Early-Stage Valuation in the Biotechnology Industry

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Early-Stage Valuation in theBiotechnology Industry

Vinay Ranade

February 2008


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THE WALTER H. SHORENSTEIN ASIA-PACIFIC RESEARCHCENTER (Shorenstein APARC) is a unique Stanord Universityinstitution ocused on the interdisciplinary study o contemporary Asia.Shorenstein APARCs mission is to produce and publish outstandinginterdisciplinary, Asia-Paciicocused research; educate students,scholars, and corporate and governmental aliates; promote constructiveinteraction to infuence U.S. policy toward the Asia-Pacic; and guide

Asian nations on key issues o societal transition, development, U.S.-Asia relations, and regional cooperation.

The Walter H. ShorensteinAsia-Pacic Research Center

Freeman Spogli Institute or International StudiesStanord University

Encina HallStanord, CA 94306-6055

http://shorenstein.stanord.edu


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About the Author

Vinay Ranade is chie executive ocer o GeneMedix plc, an Alternative InvestmentMarket (AIM) company listed on the London Stock Exchange. GeneMedix is engagedin the business o research, development, manuacturing, and marketing o biosimilars(biopharmaceutical products) in Europe. GeneMedix is a subsidiary o Reliance LieSciences, a research-led, biotechnology initiative o the Reliance Group o Companies,India. Ranade is a chartered accountant (CPA), qualied in India, and a managementgraduate o the Asian Institute o Management, Manila, Philippines. Ranade hasworked in investment banking in India, both in capital market and project nancegroups. He has also worked with Faber-Castell India and was part o the core team

that set up Faber-Castells Indian business and operations, with specic responsibilityor nance and procurement unctions. He joined Reliance Lie Sciences in 00 andhandled corporate development, nance, procurement, and materials managementunctions.


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Abstract

Biotechnology (or biotech) has impacted almost every aspect o human lie. It has reorganizedindustries, drastically changed healthcare, helped to improve the environment, and led toimportant changes in laws and ethical norms.

Among the various biotech elds, medical biotech has been by ar the most infuential,benecial, and controversial. It has generated not only superlative discoveries to improve theliespan and quality o human lie, but also the greatest amount o wealth or all the playersinvolved, and the greatest volume o public debate.

Several important trends are shaping the uture o the pharmaceutical (or pharma) andbiotech industries. The biotech industry is characterized by the presence o strong clusters in allcountries. The pharma and biotech industries are experiencing an outsourcing phenomenon,

mainly due to a lack o in-house expertise and eciencies. Diagnostics and therapeuticsare increasingly converging, a trend that will lead to predictive and precise diagnostics andpersonalized and preventive medicine. The rst ew years o the twenty-rst century havewitnessed signicant changes in the pharma/biotech alliance landscape. Today we are seeingthe omic-ization o the biotech industry: most o the emerging technologies are genomics,proteomics, cellomics, and pharmacogenomics. In addition, the biotech industry aces uphillethical issues, including excessive marketing, third-world drug availability, genetic engineering,stem cells, and cloning.

The medical biotech industry aces several challenges. First, science, the human body,and disease are, essentially, complex. Second, unlike other high-technology industries, thebiotech product development cycle is very long, even ater proo o concept. Biotech projectstake between ten and twenty years to become successul and cost over $00300 million

beore a product reaches the market. Third, delivery o most biotech products and therapiesis complex and can be painul, oten involving intravenous delivery. Fourth, the precedingthree actors pose signicant challenges or research and development (R&D) nancing. Inaddition, there are certain outside determinants that infuence the biotech industry, includingregulation, demography, reimbursement climate, and big pharma companies.

Stem cell research is one o the most ascinating areas o biology, but it raises questionsas rapidly as it generates new discoveries. The greatest potential application o this research


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is the generation o cells and tissues that can be used or cell-based therapies. A stem cell isa special kind o cell that has a unique capacity to renew itsel and to give rise to specializedcell types. Through the process o dierentiation, stem cells orm various tissues and organs,and the combination o these dierentiated materials develops into the whole human body.This class o human stem cell holds the promise o being able to repair or replace cells or

tissues that are damaged or destroyed by many o our most devastating diseases.Diabetes mellitus is a group o diseases characterized by high levels o blood glucose

resulting rom deects in insulin production, insulin action, or both. Diabetes mellitus is a typeI diabetesalso called juvenile-onset diabetes or insulin-dependent diabetesand developswhen the bodys immune system destroys pancreatic beta cells, the only cells in the bodythat make the insulin that regulates blood glucose. Type II diabetes, also called adult-onsetdiabetes or noninsulin-dependent diabetes, may account or 9095 percent o all diagnosedcases o diabetes. There are more than 94 million diabetics worldwide, with this numberexpected to exceed 333 million by 05.

Insulin is currently the most eective drug or controlling hyperglycemia and is widelyaccepted as the gold standard or treating type I diabetes and even late-stage type II diabetes.However, physicians and patients are reluctant to use insulin until other less eective drugshave been attempted. This is mainly because insulin therapy is invasive and painul: patientsmust take insulin intravenously.

One o the most promising ways to cure diabetes is to restore the unction o islet cellsbiologically, either through islet cell transplantation or by engineering cells to restore the insulinsecreting unction. Islet transplantation, a procedure that can restore insulin production inpatients, is a highly promising area o research.

Based on analysis o stem cell research, diabetes market opportunities, and the developmento stem cell therapies, it is possible to place a value on a company in the early (preclinical)development stage o a stem cell therapy or diabetes. Such an exercise involves valuing acompany based on three dierent approaches() the discounted cashfow model, () theroyalty or licensing model, and (3) the comparables valuation model. Sensitivity analysis

based on market, pricing, costing, R&D, and development stage can urther lead to precisevaluation range or a given company.

For biotechnology companies, various drivers play a critical role in company valuation,including people (management team), alliances and partnerships, intellectual property rights,R&D and technology, unding and nancing, market opportunity, and therapeutic area.


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Early-Stage Valuation in the Biotechnology Industry

Vinay Ranade

In laymans language, biotechnology (biotech) entails the use o techniques based onliving systemsplants, animals, or microbesto make products or improve otherspecies. Biotech is a symbiosis o biology/science and technology/engineering. It isperceived to improve the quality o lie on two ronts: () through gains rom thesocial value o its products, and () as an engine o economic growth and development.Biotech has impacted almost all aspects o human lie. It has reorganized industries,drastically changed healthcare, helped to improve the environment, and led to

important changes in laws and ethical norms. This paper evaluates progress in biotechby considering important recent technologies and their applications.Biotechs industrial applications are rooted in the distant past, an overview o

which appears in Table . The modern biotech industry has created large, highlyprotable industrial outlets o great value to society, such as the ermentation,biopharmaceutical, and ood industries; the modication o microorganisms, plants,and armed animals or improved ood production; improved plant and animalbreeding; and environmental remediation and protection. Biotech research is openingup more areas where its application is proving to be a boon, including the ollowingselected industrial applications: healthcare; industrial chemicals and industrial

enzymes; biosensors; bioelectronics/biochips; insecticides, ungicides, and herbicides;the ood industry; the favor and ragrance industry; waste treatment and pollutioncleanup; oil production and processing; and microbial desulphurization o coal.

According to a survey o more than 3,000 rms in the United States, published bythe U.S. Department o Commerce in October 003, a broad range o industries isengaged in biotech. Survey respondents identied themselves within more than sixtyour-digit classications or U.S. industry, rom paints, coatings, and adhesives


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and semiconductor and related device manuacture to waste management andremediation services. Given the astounding variety o industries that apply cellularand molecular processes to solve problems, conduct research, and create goods andservices, it is clear that the application o new biotechnologies is an integral parto the national and international economic abric and thus a critical component oeconomic competitiveness, social well-being, and security.

Table 1. Brie History o Biotech

Period Developments

Pre-science Robust technologies developed and applied withoutunderstanding o scientic principles.

Examples: Alcoholic beverages, bread, cheese, ermented

oods (yogurt), tanning, purication o sewage.Mid 00s940 Medical operations dependent on near-sterility;

manipulation o media to increase product yields; specicprocesses o strain selection; use o pure cultures.

Examples: Acetone and butanol, glycerol, citric acid,lactic acid, yeast in pure culture or ood, odder, baking,alcoholic ermentations, crude enzyme preparations, rstmicrobial (ungal) insecticide.

