MIT BIOSTRATEGY SEMINAR SERIES

1. MIT BIOSTRATEGY SEMINAR SERIES Trends in Venture Capital and the Biotechnology Industry Michael Lytton General Partner Oxford Bioscience Partners Boston, MA mlytton@oxbio.com December 12, 2001

2. The Biotechnology Industry in the mid-1990s • Investors wanted certainty in new drug discovery. . . So large pharmaceutical companies were prepared to spend significant funds to reduce their R&D and regulatory expenditures • The search for novelty and the downgrading of me-too research (McKinsey's 90% generic, 247 drug formula that met 95% of 1995 drug needs) • Message: only novel drugs are worth pursuing, and new biotech tools will increase productivity and novelty • The “omicization” of biotechnology (genomics, proteomics, metabalomics. . .) will transform drug discovery

3. The Tool Company Business Model • The best product to sell is stock (never make a product, never make a profit – the price-to-dreams ratio) • The $33 billion raised in 2000 exceeded the amount invested in the previous five years combined • 1999 -- 55% of public biotechs have less than two years’ cash 35% have less than one year • 2000 -- 42% have more than three years’ cash 33% have more than five years’ cash • But, this success is over-shadowed by a persistent, nagging problem. . . .

4. While Critical for Long-Term Value, Genomics Is Likely to Lead to Higher R&D Cost Pressure Short-Term Complicating Factors in the R&D Process Genomics Poorer “In 1990, there were 100 literature Increased has led to an quality literature references/target - downstream explosion of of Now we average 8. We are also attrition new potential target exploring many more targets than targets valida- before. What we don’t know tion about the targets leads to more problems downstream and worse attrition.” - Pharma R&D executive Source: Lehman Brothers & McKinsey & Co. Report, January 2001

5. While Critical for Long-Term Value, Genomics Is Likely to Lead to Higher R&D Cost Pressure Short-Term Complicating Factors in the R&D Process Companies Novel “New targets will require novel Increased are pursuing Chem- chemistries and will create new R&D Costs a much higher istry barriers in toxicology.” proportion of novel targets - Biotech executive Source: Lehman Brothers & McKinsey & Co. Report, January 2001

6. While Critical for Long-Term Value, Genomics Is Likely to Lead to Higher R&D Costs Pressure Short-Term Complicating Factors in the R&D Process Other Uncertain “The trial and error cost is Increased high clinical high when you have a new R&D Costs impact develop- drug target without a well-known tech- ment clinical protocol.” nologies are in early development Source: Lehman Brothers & McKinsey & Co. Report, January 2001

7. The New Discovery Tools Have Not Increased Output • Accenture survey: • in 1997, drug companies predicted new technologies would make them 50% faster and 300% more productive • in 2001, drug companies are no faster and no more productive Why? • Novelty is risky • New targets increase R&D risk 2X; compounds can fail and targets can fail (with older targets, developer runs only compound risk and chemistries are easier) • FDA cautious about new mechanisms; inclined to go slow (e.g., Xigris) • Pharma companies hit the wall of data overload, and biotechs fail to contribute improved processing capabilities • Tool companies must, annually, predict pharma’s bottleneck next year in the drug discovery process • Startup fratricide – 50+ proteomics companies

8. The Sobering Statistic Cost of Developing a New Drug: $100 million Cost of Failures Associated with Development: $300 million $400 million

9. Why do compounds fail to become successful drugs? Toxicity Issues 22% Biopharmaceutical Issues 41% Efficacy Issues 31% Marketing Considerations 6%

10. Drug Discovery Technology – The Opportunity Reducing the Failure Rate in Pre-Clinical and Clinical Development and Increasing the Efficiency of Drug Discovery Failures occur on account of: • Lack of specificity • Poor absorption • Too rapid metabolism • Toxicity

11. Drug Discovery Technology – The Opportunity Efficiency is enhanced as a result of: • Target selection and validation • Assay development • High throughput screening • Lead optimization • Generation of suitable back-up compounds • Appropriate pre-clinical models

12. Drug Discovery Technology – The Opportunity • The 1990s revolutionized the study of associations and created data overload • Hopefully we are now entering the decade of understanding the behavior of whole systems • Finding the right target(s) • Finding the right drug • Improving the productivity of clinical trials

13. For the Time Being, the Only Long-Term Successful Business Model Is Still Developing a Successful Drug • 125 biotechnology products are on the market (50 to be approved this year) • 300 biotech products are in Phase III (80% chance of FDA approval) • Currently, there are 40 profitable biotech companies, with 60 anticipated by year-end, accounting for $25-30 billion in revenues • As pharma companies’ drug discovery efforts continue to fail to yield results, the value of late-stage products rises

