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by Michael J. Hogg

r&D Enterprise - Asia Pacific
October/December, 1998


Early stage biotechnology companies face daunting odds in their quest to bring their first products to market. Strategic alliances are a sound means of leveraging scarce resources to increase the biotechnology company's ability to build a successful business. This article draws upon experience in the U.S.A. to provide a series of tips to facilitate establishing productive business alliances.

1. Why Partner?

One of the biggest problems faced by biotechnology firms is how to find venture capital to finance the commercialization of a novel product idea. The product idea is frequently a new chemical entity that has shown promising biological activity against a screen or early results in animal tests. It may show diagnostic or therapeutic potential. It may have agricultural or industrial applications. It may even be a novel delivery mechanism or a discovery tool.

Depending on the nature of the product idea, the development costs will range from a few million dollars to hundreds of millions of dollars. The start-up company must finance the costs of protecting its intellectual property, taking the product through proof of principle, scale-up, testing and regulatory approvals before it can sell the first commercial product. In the case of a pharmaceutical, product development through regulatory approval can take ten years from discovery to marketing approval and US$500 million. An agricultural product takes approximately eight years and US$35 to 50 million. Even an in vitro diagnostic takes at least eighteen months and several million dollars.

Recent American experience has shown that the venture capital community is an appropriate financing source once the biotech company can show that a viable product exists and there is a market for its product. Pharmaceutical companies with a product in Phase II or III clinical trials, a medical diagnostic company preparing its Premarket Approval Application or premarket notification (510k), or an agricultural biotechnology company preparing for US Department of Agriculture market approval are good candidates for venture capital investment. Before these phases in product development, however, the typical start-up company must rely on "angel" capital -- friends, relatives and wealthy individuals -- or government research grants.

An alternative to angel capital and research grants could be funding from strategic partners: suppliers, manufacturers and customers. Strategic partners are potential sources of development funding. They also offer a way to leverage internal resources without depleting the corporate treasury.

For the cash-strapped start-up company or project, partnering is important for two reasons. First, in today's environment a biotech company should focus on what it does best, whether that be in providing leading edge science or an enabling technology. It should leave manufacturing, regulatory and marketing to the specialists. Secondly, the biotech company needs to hedge its risks. In both cases partnering offers the best vehicle.

2. Finding a Strategic Partner

A strategic partner will work with the biotech company providing its skills and resources in a joint effort to attain goals that neither can achieve alone. Both companies remain independent. The strategic partner will be a source for one or more of the resources that the biotech company needs but cannot afford to buy at market prices. The resource may not even be available for hire.

The biotech company evaluating whether to partner must answer the following questions. What resources does it lack? The missing resource may be access to technology or biological screens, optimization or formulation expertise, manufacturing capabilities, clinical research skills, regulatory know how, or access to distribution channels. Can these resources be bought? Can it afford to buy the resources? Who has the resources required? It will be obvious to the sophisticated reader that the evaluation process is a necessary business-planning tool whether or not the biotech company wants to partner.

Information exchange required for the partnership may be distinguished by recognizing the needs of both parties. The well-funded biotech company with the cash to buy the resource required need not reveal much of its plans. It will only need to reveal its technology in sufficient detail to enable the seller to match its resource with the biotech company's requirements. It will also have to provide some assurances that it can pay the resource seller. The biotech company wanting to partner rather than buy will have to reveal much more about itself and its business plans. This is not unreasonable since the biotech company is asking the prospective partner to expend its resources in return for an uncertain future return.

What will the prospective partner want to know? It will want to know what the biotech company's business concept is. It will want to know what market need will be met. Does the product meet a present market need? Will that market need still be there when the product is ready for market and, if so, for how long, i.e. what are the market trends? It will want to know the size of the market. Does the product have differentiating features? It will want to know whether it can recover its investment in the partnership with an acceptable profit margin in light of the risks involved, i.e. what are the market economics? If the biotech company can satisfactorily answer those questions, the next question will be "what do you want from us?" Finally the prospective partner may want to know who the company is already working with. Some partners may be incompatible. The reputation of others may help to sell the proposed alliance.

3. How to Approach the Relationship

It may seem obvious but seeking a partner should not be a hit or miss affair. The biotech company should carefully plan its partnering strategy. Having evaluated its resource needs and prepared its business presentation to answer the prospective partner's questions, the biotech company should pre-qualify its prospective partners. Will an alliance with the prospective partner enhance the biotech company's future prospects? Can it do the job? Will the partner be attractive to other constituencies investors, customers, and other partners? What is the partner's reputation for quality, for business relationships? Can they be trusted? In this day and age when even very small companies are entering into international alliances, due diligence can present a significant hurdle. Another company in the home market is a relatively known entity. There will be shared culture, and contacts with knowledge of the prospective partner. This changes when the biotech company looks outside the home market for its partner. This is not to say that the company should not look outside the home market, only that due diligence will be harder, more difficult and more expensive.