94090s Microbial processes leading to pharmaceutical (pharma)products; high standards o sterility; pure cultures andextensive strain development essential. This era alsowitnessed sophisticated process control and quality controltechniques.Examples: Antibiotics, single-cell protein, vaccines.

Late 90spresent Identication, isolation, controlled alteration, andgeneration o specic gene products.

Examples: Production o drugs by gene transer (humangrowth hormone, insulin); prenatal screening or geneticdisease (sickle cell anemia); identication o individualsor orensic purposes rom blood or semen samples; genemanipulation strain improvement.


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Based on current biotechnological applications and the industrys near-termpotential, biotech can be segmented according to Figure .

Figure 1. Biotech Industry Segmentation

Diagnostics

Cell biology Therapeutic proteins Gene therapy

Therapeutics

Medical Biotechnology Industrial / environmental biotechnology

Agricultural biotechnology Neutraceuticals

Plant biotechnology

Biotechnology

Each o the segments can be urther divided into more specialized biotech applications.However, in the common parlance, the term biotech reers to medical biotech, asillustrated in Figure .

Medical Biotech

DNA Makes RNA Makes Protein Makes MoneyMedical biotech has been by ar the most infuential, benecial, and controversial eldo biotech. It has not only generated superlative discoveries to improve the quantityand quality o lie, but also the greatest amount o wealth or all the players involved,and the greatest volume o public debate. Rapid advances in molecular biologyrecombinant DNA (rDNA) technology, or genetic engineering, in particulararegiving bioscientists a remarkable understanding and control over biological processes.This rDNA technology will be the most revolutionary technology o the rst part othe twenty-rst century. It will have a proound impact on medicine, the diagnosisand cure o hereditary deects and serious diseases, and drugs and vaccines or human

and animal use.The biotech and traditional pharma industries overlap in many ways and thus need

to be evaluated together, though they dier in many respects. The basic dierencebetween the two industries is that the traditional pharma industry makes drugs andmedicines based on chemistry, whereas medical biotech uses biology to make drugs andtherapies. The most compelling reason to study their relative positions and strengths


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is that they aim or the same end result: improving the lives o their customers, thepublic. In the uture, however, we shall see these industries convergein businesscontrol rather than process. This convergence has already begun through alliances,partnerships, and mergers and acquisitions (M&A).

Today there is a great mismatch between the two industries in terms o theirpotential and refected market valuation. Figure compares the two biggest rms othe pharma industry, Merck and Pzer, vis--vis the biotech industry as a whole.

Figure 2. Pharma versus Biotech

0

50

100

150

200

250

300

350

400

mkt cap revenue drugs pipeline

Merck &Pfizer

Biotech

Source. Burrill & Co. presentations, November 4, 003 and April , 004.

Figure illustrates the uture potential o the biotech industry in nancial terms.However, the pharma industrys potential exceeds that o the biotech industry onthree counts:

Expertise to take products rom bench to market. Pharma players are wellequipped to conduct clinical trials and work with the FDA to obtain productapproval. The biotech industry lacks this experience and capability, and in manycases has depended on the pharma industry or it.

Marketing and distribution. The biotech industry has neither the necessary salesand marketing expertise nor the reach to physicians and patients to make aproduct a blockbusterthat is, one with sales o more than $ billion.

The pharma industry has the tremendous nancial muscle needed to take apotential product through all the phases o laboratory and clinical developmentthrough to market launch.


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In these key respects, the biotech industry has a long way to go to catch up withthe pharma industry. But there are indications that the pharma industry is willing toshare a larger slice o the prots with the biotech industry, as the latter shows signso moving up the value chain.

Medical Biotech Industry Statistics

The medical biotech industry has achieved rapid success in recent times, as theollowing acts show:3

More than 55 biotech drugs and vaccines approved by the FDA have treatedmore than 35 million people worldwide.

Seventy out o 55 biotech products were approved in the last six years. There are more than 30 biotech products currently in clinical trials targeting

more than 00 diseases including various cancers, Alzheimers disease, heart

disease, diabetes, AIDS, multiple sclerosis, and arthritis.Biotech is responsible or many medical diagnostic tests that detect diseases early

enough to treat them successully.

Table 2. Biotech Industry Statistics or Major World Markets (2002)

Particulars Unit U.S. Europe Canada Australia

Revenue $ B 45. .3 .5 0.9

R&D $ B 3.3 5.0 0.6 0.

Market cap $ B 34 5 . 4.

No. o companies Nos. ,455 4 4

No. o employees Nos. 43,000 33,300 ,00 6,500

Source. Burrill & Co. presentations, November 4, 003 and April , 004.

Medical Biotech in the United States

The rst in-depth government assessment o the development and adoption o biotechin industry was accomplished by a survey o more than 3,000 U.S. rms, conductedby the U.S. Department o Commerce in October 003.4 Its ndings were:

The industry is diverse.

Firms vary greatly in size and scope, rom small, dedicated biotech companiesthat are research and development (R&D) intensive and operate primarilyon venture capital, grants, initial public oerings (IPOs), and collaborativeagreements to large, diversied companies that have greater in-house resourcesand well-established production and distribution systems.


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Most companies are at a nascent stage.

Ninety percent o respondents had 500 or ewer employees. Fourteen percent were established prior to 90, 0 percent were ounded ater

96, and 9 percent emerged during 99300.

Biotech is the core business and healthcare the major ocus.

For 90 percent o the rms, biotech-related business lines accounted or morethan 5 percent o net sales, employment, and operating income.

Seventy-two percent named human health applications their primary area obiotech-related activity.

Sixty-ve percent t into one o two broad categories: medical substances anddevices and scientic R&D services.

Biotech is characterized by rapid advancements.

Patent data underscore the dynamic and rapidly evolving nature o biotech. In thelast quarter o 00, companies reported 33,3 pending applications or biotechproducts or processes, compared with 3,99 current portolio patents.

Beore addressing trends in the industry, I will discuss intellectual property rightsand the nancing o biotech ventures.

Intellectual Property Rights (IPR)

Broadly, intellectual property consists o design rights protecting aesthetic creations,trademarks, copyright, condential inormation, patents, and other special rights,including Plant Breeders Rights.

A patent is a negative right, which permits the inventor to stop third parties romusing the invention. It is not a positive right in that it does not give the inventor theright to do something that he would otherwise not be able to do. A patent is notobtainable on demand by the inventor, nor does it act as an all-powerul talismanpermitting the inventor to have the market or his invention all to himsel. Patentsinvolve considerable time and expense.

Patents can be obtained or most industrially applicable processes, devices, and

products. Patents are not granted automatically, and in practice an inventor is notentitled to a patent as a right. Patent examiners normally conduct a search to nd outwhat prior proposals in the same general area have been published. Frequently, theprecise orm o the patent is the subject o much argument with the examiner.

A patent specication usually contains an abstract, ollowed by a detaileddescription o the invention, and nally some numbered statements, which are called


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the claims. The claims dene the boundaries o the monopoly that the applicant isclaiming. Once the patent is granted, any third party can look at the claims andintheory at leastunderstand the orbidden territory o the patent. It takes one to veyears to obtain a patent, depending on the country. Generally speaking the inventor oa completely new technology will be able to obtain wide claims, but as a technologydevelops, the allowable scope o claims narrows considerably. Though as a generalrule the words o the claims must be regarded as the absolute boundaries o what isprotected, courts are occasionally prepared to bend the rules, and hold that somethingnot literally within the scope o the claims is nevertheless an inringement. This canbe done by the doctrine o equivalents, or what is known as the doctrine o pith andmarrow. The cardinal rule o patents is that whatever is claimed must be new andmust not be obvious. A patents age is judged by its date o application. The ParisConvention permits an inventor to claim as the priority date the date o rst lingin his home country, provided that the ling in the oreign country has been madewithin one year o the rst ling. In the United States, though, when there is a dispute

between applicants as to who made the invention rst, an inventor can obtain a dateearlier than the date o ling i he can show that the invention was conceived andrst reduced to practice at a date earlier than the ling date.

The law is a creature o the society that makes it. Labor laws are adapted to real-world labor-management disputes. Commercial laws generally are adapted to thenorms and expectations o actual business practices. Technology has driven mucho the change o the late twentieth century, and some o the most rapidly evolvingareas o law are those relating to science and technology. Patent law is no exception.Patent law serves a public policy to stimulate innovation and promote the progresso science and the useul arts. Inventors and owners avor a broad scope to patents,

whereas their competitors would preer such claims to be narrow. The public interestlies in between, allowing sucient scope to aord a meaningul commercial benet orinnovators but avoiding claims that block competitors rom related areas, since ulldisclosure promotes progress in science by providing ideas to build upon. For biotechcompanies, the existence o pending applications can provide tangible evidence o acompanys research progress and intellectual assets o the company. A granted patentwill in turn infuence the companys development and marketing strategies.

