remainder going solo. While the few companies with partnerships commanded slightly higher valuations, and most panelists agreed that a pharma partner’s diligence goes deeper than any retail investor's would, Anacor CEO David Perry pointed out that partnering can add risk too, in the event that the licenser changes its priorities.

As far as creative asset-based financings go, we’re no stranger to mouse antibody platform developer Ablexis’ one-of-a-kind Series A deal that looped in five pharma partners to provide its VC investors with eventual liquidity, obviating the need for an IPO or M&A deal to provide returns. That agreement, which featured an LLC structure to avoid double taxation of proceeds passed back to investors, took our Roger award for Exit/Financing Deal of the Year in 2010, and was discussed at length in a morning panel. Pfizer Venture Capital’s Barbara Dalton, who backed Ablexis alongside Third Rock Ventures in the $12 million round, affirmed that such arrangements aren’t for every company, and are best suited for “variations on a theme”-- companies that add value to known science. Does Pfizer still view it as a good deal? “I’m looking forward to more transactions like this one,” she said.

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