By Arthur Pappas, Pappas Ventures
February 1, 2012

A few tweaks to the approval process would help serve innovators and investors in a sensible way.

Despite recent sniping, the Food and Drug Administration doesn’t need an adversarial relationship with drug and device makers. We’re partners in a shared mission: to bring life-saving innovations safely and efficiently to market.

That mission can succeed under stringent standards. No one is calling for laxity. But it also takes transparency, a process that values innovation, and a smart balance between risk and reward.

With just a few changes, everyone—chiefly the public—would benefit.

Toward consistency and transparency. The clinical trial process is unnecessarily daunting when the goal posts change from one product to another, or from one phase of development to another. As science accelerates, a mid-course change is sometimes necessary, but the FDA has to judge whether such a twist outweighs the need to be consistent.

Here, the FDA needs to recalibrate. It should give more weight to the value of regulatory expectations that are clear and predictable. The agency can also promote fairness by respecting statutory timelines. Currently, it can “stop the clock,” restart it months later, and count a project as on-time. Our nation’s pipeline of new cures and therapies should run on real time.

Communication is not collusion. Today’s FDA is too wary of informal dialogue. The result means a delay, at best, and at worst a chilling effect that stymies useful conversation. The process would benefit from an “open file” approach that lets applicants learn what FDA scientists and consultants are thinking during the review process, not after approval or rejection.

Reform the appeal process. There are no official penalties for appealing an FDA determination. But FDA regulators are human, and we all know how relationships suffer when one person goes over another’s head.

A small, underfunded applicant may stake its entire future on its reviewers’ good graces. Both sides would be better served by a formal, non-confrontational appeals process. This could take the form of a rapid-response arbitration panel, or possibly even a market for appeal rights that combines the spirit of cap-and-trade with the peremptory challenges of jury selection.

Be aggressively progressive. The FDA works hard to reduce one kind of risk: bringing something unsafe or ineffective to market. It needs to work harder to avoid the opposite risk: delaying or rejecting innovations that people need.

The agency was founded to counter both threats, but its culture has swung too far toward holding things back. One solution is an aggressive program of “progressive approval,” that allows regulators to make case-by-case, risk-reward judgment calls and approve products for use when the evidence tells them the benefits likely outweigh the risks.

I’ve been on the front lines for both triumph and failure in this process. My firm played a part in one recent success story, a product that uses genetic targeting to combat melanoma. Its creators were able to keep up a robust dialogue with their FDA counterparts, and together, the innovators and the regulators brought physicians a new treatment much faster than usual.

Unfortunately, my experience tells me that’s an exception. I’ve seen the chilling effect of regulatory uncertainty at work. I’ve been in the room when we had to shut down funding for promising avenues of research because the path through the FDA was just too unclear.

By its own description, the FDA is “responsible for advancing the public health by helping to speed innovations.” It is meant to be both a policeman and a partner.

No one—neither venture investors nor the people in lab coats—wants to be hasty in the way we approve drugs or medical devices. We’re not asking for an easy process. We want a transparent, predictable one that lets innovators and investors plan and carry out their work in a sensible way.

Arthur Pappas is managing partner of Pappas Ventures, a Durham, N.C.-based venture firm that specializes in life sciences.

Bruce Booth

Early stage life science VC

It’s certainly not Breaking News that M&A deals are an important source of liquidity in biotech VC today.  But last year did mark an important milestone for biotech over the past few years: in 2011, the capital returned to investors from private M&A alone likely exceeded the total capital invested into private biotech companies.

2011 was a banner year for private company M&A.  Based on the data compiled by BioCentury, and Walter Yang in particular, deal values were up over 3x since the nadir of 2008.  Here’s the snapshot:

• 64 private M&A deals closed in 2011, representing $23B in proceeds (upfronts and milestones).  This includes great deals like Plexxikon/Daiichi, Calistoga/Gilead, Amira/BMS, BioVex/Amgen and Advanced BioHealing/Shire, among others.

• Only 45 of these 64 deals disclosed financial information

• Nycomed was worth $13.6B and was clearly not venture capital, so taking that out leaves $9.4B in total

• Several of the remaining deals had significant earnouts; removing these milestones leaves $7.1B (i.e., only upfront payments)

• If you assume that investors owned on average 75% of these exits, which is in line with ownership benchmarks, then an estimated $5.3B was realized last year from this set of disclosed deals.

(see graph)

Comparing these capital flows to the biotech venture capital investment pace reveals a surplus of realizations.  In 2011, again according to BioCentury’s database, $4.8B was invested in biotech venture capital deals (therapeutics only).  Compared to the $5.3B in estimated realizations above, this yields a $500M surplus.  By comparison, in 2008 over $3B more flowed into financings than M&A.  The chart below captures the net capital flows between these two over time.

(see graph)

Having more realizations than investments is not remarkable; in fact, its critical for long term viability of a sector.  But it is remarkable that just this set of disclosed M&A deals of private biotechs alone outpaced the total amount invested, and highlights how strong the biotech M&A market was in 2011.  The reality of the full realization picture for biotech is obviously even better than these numbers: first, this M&A dataset doesn’t include any public equity realizations, so misses both sales by venture investors of post-IPO biotech stocks or public biotech acquisitions where VCs still had big positions (e.g., Burrill’s position in Pharmasset, NEA’s in Inhibitex).  Second, many VCs also do PIPE investments and a number of these were big hits this year as well (e.g., Amarin). Third, as noted above, almost a third of the private M&A deals didn’t reveal their financials, clearly biasing the overall number lower.

This positive net capital flow by M&A in biotech is better than the relative impact of M&A on the aggregate, cross-sector venture landscape: according to the NVCA, $23B in venture-backed, disclosed M&A deals closed in 2011, so using the same assumptions that investors owned 75%, that would imply $17B in realizations.  The early data on 2011′s total venture financings (from CBInsight) has the aggregate funding at $30B.  The data might not be perfect, but it does suggest a large net-negative relative capital flow.  A big caveat is that IPOs have played a big role in social media and IT in 2011, but when comparing relative M&A impact, its fair to say venture-backed biotech had a great 2011.

While it’s true that the amount returned and the amount invested in any given year aren’t directly related (i.e., one year’s exits represent capital invested over many prior years), the crossing of these trends in capital flows is quite positive and highlights the increasing investment realizations we’re getting in the life science venture world.

A second metric is also worth highlighting: the realizations from these 2011 M&A deals also outpaced the likely biotech allocation of recent venture capital fundraising. If one assumes that ~17% of all recent venture fundraising will go to biotech (in line with biotech’s share of venture investments over the past five years, according to MoneyTree), then last year’s $18.2B in venture fundraising will provide $2.8B in biotech allocations in these new funds. This is substantially less than the $5.3B in estimated returns.  The chart below captures the net capital flows between these two over the past few years, trending favorably towards returning more capital after the challenging years of 2008-2009.

(see graph)

A caveat to this data is that the real gap probably isn’t this large, as corporate VCs don’t have to report their fundraising and play an important role in 20-30% of biotech venture financing's.

In summary, 2011 was a solid year for biotech investor returns through M&A.  As life science companies chalk up more exits, and both fundraising and fund sizes continue to be ‘right-sized’, its likely the this surplus of biotech realizations over both investment pace and fundraising will continue for the foreseeable future.  This is a good thing for venture capital and our LP’s, and will hopefully bring a better appreciation of the merits of life science venture capital.