14. The Increasing Value of a Late-Stage Product • In 1996, Pfizer paid Warner-Lambert $25 million upfront for U.S. and Europe rights to Lipitor (Phase III) • In 1998, Pfizer paid Searle $85 million upfront for U.S. rights to Celebrex (Phase III) and Pharmacia paid Otsuka $80 million for North American rights to Pletal (filed for approval) • In 2001, Bristol-Myers Squibb pays Imclone in excess of $1 billion upfront for its Phase III epithelial growth factor for cancer

15. The Future: More Big Value, Late-Stage Product Deals • In-licensing is cheaper than acquisition since it avoids dilution and provides the potential for off-P&L transactions (nearly half the cost of the Imclone deal is on BMS’s balance sheet) • The biotech industry responds by trying to create fully integrated research platforms through M&A (e.g., Vertex/Aurora, Lexicon/Coelecanth) • Alternatively, platform companies become product companies as well (e.g., Millennium’s acquisitions of Cor and Leukosite, Celera’s acquisition of AxyS)

16. What Does All of This Mean for Venture Funding? • Funding devoted to life sciences increases from 9% (in 2000) to 15% in 2001 of all venture capital investing (approximately $5 billion) • New funds raised in 2000 and 2001 will push percentage to approximately 20% ($6 billion) • Fewer, bigger specialized funds • Multiple reasons to be optimistic • Doubling of NIH budget • More trained management • Gloomy investment climate leads to more reasonable valuations for early-stage investments • Less competition, due to the number of vc firms that exited the sector with the Internet boom

17. What VCs are Looking For. . .Products • A novel biological or chemical hypothesis • A well understood mechanism of action • Proof of principle • A broad intellectual property portfolio • A strategy for partnering so that the risks associated with the timing of FDA approval can be passed on to someone else • Multiple shots on goal

18. What VCs are Looking For. . .Tools • Provide new information which addresses an unmet need • Reduce the failure rate and/or increase the efficiency of drug discovery or development – eliminate a “bottleneck” • Commercialize via a business model that takes account of (i) lengthening sales cycle for platform technology deals due to pharma company confusion and information overload, (ii) commoditization and obsolescence, and (iii) the need to ultimately share in the upside of a successful drug

19. Still, There Remains Unlimited Potential for Mistakes. . . • Investing in a scientific hypothesis that has not achieved proof of principle • Investing in a technology that works, only to find out that no one cares

20. Still, There Remains Unlimited Potential for Mistakes. . . • Backing a company with weak management or board of directors • Investing as part of a weak syndicate of investors

21. Still, There Remains Unlimited Potential for Mistakes. . . • Valuing a company based on the valuation of comparable companies • A successful venture fund must earn a compounded, cash-on-cash gross return in excess of 30% over its ten-year term (at least a 22.5% net return) • The analysis is driven by multiples (10x or greater), not the time value of money • Valuation is determined by reference to (i) the ‘pre-money’ valuation of the next round, (ii) the number of financing rounds required until liquidity, and (iii) the amount of money needed in each round So, comparables are of limited utility—high tide in the Bay of Fundy is not a useful metric for Boston Harbor

22. Still, There Remains Unlimited Potential for Mistakes. . . • Betting on the timing of a clinical milestone, corporate partnering deal, or IPO • Investing in a company where success is dependent on accelerating the FDA’s review and approval process

23. Still, There Remains Unlimited Potential for Mistakes. . . • Investing in a company without doing careful intellectual property due diligence • Firing, then aiming or aiming, and not firing: waiting too long, or not long enough, to change management

24. Still, There Remains Unlimited Potential for Mistakes. . . • Bad Timing • Monoclonal antibodies • Antisense • Sepsis • Gene therapy • Diagnostics

25. What’s Next? • Predicting disease at the molecular level through biomarkers, and developing a value proposition for new diagnostics • Going from gene to drug to develop new therapeutics • Miniaturizing drug discovery technology to enhance throughput (and maintain accuracy) • New antibiotics that overcome resistance • Finally, the Decade of the Brain?

26. What’s Next? • Focusing on the right applications to benefit from biotech/IT convergence • Executing successful specialty pharma business models • Quality of life devices and drugs (from cholesterol to male pattern baldness, wrinkle removal, smoking cessation, weight loss, and arthritis pain relief)