Patent Protection Strategies

With ewer innovative drugs emerging rom pharma companies pipelines to replace

the loss in revenue that mass patent expiration represents, research-based companieswill become increasingly reliant on patent protection strategies, at least or their short-to medium-term growth. In the United States alone, blockbusters with global sales oalmost $ billion will be exposed to generic competition by the end o 00. Theglobal generics market was worth US$ billion in 00 and is orecast to grow bya compound annual growth rate o 3.3 percent between 00 and 00.


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Patent protection strategies include regulatory options and product-relatedoptions. Supplementary protection certicates, orphan drug privileges, and pediatricextensions all into the ormer category; all extend the lie o a patent through avariety o regulatory means.

Among the latter options, pharmaceutical companies initiate reormulation andline extension strategies, generally ve to six years beore a patent expires. Inevitably,as more companies market products or multiple indications rom the outset,opportunities to develop and launch new indications or existing products as a meanso extending patent protection will decline. Line extensions do not oer the same levelo revenue protection as reormulations, due to the potential or o-label prescriptionso generic versions o the original drug. Companies also ocus on additional revenuespost-patent expiration by diversiying into the over-the-counter (OTC) and genericsmarkets. That is, in order to optimize revenues, companies switch their product toOTC status beore the patent expires, rather than aterward. Some companies evenorm alliances with generics companies prior to patent expiration.

Licensing and M&A

Deensive licensing/M&A is the last option when a companys R&D pipeline doesnot oer any promising new revenue generators and the potential or litigation, lineextensions, and reormulations has already been maximized. Licensing agreementopportunities will substantially rise over the next decade.

Patent Protection in the United States

Major dierences between the U.S. and other countries with respect to patent positioninclude the ollowing:

In the United States only, an inventors own disclosures will not invalidate hisU.S. patent provided they are made no earlier than one year beore the date oling in the United States.

Patent applications are not published at the -month stage but remaincondential until they are issued, reused, or withdrawn.

Normally in other countries, it is not possible to add any urther description to apatent application ater the initial one-year priority period. In the United States,an addition can be done by ling a Continuation-in-Part Application.

The United States Patent and Trademark Oce has a completely dierent

philosophy rom other patent oces regarding the prosecution o patentapplications. In the United States, the applicant must be scrupulously careul notto mislead the patent examiner; otherwise, this may have the eect o makinga patent that appears perectly good to be unenorceable.


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Licensing o Rights and Exploitation o Technology

In the biotech eld, exploiting a technology by putting it into practice and selling theresulting product or carrying out the patented process is not the most practical method.This is more so or a new venture, especially i it involves heavy capital expenditure or

i it is not necessarily the most remunerative. Much depends on the size and nancialstrength o the investor. In deciding how to exploit a new technology, one o themajor considerations is what protection is available. Cost determines whether aninventor chooses the trade-secret route or a patent. Obtaining a patent and policingand deending it are expensive.

Smaller biotech companies enter into two major types o agreements with largercompanies. The rst is outright sale o technology. In this case, the inventor loses his rightover the property but, equally, sheds the responsibility or paying or it. A simple assigningdocument is executed that identies the rights to be transerred and the price to be paid.

In the second agreement, licensing is allowed to make use o the technology.Licensing is much more complicated. The license agreement deals with the rights to belicensed, the exact nature o the license, how royalties are payable, and the conditionsunder which it can come to an end. Normally, certain competition constraints areimposed on license agreements but not on assignments. Sometimes, the existenceo complementary technologies leads to a cross-license between the owners, so thateach is authorized to use the others technology. The type and terms o the licenseare primarily a commercial decision, which varies rom country to country and romcompany to company.

Biotech companies rely on patents to protect their discoveries. Without patents,most, i not all, biotech companies would be unable to stay in business. As withprevious waves o technological advancement, patents are undamental to the industry

and oten are contested by competitors.

Financing

According to survey results published by the U.S. Department o Commerce, 53 percento rms reported that the main impediment to the advancement o biotechnologyresearch or product commercialization is access to startup capital.5 This claim doesnot accurately represent the critical role that money matters play in biotechnologycompanies. Indeed, one o the most intriguing nancial stories o the last quarter-centuryis the successul nancing o independent biotechnology companies. Biotech ventures

have been remarkably successul in raising capital on the basis o potential, rather thanactual, operating results, primarily because they oer the possibility o huge returns.The main actors in this success, especially in the United States, include:

Entrepreneurial spirit Availability o risk capital


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Extensive, sustained ederal support o basic research Skilled and motivated workorce Accessible capital markets.

One o the principal determinants o a biotechnology ventures success is its ability

to raise capital at a reasonable cost and in amounts sucient to meet its businessobjectives. The main sources o nancing o biotech companies are:

Equity (including quasi-equity) purchases by venture capital and other privateinvestors

R&D and joint venture (including licensing) arrangements with and equitypurchases by established companies

Government-supported R&D Sales o equity in public equity markets Payments rom research and development limited partnerships

Equipment lease lines Debt nancing

The major stages o nancing are:

Seed investment o no more than a ew hundred thousand dollars; Six months to a year later, rst-round venture capital unding with a lead investor,

ollowed by subsequent rounds o unding;By year three or ve, an additional requirement to pay or the acilities to commence

production and clinical trials (i.e., second and third rounds o unding);

Around year six or eight, the company may become a public corporation, orman alliance, or be acquired by a large pharma or biotech company.

Further, biotech companies conront unique problems and circumstances,including high cash-burn rates, lengthy product development cycles, and uncertainand oten unreceptive capital market. All o these potential diculties have led to thedevelopment o several innovative variations on traditional nancing methods.

R&D Limited Partnerships

Federal income tax regulations ormerly in eect liberally permitted avorable tax

deductions by limited partners in a partnership engaged in passive loss-makingactivities. This led to the widespread use o R&D partnerships, which allowedbiotechnology companies to report, or accounting purposes, payments receivedrom a properly constructed R&D partnership as contract revenues and, at the sametime, permitted limited partners to obtain avorable tax deductions. Once this tax


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treatment was eliminated, the importance o R&D limited partnerships as a vehicleor unding research activities drastically declined.

SWORDStock and Warrant Oering or Research and Development

The SWORD arrangement allows companies to pursue promising but risky researchactivities in an o-balance-sheet manner. A typical SWORD transaction consists othe creation o a new special-purpose corporation, which is sold to the public throughan oering o investment units, or SWORDs. Each SWORD consists o one share oa special-purpose corporation, subject to a call option in avor o the company, and awarrant to purchase one share o stock in the sponsoring company. SWORD becomesunbundled ater a specied period, generally 3 to 30 months, at which time stock andcompany warrants start trading separately. The money raised is transerred to thesponsor company in exchange or an undertaking to perorm certain research activitieson behal o a special-purpose corporation. The special-purpose corporation is givenownership rights to all products and technologies developed out o that research.

However, the companys call option on the special-purpose corporation stock allowsit to capitalize on such developments should they prove successul.

SWORD allows the company to account or R&D costs as income rather thanlosses, and the sponsor company is also able to protect itsel against exposure to riskin the event o an unsuccessul research eort. Purchasers benet in two ways: thereis a signicant upside i the company exercises its call option, and i it is not exercisedthere is a lesser benet through exercise o warrants to purchase the companys stock,provided the stock continues to trade at a level above the warrant exercise price.

The Virtual Corporation

The search or sustainability has led to a variation on traditional top-downorganizational structure. In a virtual corporation, employees are ew and key companyunctions are contracted out to third parties. This helps to avoid many o the bricks-and-mortar costs associated with building laboratories and manuacturing acilities.However, it also leads to the loss o oversight and control that is inherent in dependingupon a third partys perormance. Many biotech startups have used this model onlyto build the bricks-and-mortar model ater initial success.

Follow-on nancing means subsequent public oerings. PIPES (private investmentin public equity securities) was introduced in the early 990s. This method o nancingis a public-private hybrid that allows investors to buy stock in public companies at a

discount, usually 5 to 5 percent o the market price, and eliminates the restrictionsnormally placed on private investors. The closing o such nancing is contingent onthe ling o a shel registration statement.


