To maximize Series A runway, biotech investors must look for this key trait
By Huaxia Zhou
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Executive Summary
In an industry where 90-95% of the projects never succeed, and a biotech is lucky to have just 75% of its total R&D costs devoted to such eventual discontinuations, the idea of “fail faster” is essential to survival. Early-stage biotech investors that can better predict “fail faster” firms are more likely to see their investment get from Series A to Series B rounds before running out of cash – more important than ever in today’s tough biotech funding environment as EY has reported.
Research published in the Journal of Operations Management indicates that biotechs with multiple prior success AND failure experiences in related drug development projects will waste 1.5-3.5 years less time to discontinue a “dead-end” project line.
Series A investors in biotech startups should be positively weighing the success AND failure experiences of biotech companies in their evaluation metric, and monitoring projects down to the manager level to ensure that mix of past experiences.
Implications: “fail faster” lengthens the runway before the “Series A cliff”
The 90-95% of drug candidates that fail do so for any number of reasons across the pre-clinical to Phase I-II-III, to release: lack of clinical efficacy, unmanageable toxicity, poor drug-like properties, or a lack of commercial needs and poor strategic planning. Moreover, the failure could also be due to incompetence (i.e. budget or timeline overruns, insufficient research and development, and lack of program-level clarity) or competent execution with unexpected outcomes that requires more budget than originally accounted. Along the way, 75%+ of a biotech’s R&D budget will be allocated to lines that will eventually fail, if they are lucky, and it may be they spend the entirety of their budget before hitting any winner.
In recent years, biotech public markets have faced challenges, with the S&P Biotechnology Select Industry Index down over 50% from its peak in February 2021 by the fourth quarter of 2023. This downturn prompted a substantial response from the industry, with more than 250 biotech companies implementing layoffs during 2022 and 2023 as a strategic measure to navigate financial difficulties (“What early-stage investing reveals about biotech innovation”, McKinsey, December 2023).
Between 2020 and 2021, 91% of 223 publicly traded biotech companies faced a notable decline in market value, with an average drop exceeding 50% at their initial public offerings (IPOs). Long-term viability concerns also extend to 55% of emerging biotech companies that report insufficient cash to cover the next two years. Moreover, the biotech sector witnessed a 29% reduction in venture funding in 2022. (“Beyond Borders: EY Biotechnology Report 2023”, EY, 2023”). The equity capital is still there, it is simply not being deployed – which means many ventures with Series A rounds are simply not getting the Series B follow-ups from new investors, and sometimes even follow-ons from their pre-existing investors.
Financially speaking, spending fewer months on dead-end projects is advantageous for both investors and biotech startups. Discontinuing the project early preserves financial resources and minimizes losses for investors. Startups may also redirect resources towards more promising and viable projects, ultimately increasing their chances of success in a competitive industry. It buys more time (i.e. runway) for a Series A investment. Being able to predict how management will behave should be a key investment criterion for today’s Series A biotech investors intent on stretching their investment dollar.
Research: experience predicts biotech’s that “fail faster” by years, not just months
Successfully developing just one new pharmaceutical requires billions in investment and carries a 90-95% chance of complete failure along the way. The decision on whether and when the development process should be discontinued can be as crucial to the success of a biotech company as the one that they may be so lucky as to get through. This has led to the popularly referred to the goal of “fail faster” (“Failing by design”, Harvard Business Review, April 2011) – but how much faster can that be, and how well can an outside observer predict which startup firms may do so sufficiently to actually make a difference? One strategic approach is to assess based on the venture’s prior experiences of developing products. A recent study published in the Journal of Operations Management investigates how a firm’s prior success and failure on product launch experiences impact the future time they will spend on doomed projects before they discontinue them.
The study sought to predict the length of discontinuation - as measured by the number of months between the origination and the discontinuation of each project (i.e. dependent variable) - based on the number, attributes, and relatedness of success and failure experiences of the initiating firm. To further mitigate the prior success/failure variable, they include the codification and quality of knowledge of the past projects and how related the focal drug was to the firm's prior experiences with the other drugs. Finally, to isolate the impact they included control variables such as R&D intensity (percent of revenues spent on R&D), firm size, patent propensity, number of prior experiences in general, size of drug development portfolio, extent of competition, and project-level variables such as the number of indications and countries involved.
The data was drawn from the worldwide biopharma industry over 27 years: 2,938 worldwide drug development projects (originating from 560 global biopharma firms) from 1990 to 2017. Of those 2,938 drugs, 24% of drugs were successfully launched and the remaining were discontinued, and detailed patent and financial information on each was retrieved from PatSnap and Osiris databases. The knowledge attributes were measured through patent information: codification of knowledge was measured through the number of past patents, and the quality of knowledge was measured through the citation of past patents. On average, it took about 59 months (about five years) after the project initiation for the discontinued projects to be ended.
The findings revealed that, all else being equal, prior success AND failure experiences lead to a significant shortening of discontinuation duration. For every prior success experience, there was a 2% reduction in months wasted on discontinued projects – so for an average firm that could represent as much as 32 months saved, given the average successes prior count. But for every prior failure experience also resulted in a 0.32% reduction in time wasted - so for an average firm that could represent as much as 16 months saved, given the average successes prior count.
Layering in the number of past patents associated with success experiences, there was an additional 46% reduction in the discontinuation duration. For the relatedness between a project and prior failures, there was an additional 13% reduction in the discontinuation duration. So, all told, including these past experiences could shave 1.5-3.5 years off the time needed to end a “dead-end” project.
Strategy: also take prior failure into consideration to evaluate investment
Prior failure is not always a bad thing. Understanding and leveraging prior successes and failures in drug development is essential for making informed decisions about the continuation or discontinuation of a project. Biotech Series A investors should be using these criteria when assessing venture opportunities, especially in an environment where Series B may be difficult in the foreseeable future:
Initially: Series A investors should request the firm’s previous success AND failure data (on the whole), and each of the firm’s individual management team, to decide their potential investments, along with how long the principals have taken to discontinue their failed projects in the past. Prior failure is not a negative necessarily – only if it took too long to realize.
Next: Series A investors, as part of the Board of Directors, should coordinate with the management team to regularly assess and benchmark time to discontinuation of their investments’ projects and in the industry producing similar drugs on the whole. Good “portfolio hygiene” via cutting losses quickly is an essential part of extending the chance to get from Series A to Series B.
Finally: Series A investors should track the records of individual managers assigned to each project within their funded venture as ensuring past success and failure on any project (not just in a firm-wide sense) may also minimize the time needed to discontinue a failing drug line.
While there are any number of TECHNICAL innovations being developed to shorten the development window, the HUMAN barrier (be it rational or psychological) to killing projects quicker will always exist. The cautionary tale is that Series A investors ONLY selecting for “doggedly determined” biotech management with a “Midas Touch” may in fact not be setting themselves up for investment success – and that management’s past behavior does indicate their future decisions.
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Huaxia Zhou is a PhD candidate in Electrical Engineering at Northwestern University and a member of the Northwestern Advanced Degree Consulting Alliance. The research applications proposed in this article are solely the views of the author and do not necessarily reflect the views of the original academic journal article authors nor any individual member of our Editorial Board.