How to assess RISK on a Biotech Investment? (by Marcos Valadares)
Last post we made brief intro on the uniqueness of developing a biotech business in a mostly tech flooded world where most metrics and KPIs generally used do not apply. Well, then, what should apply? How should we evaluate progress on of a biotech? Again, remember we are mostly focused here on the concept of therapeutics, biotherapeutics and advanced therapy medicinal products (ATMPs – mostly cell and gene therapies) but the framework could be cautiously extrapolated to related fields as well.
In a tech drive world, revenue is a very relevant metric as it speaks quite directly to the acceptance of the costumer to your product to the point of paying for it and recurrent revenue speaks to how loyal these costumers are to your solution. As you know, a biotech can’t sell until regulators approve its product. Therefore, generally speaking, approval by regulators serves as a proxy for a successful product meaning that if you can convince regulators that your product works, you will have a market to tap into (there are relevant considerations to be made here, but this will be for later posts). Now, the question becomes: how to get approval from regulators about the efficacy and safety of your product and how this relates to risk? Historically, this has been roughly divided in 4 stages (before approval), but I will add an extra one in the beginning to explain investors rationale from a startup perspective.
According to the handmade lines in figure 1 you will see the four stages, namely: preclinical, Clinical trials phase 1, phase 2, phase 3 and I will add the proof-of-concept (PoC) before the preclinical stage. Notice that as the stage of the product towards approval progresses in time the perceived risk diminishes (inverse correlation). This seems like a straight-forward model to evaluate risk and it is. Now we will share some insights on what to expect on each stage.
On the first stage (PoC) the company is laying out its foundations filling (or licensing) patents and building a strong case for its business. Scientifically, the company is running the most fundamental of its experiments to prove beyond reasonable doubt that its tech works and this very likely involve key animal experiments in the most translational model accepted in the literature. Likely the results would need to be published (after being file for patent when relevant) and this generates reliance to the general public and investors that you have a somewhat solid case for your business. Generally, the company is taking high risk capital (pre-seed/seed capital) and relying heavily on grants. Some cases the company is still inside universities, sharing a room with other companies somewhere or at incubators on stealth mode. Larger venture firms (like Arch Ventures, Flagship Pioneering, Atlas Ventures, etc) create their own companies internally at this stage and no one knows about them. It is harder to find investors at this point and negotiations need to be kept simple (SAFEs from Y Combinator are a good benchmark) because, in the end, there will be much more to come. Investment sizes vary immensely but I would say anything adding up to US$10MM could be considered a seed round and do not expect one single check but rather many small checks ~US$200-1M) until your point has been made clear. There are cases of large seed rounds (>US$10MM) but these are the exception, not the rule.
Next time, we will take a deeper look into the Preclinical stage and what to expect. Stick around! 🙂