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Table 3. U.S. Biotech Industry Funding (in millions o dollars)

Year IPO Follow-on PIPES Debt VCs Others Total

99 6 ,60 ,3 , 569 4 5,63

99 369 5 9 ,6 00 4 4,03

999 60 5,05 ,433 ,50 ,04 4 0,696

000 6490 ,65 4,06 5, , 03 3,005

00 440 ,539 ,4 4,4 ,39 9 ,94

00 445 99 90 5,5 ,6 0,44

003 453 3,536 ,05 ,0 ,4 44 6,95

Source. Burrill & Co. presentations at industry events, November 4, 003 and April, 004.

Venture Capital (VC)

As is apparent in the above table, VC money has contributed signicantly to biotechindustry nancing and, unlike other orms, has been steadily increasing. Recently, inact, the biotech industry overtook the IT industry in terms o attracting VC money inthe United States. VCs normally und companies in the early stages o development, upto the rst or second phase o clinical trials. It is interesting to note that VCs do notbase their investment decisions on nancial models or on numbers in the companiesbusiness plans. Instead, they consider the people (i.e., the management team and theCEO), the market opportunity that the biotech company addresses, and the technologyitsel. VCs attach little importance to intellectual property rights (IPRs) unless theyare a necessary condition or the companys success.

Industry Trends

Several important trends are shaping the uture o the pharma and biotech industries.Some may be more applicable to one segment than the other, but studying them willhelp either industry to help prepare valuable strategies.

Clusters

An industrial cluster is a geographic concentration o interconnected companies,specialized suppliers, service providers, rms in related industries, and associatedinstitutions that compete but also cooperate. As in the IT industry, the biotech industryis characterized by the presence o strong clusters in all countries. Examples o suchclusters occur in the United States (e.g., Silicon Valley (San Francisco), Boston, SanDiego, Seattle, Maryland), and especially Caliornia; the United Kingdom (e.g.,Cambridgeshire and Oxordshire); Germany (e.g., Munich and the Rhineland);Canada (e.g., Toronto, Montreal, and Vancouver), and India (e.g., Bangalore andHyderabad).


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Many actors play a critical role in the development o these clusters. While itis understood that such clusters cannot be created, support and incentives certainlyencourage their growth. The main contributors include a strong science base, anentrepreneurial culture, availability o talent, inrastructure, research institutions,nancing options, and a supportive policy environment.

Outsourcing

Like the IT industry, the pharma and biotech industries are experiencing an outsourcingphenomenon. This is due to a lack o in-house expertise and eciencies. The pharmaindustrys protable heritage did not provide the impetus to address internal companyeciencies properly, as other sectors have. Investment decisions have not necessarilybeen explicitly linked to shareholder value. From an economic perspective, pastdecisions have not necessarily been based on eciencies, due to the industrys highprotability, protection o perceived core competencies, and lack o aith in thecapability o outside vendors.

As erosion in prices and margins challenges the industrys protability, outsourcingwill increase. In the United States, R&D outsourcing is expected to increase rom $0billion today to $36 billion by 00.6 Unlike the pharma industry, which currentlycontracts out and will continue to increase outsourcing purely or cost savings, thebiotech industry is orced to outsource because it lacks all the expertise o the valuechain. R&D and sales and marketing unctions suer rom declining productivity.It is estimated thatcompared to the 0 percent o activities perormed in-housetodayonly 40 percent will eventually be perormed in-house, and 60 percent othose through a risk-managed portolio o straight outsourcing arrangements andstrategic alliances. In the short and medium term, however, outsourcing is likely to

remain internal or domestic, rather than oshored to low-cost developing countries,due to FDA regulations and intellectual property concerns. Further, e-technologiesin R&D will have a positive eect on the outsourcing sector. They have the potentialto improve outsourcing eectiveness through superior knowledge management andcommunication between vendors and sponsors. Thus outsourcing will help reduceboth the time and the cost o drug development.

Theranostics and Personalized Medicine

The term theranostics has arisen rom a combination o diagnostics and therapeutics.Diagnostics and therapeutics are increasingly converging, a trend that will lead to predictive

and precise diagnostics and personalized and preventive medicine. Many scientists believethat personalized medicine will be the dominant trend o the uture due to the sensitivityand specicity to individual patients, and the compliance benets that it provides.

The new rontier o the post-genomic era is preventive medicine, initiated by predictivediagnostics. Most genomic technologies are enabled to discover molecular signaturesproduced by cells in the early stages o disease that lead to early and correct diagnostics.


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Another trend is the development o theranostic tests that predict drug responsein individual patients. The pre-genomic era has successully developed drugs totreat the symptoms o disease. In the post-genomic era, molecular diagnostics andtherapeutics will allow preventive steps to be taken to stop disease rom developingin the rst place, or to prevent disease rom progressing by treating its cause, notjust its symptoms. In addition to theranostic tests, according to industry experts,predictive tests or approximately twenty-ve conditions are likely to becomeavailable by 00.

Partnering/Alliances

The Commerce Department survey points out the growing importance in biotech opartnerships, alliances, and collaborations. The near-term strategies o 53 percent othe rms surveyed ocus primarily on developing technologies that can be licensed toother customers. Forty-seven percent o rms are ocused on acquiring technologiesrom other companies through licensing arrangements, and 3 percent o rms are

intending to develop joint-venture agreements or technology development. Sincethe early 990s, research and discovery collaborations between biotech and pharmacompanies have increased to the point that they now provide more than hal the totalcapital invested in the biotech sector. Although smaller biotech companies may beengaged in only a ew alliances at a time, some o the most active pharma playersmay be engaged in anywhere rom thirty to orty alliances at once. Not only arethese partnerships o long duration, but the agreement process itsel is lengthy. Inone case study, Novartis screened about one thousand alliance proposals, o whichsix hundred were shortlisted. Due diligence was carried out on orty companies andnally only ten to teen agreements were nalized. This gives an indication o the

time and resources the big companies devote to this purpose.According to the conclusions o another report, the rst two years o the twenty-

rst century have witnessed signicant changes in the pharma/biotech alliancelandscape. These changes concern the number o alliances announced, the value oalliance agreements, the split between relationship- and transaction-based alliances,and the proles o the partnering companies. This study revealed the ollowingtrends and outcomes:

There has been major growth in relationship-based alliances, whereas the numbero transaction-based alliances has remained constant.

There has been an overall increase in the average deal value. More than one-hal o the companies covered under the study are categorized

as biotech companies. Alliances are divided equally between deals involving technology and therapeutic

areas, those involving only therapeutic areas, and those involving technology only.


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Well over one-hal o alliances65. percenthappened in the discovery/preclinicalstage, 4. percent in the clinical development stage, and 0. percent in theregistration, approval, or marketing stages.

Relationship licensing agreements were the most widely employed, co-commercialization agreements were the highest value type, and co-developmentagreements are experiencing the greatest growth.

Oncology was the most popular subject area and also has the highest-value alliances,but cardiovascular medicine is experiencing the greatest growth rates.

Genomics is the most popular subject area, bioinormatics has the greatest value,and drug-delivery agreements are experiencing the highest growth rates.

Agreements between two or more biotech companies are the most popular, bio-pharma oers the highest-value alliances, and alliances involving equipment anddevice companies have the highest growth rate.

Figure 3. Alliances between Biotech and Pharma since 1993

0

100

200

300

400

500

1993 1995 1997 1999 2001 2003

Collaborations

Source. Burrill & Co. presentations at industry events, November 4, 003 and April, 004.

In their simplest orm, these alliances consist o a contractual arrangement underwhich the biotech company perorms specied research unded by the establishedcompany and licenses the sponsor to develop, manuacture, and market products that

incorporate the research results in return or a royalty on net product sales. A jointventure between two companies is ormed with the biotech company contributing itsresearch results and capability and the established company contributing its nancial,manuacturing, distribution, or marketing resources. As the biotech company gainsstrength, it negotiates to retain the right to develop its other products and manuacturea portion o the licensees needs or commercial products. It also seeks to preserve one


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or more countries as its exclusive territory or marketing and sales. I a company isjudicious in its selection o venture partners, the venture can be a creative vehicle toaccelerate the commercial introduction o the companys technology in a dened area,or to build a oundation or the companys eorts in other areas. The relationshipmust be structured to ensure mutual interest and an equitable sharing o control andreturns based on the value o the respective contributions o the partners.

The major terms o the alliance agreement are:

Technology rights: Distinction between basic technology and product technology. Field: Product, application, and territory. The most dicult element is determining

what product is being licensed. It is relatively easier to express specic permitteduses, such as therapeutic vs. diagnostic, human vs. animal healthcare, health vs.agriculture, etc.