Having selected the target partner, the next step is to make contact. It is often a mistake to use the first introduction that can be found. It is important to understand the culture of the prospect and its internal structure. A first contact with the wrong party can severely handicap the chances of negotiating the alliance. Rather than use the introduction of the cousin who happens to play golf with the President or the Managing Director of the target partner, it may be prudent to retain a consultant with a track record of deals in the industry who may know the prospect. Even if the consultant does not know who to contact, his network can provide that information. Particularly with larger companies, the wrong contact can engender the "not invented here" syndrome so deadly to a potential deal.

Once the initial contact has been made the next step is to establish interest. This is usually achieved through a face to face meeting but may be done with written materials. This is the correct time to request the prospective partner to sign a confidentiality (secrecy) agreement to protect the biotech company's disclosures. Larger companies may refuse to sign at this early stage. If so, the biotech company should limit its presentation materials to information already in the public domain or which the company is willing to have published, so as not to compromise the company's trade secrets. If the initial presentations establish interest but the prospective partner still won't sign a confidentiality agreement, the company needs to ascertain why not. There could be a cultural reason. Smaller European companies may be suspicious of the agreement. There may be a competitive reason. The prospect may be actively engaged in similar research to the biotech company's in which case it will want to make sure there is no conflict before it will agree to restrictions on the use of disclosures made to it. In either event the biotech company should withhold disclosure of confidential matter until the other side agrees to maintain the confidentiality of disclosures and to limits on their use.

4. Negotiating the Deal

Negotiations begin with the biotech company's first presentation. It is important from the first that all contacts are professional. This starts with the introduction, the quality of the presentations and other materials, and continues with each and every contact, including the way in which the company conducts the negotiations. The failure to protect confidential disclosures, not having a well thought out plan, and rushing the deal are typical mistakes which can lose the deal.

Deals come together more easily when the parties focus on the business terms first. After the confidentiality agreement, the next formal document ought to be a non-binding letter of intent that encapsulates the deal. There are several labels used for the letter of intent, including term sheet, heads of agreement and memorandum of understanding. They are all the same thing and are intended to record the agreement in principle prior to the definitive agreement. Care must be taken in their drafting to avoid unintended legal consequences. Unlike letters of intent under the common law, letters of intent in civil law jurisdictions can be construed as a binding agreement with the definitive agreement treated as merely a supplemental agreement spelling out the deal terms in greater detail. The advice of experienced legal counsel is recommended to avoid such pitfalls.

In most circumstances the exchange of draft agreements prior to reaching agreement in principle on the business terms takes the focus off the deal and puts it on to the boilerplate legal issues. It may also lock the parties into preconceived deal terms that turn out to be inappropriate as the negotiations develop. It is easier to deal with the legal boilerplate after the deal has been sold. It may be counter-productive to focus on termination rights, indemnities, governing law and other legal provisions before the business terms.

The essential terms of the alliance cover the purpose of the alliance, the contributions of the parties, patenting responsibilities, the parties' respective rights and the duration of the alliance. The rights of the parties' typically concern ownership of intellectual property, rights to manufacture, rights to market and sell, and the split of revenues arising from the alliance. The split of revenues may take several forms. Some alliances are structured so that the partners recover their costs and then split the remaining revenues. Others take the form of compensation for the right to make, use and sell. Often the biotech company can negotiate upfront payments for licensing rights with milestone payments at significant development events such as regulatory filings and market approval, followed by running royalties. In other alliances equity funding, loans, research funding and contributions in kind are negotiated.

5. Conclusion

For the early stage biotech company, the strategic alliance is an important tool. Its use can accelerate the product development process by enabling the company to tap into resources not otherwise available to it, while at the same time reducing the internal burn rate. This in turn takes pressure off the need to raise funding, and allows management to focus on product development. It also spreads the development risks. There is no magic formula as to when or on what terms an alliance should be negotiated. Both factors are influenced by the company's stage of development and needs. In terms of contributed value, the greater the risk the alliance partner is being asked to take, the less it will be willing to invest in the alliance and the greater will be the expected return. In other words, the further up the development process, the less risk to the partner and the higher the valuation of the biotech company's contributions to the alliance.

This article is based upon a presentation made by the author at Northwestern University's 1998 Summer Biotechnology Institute held in Chicago, U.S.A.

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