The biotech conundrum – is patient capital the solution?

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By Min Hu, PhD

Starting a biotech company is a monumental task. Entrepreneurs need to be prepared to commit for the long term, and spend tens or hundreds of millions of dollars before reaching the first customer. It is a dark and winding tunnel fraught with traps; at any point the doors can slam shut because of a tiny misstep, or from forces outside the founders’ control. The company can become worthless overnight if a key product fails to demonstrate sufficient efficacy in a clinical trial, or if the company can’t raise further capital to continue. 10 years of sweat and toil can go to waste in an instant.

But the promise of becoming a unicorn and curing some of the world’s most debilitating diseases is worth the cost to some. A startup with a therapeutic technology in clinical trial phase 3 is easily valued at over US$500 million, sometimes over a billion dollars. Many are listed, for example on Nasdaq. Founders and investors can cash out their millions even before the product gets FDA approval.

With such a big prize at stake and high risks involved, investors have been asking, how can we make this process smoother and chances of success higher?

One of the solutions we have seen over the last years was “patient capital”. Investors would commit capital to startups with no medium-term exit in mind. Entrepreneurs were free to use the money for as long as needed to make their technologies work. Capital could be locked in for 10 years or more, before the company eventually launch their products and generate revenue and profit. This concept sought to solve the conundrum that entrepreneurs and investors faced – biotech startups require enormous amounts of capital for many years, before seeing its first customer. Patient capital is supposed to remove the pressure and stress on entrepreneurs for having to deliver an equity exit within a 5-year timeframe, a typical structure in the traditional private equity GP-LP setting, so that entrepreneurs can focus on long-term value creation. They can rest assured that money invested in the business will stay with the company until it generates revenue itself.

Sounds like a good idea. But is it the most efficient solution?

Let’s imagine a biotech startup invested by deep-pocketed “patient capital”. The founders know that this money is in no rush to exit, and new capital will most likely come in when the company needs it. So they create a grand plan to build one of the greatest biotech companies. Everything should be done to perfection. This of course will take a long time, but never mind, there is no rush anyway.

The entrepreneurs are crafting a masterpiece. The vision is grand, but there is a high risk of losing touch with the tough commercial world. Mistakes are tolerated without immediate self-reflection and consequences, and frequent check-ups are not performed. There isn’t an urgency to “deliver value”, so failure is not well defined.

Let’s imagine another biotech startup invested by a couple of small VC funds who have to deliver an exit for its LPs in 5 years’ time. In order to achieve that, the investors work with the company to carefully examine all the possible paths it can go down in the next few years, and choose one that would generate the biggest “value inflection” with reduced risks. Of course, there are also backup plans and detailed milestones to keep the company always in check.

Goals are set carefully to increase the company’s value in the medium term. With the urgency and single minded goal to create value, the company naturally focuses solely on developing the most valuable assets. They might well miss some great opportunities, but resources are limited and time is tight. With short-term and medium-term milestones set and relentlessly monitored, signs of failures emerge quickly. This allows either an early fix or quick death, which would no doubt increase capital efficiency and benefit the ecosystem.

Capital is like a river. It has to flow in order to bring life. When capital stops flowing, it loses its vitality, and the water gets murky. A stagnant river is effectively, dead.

When capital gets invested into a new company, it allows the company to acquire essential ingredients to grow and mature: cash, expertise, manpower, connections, a stamp of approval, etc. Then, capital has to move on, giving way to new capital, offering a different set of ingredients appropriate for the next stage of its growth. Flowing capital also instills discipline in the deployment of resources. Valuable assets get their deserved attention and floundering projects are cut off quickly.

Flowing capital alone is, of course, far from a complete solution for the biotech conundrum. It needs to pair up with intelligence, or “smart capital”.

I will leave it to another time to elaborate key ingredients of smart capital. As a venture investor in healthcare, I’m privileged to be running at the forefront of an exciting and vibrant industry and learning many invaluable lessons every day. I would be thrilled to share these with you in the near future. So stay tuned.

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