License grant: Grant o right describes the primary subject matter o the licensein connection with products commercialization.

Diligence: It is extremely important that the licensor be protected against thepossibility that the license will put the technology on the shel. Two solutions canbe worked out: termination o the license or payment o minimum royalties.

Termination: Agreements commonly contain a termination right or the licenseein the event that the alliance becomes technically or commercially ineasible.Another saeguard is a non-compete clause.

Patents: Licensor should retain the right to prosecute patent applications andenorce patent rights i a multiple licensing strategy is its objective.

General terms: Licensor should obtain product liability indemnity and shoulddisclaim warranties.

A typical deal might involve a small biotech company collaborating with a bigpharma or biotech company or joint development o its product. In such a case, bothcompanies agree to take the product through clinical trials, with the bigger companyhaving the exclusive right to market the product in the U.S. market. The biggercompany makes some upront payment to the smaller company and agrees to undclinical development. The bigger company also agrees to pay certain royalties on netsales to the biotech company once the product is launched. We are also witnessing agrowing trend toward nonexclusive deals wherein biotech companies retain the righto co-promotion or co-marketing.

Research alliances with small, close-to-the-science companies are the source omany innovative ideas, but they present ormidable challenges. Successul collaborationdepends not only on solving scientic and technical problems, but also on successullyresolving many leadership and organizational problems. Eective alliances mustresolve the ollowing issues in order to succeed:

Power dierences and other asymmetries between partner rms, with implicationsor alliance dynamics.


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Sector history and evolution as a basis or understanding the cultural divide thatcharacterizes many biotech-pharma relationships.

The need or leaders on the biotech side to assume greater leadership responsibilityin these alliances.

Dierentand predictablechallenges over the alliances lie cycle, rom startto completion/termination.

Leadership roles needed or productive and eective collaboration across groups,locations, and companies.9

A single alliance may be the lieblood or a small biotech company; the samerelationship may be just one o many or the pharma partner. Management andleadership o these alliances should rest squarely on the shoulders o those on thebiotech side. Alliances should be led and managed by the biotech companies, eventhough it is the big pharma companies that experience the innovation gap, whoneed biotech expertise beyond their own in-house R&D, and who are the paying

parties. Strategic biotechnology alliances are not relationships among equals. Smallercompanies invariably have less say in the alliance yet still have to do more to keep thealliance on track. Yet responsibility or the relationship should all on the shoulderso the leadership o the biotech company or two reasons. First, knowledge rontiersare moving quickly, and biotech companies with competent scientists are better ableto master this dynamic eld. Second, a biotech rms survival depends, to a largeextent, on alliance revenues.

Contrasting cultures, along with dierences between pharma and biotech companies,contribute to complicated alliance dynamics. Big pharma companies evolved rom thechemical industry, and biotech evolved rom academia. The pharma industry culture

is a rigorous culture o precision and objectivity, but also o hierarchical dependency,discipline, and subservience. The biotech industry, on the other hand, stems rom a primarilydemocratic, liberal culture in which ormal hierarchies play a much smaller role. Personaldevelopment and reedom are more important. Challenges also arise due to dierences inscale o operations. For the alliance to be eective, alliance team members must:

Discuss the asymmetry between partners in order to appreciate and manage itsimplications.

Perorm due diligence on the organization and its people to get a good sense othe partners strategy and the perspectives o its scientists.

Prepare each person involved in the alliance, paying special attention tointerpersonal skills.

Avoid surprises by staying in touch with one another to monitor productivityand morale through eective and ecient communication.

Be disciplined and careul in their science. Not guard inormation.


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Be willing to work collegially with one another and with scientists o the partnerorganization.

Have well-dened milestones and exit clauses in the alliance agreement. Form a joint governing group o scientists.0

Alliances may be ineective i team members () do not consider the impact o achange in the senior management o the larger partner on the priority o the alliance;() ail to be upront about diculties with a set o experiments; (3) do not trust thepartner enough to hand over data eciently; (4) assume interpersonal problems willsolve themselves; (5) do not manage the dicult scientist eectively; (6) eel theyhave to ght or attention and commitment rom senior leaders.

Evolving Technologies and Their Convergence

Today we are seeing the omic-ization o the biotech industry: most o the emergingtechnologies are genomics, proteomics, cellomics, pharmacogenomics, and so orth.

These technologies promise more rational drug discovery, aster drug development,targeted patient populations, greater chances o clinical success, aster time to market,and reduced marketing costs. It is also anticipated that new technologies, such as arrayso genes and proteins, will permit analysis o multiple gene and protein expression thatwill more accurately detect and prole a patients disease. The drive or traditionaldrug discovery research has shited rom chemistry to genomics. Previously, researchersmade chemical compounds rst and then tried to identiy compounds use or adisease target. Now, researchers rst identiy and understand a disease target, andthen develop a chemical compound that can be used to counter that target. The drugdevelopment process has become more ocused and, thereby, eective. Next, the drug

discovery process will transition rom structural genomics to unctional genomics tostructural proteomics and nally to unctional proteomics.

In this new era, it will not be any single technology but the integration o manytechnologies and the collaborative eorts o scientists that will allow drug discovery toreach its ullest potential. This will lead to improved eciency and productivity in thedrug discovery process. According to the Pharmaceutical Research and Manuacturerso America, the R&D expenditures o U.S.-based pharmaceutical companies have morethan tripled in the last decade. Pharmaceutical companies are integrating entirely newdiscovery technologies into their drug development programs, through alliances withbiotechnology companies and universities as well as their own in-house initiatives.

From the pharmaco-genomics perspective, three main trends are emerging:

Target validation will take precedence over other niche technologies. Increasing usage o inormation technology hardware and sotware tools will

drive DNA-related data recording and analysis in drug discovery, which in turnwill enhance the speed and accuracy o drug discovery process.


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Diagnostics is the next area o expansion but will continue to be dominated bya ew companies with established expertise.

Pharmaco-genomics will increasingly be driven by marketing. The incorporationo pharmaco-genomics into clinical trials will likely increase over the next decade butwill remain in either early-stage testing or post-launch in phase IV trials. Pharmaco-genomic tests can be employed throughout the drug lie cycle, including in preclinicaldevelopment, clinical trials, regulatory approvals, and marketing.

Through the use o predictive modeling tools, molecular inormatics, and ultra-high-throughput screening technologies, in addition to parallel and integrated drug-discovery approaches, the traditional sequential process o drug target discovery willbecome shorter. There is also an increasing trend toward convergence o dierenttechnologies, both within and outside o biotech, all aimed at reducing the time andcost o drug development, and achieving breakthroughs. This convergence involvesdiverse streams o sciences and technologies, including wet biology (meaning the

actual laboratory experiments carried out), digital biology (involving IT, includingbioinormatics), and extension o nanotechnology applications. Such a usion osciences will not only accelerate the process but will also help scientists to exploreuntouched areas o research.

Ethical Issues

Ethical values include belie in the promotion o patient welare and the social good,scientic reedom and responsibility, sel-determination, encouragement o civicdiscourse, public accountability o scientists and research institutions, and respect ordiverse religious, philosophical, and secular belie systems. It is important to realize

that technologies, like the tools by which they are maniested, can be used or betteror or worse. The biotech industry aces uphill ethical issues and challenges, some owhich are discussed below.

A. Excessive Marketing

Today, companies have huge budgets or promoting drugs. Marketing costs haveskyrocketed and raised the price o products, thereby increasing healthcare costs andreducing the reach o drug benets.

Possibly a more important development is that companies today are reinventingnormal health conditions as diseases, either to boost their new drugs, or to convert

their ordinary drugs into blockbusters. The best example o this phenomenon is drugsor male erectile dysunction. Until a variety o products designed to overcome it hitthe market, this was considered a normal condition. Now even people without thiscondition use these drugs, causing overuse o the product and increased sales andprotability or pharma companies.


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Finally, pharma advertising has reached new peaks, which again has the potentialto result in drug overuse or misuse. The claims and attractive promises made bycompanies in their campaigns induce patients to sel-prescribe medicines and sometimeseven to override their doctors. Restrictions on the costs, as well as guidelines on theauthenticity and quality o drug marketing campaigns are needed.

