For the past decade, the number of venture backed companies purchased by big pharma has not changed materially. There are only so many big companies and only so many deals that each company can do. With the renewal of consolidation between large companies (Genentech/Roche, Schering-Plough/Merck, Wyeth/Pfizer), there are fewer potential acquirors for these companies. With the public markets shut for the past year and a half plus, where are the exits? Limited partners in venture funds do not want VCs to call capital even though they are saying that they are still investing. VCs are mostly funding current portfolio companies to keep them alive. That sets the stage for either a major shakeout with bankruptcies or an alternative scenario.

What if licensing becomes the new M&A? While M&A has simply become just a licensing deal generally minus the royalties and with a change of control, licensing should be considered as a potential exit for companies. I’m sure the tax experts can figure out a way to structure this to avoid double taxation. Why can’t companies out-license their program where they do not take any commercial rights but simply take an upfront, milestones, and royalties? Whether or not the biotech remains to do the clinical development can be case dependent. Why does a company need to be a going concern? If you can develop a drug to an IND and out-license the product for >$10M upfront & near-term milestones, why not take the money off the table and “invest” for the downstream clinical, regulatory, and commercial milestones? You might potentially be able to invest less money and “exit” earlier.

What are the implications of this? VC funds would need to be structured differently. An evergreen approach would much better match the timing of cash flows if you were to really wait until commercialization to realize value but without having to spend the money to get there. Of course you can monetize the royalties once the product launches so it would not be required to hold for the duration of commercialization.

What is the downside? As companies get smarter at this and pharmas suffer more failures, companies will be paid less and less for earlier stage compounds. Later stage de-risked compounds will fetch a major premium over early stage compounds making these number potentially difficult to work. The company type (spec pharm v platform) matters since the capital required to achieve various milestones will vary greatly. Companies will need to be run extremely capital efficiently to make this model work. Universities will need to develop their products to within 18-24 months of the clinic to help bridge the gap.

In summary, pharmas are the only ones with money investing in drugs so why not cater to their needs? Forgo large scale VC money, take a modest return on a licensing deal and wait for the downstream economcis. Double taxation is a nice problem to have for an industry that perpetually loses money. This shows a belief in the asset and shares the risk. We might not have a choice!