Suppose you are the founder of a life sciences start-up. As part of preparing your financial models and presentations for investors, you are considering two exit options. The first option (“3X in 3″) involves synthesizing a preliminary candidate or building an alpha-prototype, establishing some preclinical or early clinical validation, and then seeking an out-licensing agreement. If all goes well, this option will yield a three-times return on investment within three years. The second option (“10X in 10″) involves going the distance, seeking regulatory and reimbursement approval, marketing and manufacturing the product, and eventually being acquired or going public. If all goes well, this option will yield a ten-times return on investment within ten years. Which do you choose?
The circumstances are grossly simplified, but, I feel that this is an important question. Absolutely, 10x – 3x = 7x, but relatively, a “3x in 3″ yields a compound annual return of of 44.22%, whereas, a “10X in 10″ yields 25.89%. So, the choice might not be as straightforward as it seems. Ultimately, I think there six key factors to be considered.
(i) Fundraising environment
The amount of capital required to execute the “10X in 10″ strategy is significantly greater than “3X in 3″. Even if a company were able to outsource marketing and distribution, the cost of clinical trials alone make this a very expensive proposition. In times when life sciences funding is limited (like now), the option to pursue a vertically-integrated strategy is limited.
(ii) Audience of investors
I presume that the “3X in 3″ approach would be very attractive to an audience of angels or a life sciences microfund. There are very few investments that can yield a 44% annual return in a payback period of three years. Conversely, I believe that “10X in 10″ approach would be of greater interest to venture capitalists. VC firms exhibit diseconomies of scale, in that the same due diligence process and monitoring is involved in making a $1 million investment as a $10 investment. So, in the case of a newly-raised fund with a ten year life, a VC firm would not be interested in sourcing new investments every three years. The only time a VC firm might be interested in a “3X in 3″ would be if they have a fund near maturity and have some unallocated capital, but this occurrence seems to be rare.
(iii) Human capital
The “3X in 3″ strategy requires two key players, namely someone with sufficient technical knowledge to achieve clinical proof-of-concept, as well as a business development rainmaker with the connections and expertise to get a deal done. “10X in 10″ requires a larger cast of characters with expertise in marketing, manufacturing, finance, clinical trials, etc. In this case, the ability to hire the right people at the right time is critical.
(iv) Intellectual property defense
Better IP equates to bigger lawsuits. A principal advantage of out-licensing early-stage technology is that the acquirer has a vested interest to protect its investment, and defend its IP from infrigers. Clinical-stage companies with the next breakthrough do not have the time and resources to spend in courtroom battles.
(v) What’s next?
With the exception of platform technologies, founders of life sciences companies are normally betting on one drug, therapy or device. The disadvantage of the “10X in 10″ strategy is that, if the company does go public, it will be expected to build a portfolio with its early success funding R&D for future products. The Street demands growth, and there is no guarantee that the insights or inspiration that led to the first product will lead to a second, third, etc.
In life sciences, three years is a decade and ten years is a millenium. So much happens so quickly that the research and assumptions underlying the investment may no longer be relevant at the time of exit. Pursuing the “10X in 10″ strategy means a company is susceptible to change, however, as a certain biologist said, survival does not belong to the fittest or most intelligent, but rather, those who are able to adapt.
For those who have been reading between-the-lines, I am a big proponent of the “3X in 3″ strategy, and I feel that more early-stage ventures should consider it as an option in the least. I am interested to hear the thoughts of others.
NB: For those wondering why I have included a photo of a baseball player with my article, it is to illustrate a point. Pete Rose is the most successful hitter in Major League Baseball history with over 4,000 hits. Of these, over 3,000 were singles yet only 160 were home runs. It may not have been pretty, but it worked wonders.