B. Third-World Drug Availability

Developed countries represent nearly 90 percent o global pharma sales. However,o the 4 million annual deaths caused by inectious diseases worldwide, 90 percentoccur in developing countries. The WTOs Agreement on Trade-Related Aspects oIntellectual Property Rights (TRIPS) is fexible, and to make ull use o that fexibility,member states need to adapt national patent legislation. The current patent protectionsystem restricts the access that people in developing countries have to medicines, dueto their prohibitive cost. Trade-related aspects o intellectual property rights (TRIPS)should not prevent WTO member countries rom endeavoring to protect public health

and, in particular, to promote access to medicines or all. To tackle new public healthproblems with international impact, such as SARS, access to new medicines and healthinnovations should be universally available without discrimination.

C. The 10/90 Gap

There is little R&D being carried out on diseases that primarily afict the poor.According to a report by the Global Forum or Health Research,3 the public andprivate sectors spend more than US$0 billion on health R&D a year, yet only about0 percent o this money is targeted at the diseases that account or 90 percent o theglobal disease burden. O the ,400 new products developed by the pharma industry

between 95 and 999, only thirteen were or tropical diseases and three were ortuberculosis.4 R&D in the pharma sector must address public-health needs and notonly potential market gains. This 0/90 gap has arisen due to the ollowing:

Communicable diseases not prevalent in the high-income countries continue toaccount or a large share o the disease burden in lower-income countries.

Vaccines developed or industrialized country markets may not be eective againstthe dierent types o viruses and bacteria prevalent in poorer countries.

Determinants o ill health can vary greatly between regions. Perormance o health systems and services varies greatly between countries.

Access to treatment and medicines diers between and within countries. Interventions or noncommunicable diseases available in more advanced countries

may not be directly adaptable, appropriate, or cost-eective in lower-incomecountries due to costs and inrastructure requirements.


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These high costs provoke the question: Are we over-investing in this type oresearch? Is it possible to spend more to reduce poverty and improve education andinrastructure, thereby improving peoples health? Society must consider reevaluatingits investment portolio.

D. Genetic Engineering, Stem Cells, and CloningDecisions about the immensely complicated subject o genetic engineering should notremain solely in the hands o scientists. Public attitudes will infuence its evolution andmarketplace applications. The genetic engineering debate could prove to be a criticaltesting ground or eorts to insert socioeconomic and sociocultural measurestheso-called ourth criterioninto governmental policies. Measures o ecacy, quality,and saety alone are insucient to judge the potential risk associated with these newtechniques. Social and moral considerations also play a role. Though biomedicalapplications have progressed rapidly, these actors will have a major impact onagricultural and environmental applications.

Stem cell research raises ethical and policy concerns, but such issues are not uniqueto this eld. The recommendations o the American Association or the Advancemento Science and the Civil Society Institute provide a good overview o key points toconsider about stem cell research:

It is essential that the public be educated and inormed about the ethical andpolicy issues raised by stem cell research and its applications. Inormed publicdiscussion o these issues should be based on an understanding o the scienceassociated with stem cell research, and it should involve a broad cross-sectiono society.

Existing ederal regulatory and proessional control mechanisms, combinedwith inormed public dialogue, provide a sucient ramework or oversight ohuman stem cell research.

Federal unding or stem cell research is necessary in order to promote investmentin this promising line o research, to encourage sound public policy, and to osterpublic condence in the conduct o such research.

Public and private research on human stem cells derived rom all sources(embryonic, etal, and adult) should be conducted in order to contribute tothe rapidly advancing and changing scientic understanding o the potential ohuman stem cells rom these various sources.

Public unding should be provided or embryonic stem cell and embryonicgerm cell research, but not at this time or activities involved in the isolationo embryonic stem cells, about which there remains continuing debate. Thisapproach will allow publicly unded researchers to move more quickly towarddiscoveries that will lead to alleviating the suering caused by human disease.


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Embryonic stem cells should be obtained rom embryos remaining rom inertilityprocedures ater the embryos progenitors have made a decision that they do notwish to preserve them. This decision should be explicitly renewed prior to securingthe progenitors consent to use the embryos in embryonic stem cell research.

Persons considering donating their excess embryos or research purposes shouldbe aorded the highest standards o protection or the inormed consent andvoluntary action o their decision.

Where appropriate, guidelines that can attract proessional and public supportor conducting stem cell research should be developed.

In order to allow persons who hold diverse moral positions on the status othe early participation o the embryo to participate in stem cell research to thegreatest degree possible without compromising their principles, and also to ostersound science, stem cells (and stem cell lines) should be identied with respectto their original source.

Special eorts should be made to promote equitable access to the benets o

stem cell research. Intellectual property regimes or stem cell research should set conditions that do

not restrict basic research or encumber uture product development. The ormation o company-based, independent ethics advisory boards should

be encouraged in the private sector.5

Challenges o the Medical Biotech Industry

There are about nine hundred known human diseases, o which 00 percent haveno cure. With the completion o the sequencing o the human genome, scientists havediscovered thirty thousand genes and orty pathways to work with. The healthcareneeds o the world population are so vast that in spite o achieving great success inthe last decade or so, the biotech industry still aces sti challenges. First, science,the human body, and disease are, essentially, complex. Second, unlike other high-technology industries, the biotech product development cycle is very long even aterproo o concept. In most other industries, especially inormation technology, thedevelopment period is short and a new technology or product rarely ails ater theconcept is proven. Such projects also achieve protability or viability quite early.Biotech projects take between ten and twenty years to become successul and costover $00300 million beore a product reaches the market. Third, delivery o mostbiotech products and therapies is complex and oten painul due to intravenous

delivery. There has been increasing interest in developing easier delivery mechanisms,which sometimes also prove more ecacious. Inhalable insulin is the best example owhat the uture might hold. Fourth, R&D nancing poses a challenge.

R&D investments are encouraged through the incentives o the patent regime,whereby a company obtains exclusive rights to its product or twenty years rom thepatent application ling date. On average, companies receive eight to ten years o


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market exclusivity to sell their product and recoup R&D costs. Critics have suggestedthat this regime leads to high drug prices and high protability or the industry. Indeed,there is great inequality in worldwide drug availability and aordability. Only 0percent o R&D expenditure is invested to research 90 percent o the disease burdeno the world. In this ongoing debate, there have been many suggestions or changingthe ramework o R&D nancing. Some o the alternative approaches include:

Prize model (researcher/research organization entitled to a cash prize based onthe value o the discovery or novel drug)

Direct unding through government or public-sector agencies Open collaborative models such as the Human Genome Project Competitive intermediaries to manage R&D Combination o the above approaches.6

In the case o drugs or critical diseases such as AIDS, companies are especially

challenged to address the tension between their interest and the public good.

Outside Determinants

Regulation

The FDA wants to exclude reasonably unsae products rom the marketplace andindustry wants to bring reasonably sae products in. This clash o interests andattitudes between the ood and drug authorities and industry has a major impacton the latter. In a Commerce Department survey, 59 percent o rms indicated

that the main impediment to the advancement o their biotech research or productcommercialization was the regulatory approval process and associated costs. FDAdrug approval has been delayed in the recent past.

When the FDA declined in December 00 to approve ImClones cancer drugErbitux, the market valuation o both the company and the biotech industry ellby about 40 percent. As it turned out, the FDA approved the drug two years latercompleting its ull scrutiny, whereupon the companys valuation bounced back to itsoriginal level. In the interim, however, the industry was severely challenged, especiallyduring the drug approval process. In short, the FDAs guidelines regarding clinicaltrials and the generic drug approval process can have a pronounced nancial cost.

Aging Population

In most o the developed countries baby boomers are a signicant portion o thepopulation. As lie spans increase, healthcare costs place a greater burden on developednations economies. This aects the biotech industry in two ways: rst, there ispressure to develop cures or diseases related to old age, and second, there is a needto improve drugs and therapies to reduce the cost o treatment.


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Figure 4. FDA Approval Time (months)

0

5

10

15

2025

30

Months

1993 1995 1997 1999 2001 2003

FDA approval

Source. Burrill & Co. presentations, November 4, 003 and April , 004 atindustry events.

Reimbursement Climate

Healthcare costs are an increasing burden on government budgets, and the United

States and Europe oer ample evidence to support this statement. In 003, the UnitedStates spent about 5 percent o GDP on healthcare. Because o this mounting pressureto spend, restrictions have been put in place to limit reimbursement o medicalexpenses. As these expenses are curtailed, company prots will in turn come underpressure, which might act as a deterrent to investments in R&D. Critics o the pharmaindustry believe that prices and rates o return in the prescription drug market areabnormally high. The industry counters that rates o return in the industry, whenR&D costs are appropriately accounted or, are air.

Big Pharma

Big pharmaceutical companies are investing more in R&D, but their productpipelinesalso known as new molecule entities, or NMEsare drying out, as Figure5 shows. O orty-our products generating blockbuster sales in 000, thirty-three willlose patent protections in the United States beore 00. That is, about $ billion oblockbuster sales worldwide will be under threat rom generic competition by 00.Moreover, existing product pipelines are too small to match the market expectations


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and continue to generate similar numbers in the uture. Major consolidation hasalready taken place and big pharmaceutical companies are looking to the biotechindustry to ll their product pipeline gap, as Figure 5 also illustrates.

Figure 5. R&D Investment and New Drug Discovery

0

10

20

30

40

50

60

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

0

5

10

15

20

25

30

35

40

NMEs R&D

Source. Burrill & Co. presentations, November 4, 003 and April , 004, atindustry events.

Stem Cells

Stem cell research is one o the most ascinating areas o biology today. But like manyexpanding elds o scientic inquiry, research on stem cells raises questions as rapidlyas it generates new discoveries. The greatest potential application o this research isthe generation o cells and tissues that can be used or cell-based therapies. Humanstem cell research holds enormous potential or contributing to our understandingo undamental human biology. Although it is not possible to predict the outcomeso basic research, such studies oer the possibility o treatments, and ultimately, ocures or many diseases or which adequate therapies do not now exist.

Stem cells are the cells rom which all 0 dierent kinds o tissue in the humanbody originate. Stem cells occur rom the earliest stages o human development andprovide the starting material or every kind o tissue and organ in the human body.A stem cell is a special kind o cell that has a unique capacity to renew itsel and togive rise to specialized cell types. To put it simply, stem cells, through the process odierentiation, orm various tissues and organs; the combination o these dierentiatedmaterials develops into the whole human body.


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Stem cells have three important properties. First they are capable o dividingand renewing themselves or long periods through cell division. Second, they areunspecialized. Third, they can give rise to specialized cell types with special unctionsunder certain physiological or experimental conditions. The possibility that stem cellsrom one tissue may be able to give rise to cell types o a completely dierent tissueis a phenomenon known as plasticity. This within the category o stem cells, thereare two kinds: embryonic and adult.

Embryonic Stem Cells

Embryonic stem (ES) cells are ound at the blastocyst stage, our to ve days aterthe union o the sperm and the egg, beore the embryo implants into the uterus. Theblastocyst consists o a hollow ball o cells containing about twenty undierentiatedstem cells clustered in an inner cell mass. These cells are believed to be pluripotentthat is, capable o orming all embryonic tissues, but unable to orm a completeorganism without placental support. By culturing the cells derived rom the inner

cell mass, researchers can obtain embryonic stem cell lines that can grow and divideindenitely. These cell lines can be rozen in small batches or uture experiments.Unlike most other types o cells, embryonic stem cells can reproduce themselvesrepeatedly and mature into a wide range o dierent cell types. This provides apotential source o new cells to repair damaged tissue in, say, diabetes or Parkinsonsdisease. These embryonic stem cells dislike solitude and reuse to thrive unless theyare in contact with so-called eeder cells. Mouse cells are normally used as eeders.But there are ears that such stem cells may have picked up nasty viruses rom theirmouse eeders. A number o groups are working on alternativesto use human eedercells or simply dispense with eeder cells altogether. The National Institutes o Health

has approved sixty embryonic stem cell lines developed all over the world as eligibleor ederal unding or urther research.

There are ve ways to obtain embryonic stem cells:

Somatic cell nuclear transer, or cloning as it is more popularly known, is a wayto create embryos without the conventional meeting o egg and sperm that is neededto provide a ull complement o the genetic material to make a new individual.

Embryos can also be created by parthenogenesis, a biological trick in which anunertilized egg cell is coaxed into providing all the genetic material requiredor embryonic development.

Taking one o the existing embryonic stem cell lines and orming another celltype to create new lines.

Culling etal stem cells rom aborted etuses. Removing embryonic stem cells rom unused embryos taken rom in vitro

ertilization clinics.


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Adult Stem Cells

The other groups o stem cells, called adult stem cells, are ound in tissue or organs.Adult tissue reportedly containing stem cells includes brain, bone marrow, peripheralblood, blood vessels, skeletal muscle, skin, and liver. Bone marrow contains at least

two kinds o stem cellshematopoietic stem cells and stromal cells. Adult stem cellsare responsible or repair and regeneration in the body. In the body, adult stem cellscan prolierate without dierentiating or a long period. Evidence to date indicates thatumbilical cord blood is an abundant source o hematopoietic stem cells. Current methodsor characterizing adult stem cells depend on determining cell-surace markers.

The dierences between adult and embryonic stem cells are as ollows:

The most distinguishing eature is their source. They have a capacity to specialize into various cell and tissue types. Large numbers o embryonic stem cells can be relatively easily grown in culture,

while adult stem cells are rare in mature tissues and methods or expanding theirnumbers in cell culture have not yet been worked out.

The potential advantage o using stem cells rom an adult is that such cells wouldnot be rejected by the immune system.

Embryonic stem cells may orm clumps o cells that can dierentiate spontaneouslyto generate many cell types.

Adult stem cells do not seem to have the same capacity to dierentiate.

Developments and Scientic Evidence

Research on stem cells is rapidly advancing knowledge about how an organismdevelops rom a single cell and how healthy cells replace damaged cells in adultorganisms. This promising area o science is also leading scientists to investigatethe possibility o cell-based therapies to treat disease, which is oten reerred to asregenerative or reparative medicine. In 99, or the rst time, investigators were ableto isolate this class o pluripotent stem cell rom early human embryos and grow themin a culture. Thus, this class o human stem cell holds the promise o being able torepair or replace cells or tissues that are damaged or destroyed by many o our mostdevastating diseases and disabilities.

It is now possible to grow these cells or up to two years in a chemically denedmedium. Four types o cells have been successully grown in the lab: pancreaticislet-cell like cells, cardiac muscle cells, blood cells, and nerve cells. Some o the uses

o stem cell research include new windows on human developmental biology, newmodels o human disease that go beyond current animal and cell culture models,transplantation, and gene therapy. Human stem cells could also be used to test newtherapeutic drug candidates.


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The opportunity to utilize small samples o adult tissue avoids ethical or legal issuessurrounding stem cell research. However, production o a large numbers o these cells

is much more dicult.Chronologically speaking, embryonic stem cell research has experienced ups and

downs. In 99, Congress approved a moratorium on experiments using humanembryos ertilized in labs. In 996, the rst Dickey amendment banned ederalunds or experiments that destroyed human embryos. The amendment was renewedin 99 and 000. In 99, researchers at the University o Wisconsin and at JohnsHopkins University extracted and grew stem cells rom human embryos. In July 00,a Virginia lab announced that it had created embryos or research using private unds.

On February 4, 004, news broke out that researchers in South Korea, or the rsttime, had cloned a human embryo and then culled stem cells rom it.9

While many believe that embryonic stem cells oer the greatest promise or developingnew medical treatments, others eel that adult and alternative sources o stem cells havedemonstrated much brighter prospects.The jury is still out with regard to the validityo either claim, but the publics perception will have signicant societal consequences,and may even aect levels o public and private research unding o embryonic andadult stem cell therapies. So ar, adult stem cell research is leading the race.

Swedens Potential

Sweden is a leader in stem cell research. Compared to the United States, where onlyhandul o the initial ty companies engaged in stem cell research remain viable,Sweden has orty private stem cell companies. Swedens research institutes have 3percent o the worlds stem cell inventory, close on the heels o the U.S. 35 percent.Sweden consistently leads the race in per capita output o patents and peer-reviewed

scholarly articles. Sweden has well-established stem cell research programs, thanksto government-backed unding incentives.

Challenges

Despite these promising new approaches, many regulatory, ethical, and scientichurdles lie in the path ahead. Some key questions include:

Is there a universal stem cell? What are the sources o adult stem cells in the body? How will specialized cells derived rom embryonic stem cells behave in the

human body? How can we control the dierentiation o stem cells into specic cell types? What actors in living organisms normally regulate stem cell prolieration and

sel-renewal? What stage o dierentiation o stem cells will be best or transplantation? What dierentiation stages o stem cells would be best or screening drugs or toxins?


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Table 4. Recent Regenerative Research Successes Using Adult Stem Cells

ParkinsonsDisease

Brain unction in ve patients with advanced Parkinsons disease waspartially restored using a natural body chemical known as glial-derived

neurotrophic actor (GDNF). Phase II studies are now being considered.i

A Parkinsons patient treated with his own brain cells appears to have

experienced substantial remission with no adverse side eects. Humantrials in this technique are now being considered.i

Heart disease Bone marrow stem cell, blood stem cells, and immature thigh musclecells have been used to grow new heart tissue in both animal subjects andhuman patients. Human trials using adult stem cells have commenced inEurope and other nations.i

Diabetes Harvard medical school researchers reversed juvenile onset diabetes inmice using precursor cells taken rom spleens o healthy mice and injectingthem into diabetic animals.i

In the U.S. and Canada, more than 50 human patients with type Idiabetes were treated with pancreatic tissue (islet) transplantationstaken rom human cadavers. Eighty percent o those who completed thetreatment protocol have achieved insulin independence or over a year.i

Blindness is one symptom o diabetes. Human umbilical cord blood stemcells have been injected into the eyes o mice and led to the growth o newhuman blood vessels.i

Cancer The British company Tristem is claiming to have developed a processto convert easily isolated white blood cells into stem cells. I conrmed,the technique alone could revolutionize bone marrow transplants andleukemia therapy. The key to Tristems transgeneration technique is aspecial antibody manuactured by DakoCytomation o Denmark that isnormally used to detect abnormal brain cells.ii

AlzheimersDisease, musculardystrophy, and

other neurologicaldysunction

Sweden announced that one o its biotechnology companies is the rstin the world to enter clinical trials with a new drug that could cureAlzheimers disease.iii

Bone marrow stem cells have partially helped regenerate muscle tissue inmice with muscular dystrophy.i

Several spinal cords in rats were regenerated using gene therapy to preventgrowth o scar tissue that inhibits nerve regeneration.i

Ater more than a decade o human neural transplantation studies,our knowledge o the basic immunological properties o conventionalembryonic and etal donor tissue remains inadequate. In most cases,immunological concerns are not specically addressed. The results oexperiments are encouraging with respect to the ultimate immunologicalsuccess o neural progenitor cell transplantation.iv

i

See Wesley J. Smith, Stem Cell News That Isnt Fit or Print, Weekly Standard, December 3, 003 Accessed February 6, 004.ii See Sciscoop.com Science News Forum, Major Breakthrough in Disease Treatment Via Stem Cells

Claimed, November 9, 003.iii See Red Herring, The Hard Cell, Red Herringno. 9 (February 3, 003) Accessed February 6, 004.iv Junko Hori, Tat Fong Ng, Marie Shatos, Henry Klassen, J. Wayne Streilein, and Michael J. Young, Neural

Progenitor Cells Lack Immunogenicity and Resist Destruction as Allograts, Stem Cells , no. 4 (003),4056.


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Some misconceptions persist about both adult and embryonic stem cells. First, the lineso unaltered human embryonic stem cells that exist will not be suitable or direct usein patients. Second, adult stem cells are ready to use as therapies. Recommendationso the committee ormed by the National Research Council and the Institute oMedicine provide guidance about how to proceed in this new scientic rontier.0 Onote are the committees contentions that experiments in mice and other animals arenecessary, but not sucient, or realizing the potential o stem cells to develop tissue-replacement therapies. It asserts that studies with human stem cells are essential andsuch research should continue, and nally, that high-quality, publicly unded researchis the wellspring o medical breakthroughs. Public unding oers greater opportunitiesor regulatory oversight and public scrutiny o stem cell research.

Diabetes

Diabetes mellitus is a group o diseases characterized by high levels o blood glucose

resulting rom deects in insulin production, insulin action, or both. Diabetes mellitusis a chronic metabolic disorder. It results rom the bodys ailure to produce insulinand/or the bodys inability to respond adequately to insulin secreted. Insulin is ahormone produced in the pancreas that enables the glucose released during digestionto enter the bodys cells as a source o energy. A consequence o diabetes is a build-upo glucose in the blood, which passes out o the body as urine, thereby depriving thebody o its main source o uel.

Type I diabetes, also called juvenile-onset diabetes or insulin-dependent diabetes,develops when the bodys immune system destroys pancreatic beta cells, the only cellsin the body that make the insulin that regulates blood glucose. This orm normallystrikes children and young adults, although disease onset can occur at any age. Riskactors or type I diabetes may include autoimmune, genetic, and environmentalactors. Type I accounts or 50 percent o the diagnosed patient population.

Type II diabetes, also called adult-onset diabetes or non-insulin-dependent diabetes,may account or 9095 percent o all diagnosed cases o diabetes. It usually beginsas insulin resistance, a disorder in which the cells do not use insulin properly. As theneed or insulin rises, the pancreas gradually loses its ability to produce insulin. Thisis associated with older age, obesity, amily history o diabetes, history o gestationaldiabetes, impaired glucose metabolism, physical inactivity, and race/ethnicity. TypeII diabetes usually develops in adults over the age o orty. In the late stage o typeII diabetes the pancreas ails and insulin can no longer be produced. At this point,

patients become insulin-dependent.Gestational diabetes is a orm o glucose intolerance that is diagnosed in some

women during pregnancy. It is more common in obese women. Other specic typeso diabetes result rom specic genetic conditions, surgery, drugs, malnutrition,inections, and other illnesses. Such types o diabetes may account or 5 percent oall diagnosed cases o diabetes.


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Factors that contribute to the growing number o diabetics include:

Increased prevalence o obesity Sedentary liestyle Poor dietary habits Aging populations Evolving diagnostic criteria

Over time, all diabetics experience some or all o the co-morbidities includingnephropathy, retinopathy, neuropathy, hypertension, and hyperglycemia.

The Epidemic Global Scenario

The ollowing acts about diabetes indicate the alarming proportion o the populationit is aecting and the threat it presents in the years to come. In 003, the InternationalDiabetes Foundation (IDF) reported that:

There are more than 94 million diabetics worldwide, with this number expectedto exceed 333 million by 05.

The ve countries with the largest patient populations are India (35.5 million),China (3. million), the United States (6 million), Russia (9. million), and

Japan (6. million).The ve countries with the highest diabetes prevalence in the adult population are

Nauru (30. percent), United Arab Emirates (0. percent), Qatar (6 percent),Bahrain (4.9 percent), and Kuwait (. percent).

At least one-hal o all people with diabetes are unaware o their condition. Diabetes is the ourth main cause o death in most developed countries. Diabetes is the leading cause o blindness and visual impairment in adults in

developed countries. Diabetes is the most common cause o amputation that is not the result o an

accident. People with diabetes are 5 to 40 times more likely to require a lower-limb

amputation compared to the general population. Cardiovascular disease is the number one cause o death in industrialized

countries. People with diabetes are two to our times more likely to developcardiovascular disease than people without diabetes.

People with type II diabetes have the same risk o heart attack as people withoutdiabetes who have already had a heart attack.

By 05, the prevalence o diabetes is expected to more than double in Arica,the Eastern Mediterranean, the Middle East, and Southeast Asia; to rise by 0percent in Europe; 50 percent in North America; 5 percent in South and CentralAmerica; and 5 percent in the Western Pacic.


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For developing countries, there will be a 0 percent increase in diabetes Fordeveloped countries; there is a projected rise o 4 percent.

Diabetes accounts or between 5 and 0 percent o national health budgets. O the seventy-our countries that participated in the IDF study, thirty admitted

that they could not ensure a continuous supply o insulin to people with type Idiabetes.

A person with diabetes incurs medical costs that are two to ve times higher thanthose o a person without diabetes.

As another source points out, Indias diabetic population, about twenty-vemillion in 99, is expected to double in the next decade. Less than hal o allthe diabetics in India currently receive treatment. Among those who do receivetreatment, under 3 percent use insulin.

About 90 percent o the worlds diabetics have type II diabetes, which is associatedwith obesity and lack o exercise.

U.S. Incidence o DiabetesToday, diabetes aects more people and causes more deaths in the United States thanbreast cancer and AIDS combined. It is the sixth leading cause o death in the UnitedStates with nearly 00,000 deaths reported each year.3 About . million Americans(or 6 percent) have diabetes, o which 3 million are diagnosed.4 In addition, at least0 million other Americans have a precursor condition called pre-diabetes.5 In 00,the average healthcare cost or a person with diabetes in the United States was $3,43,compared with $,560 or a person without diabetes.6 Direct medical and indirectexpenditures attributable to diabetes were estimated at $3 billion in 00. Directcosts were $9. billion, o which $3. billion was or diabetes care;

Early-Stage Valuation in the Biotechnology Industry

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