Wretched Excess Or The Future Of Biotech…Or Both?

Is starting with $3 billion a better way to make new drugs?

The launch of Alta Laboratories with a $3 billion initial commitment—likely the world record startup financing by an order of magnitude or more—says a lot about the state of venture capital, biopharma, financial markets, innovation and human nature. Money made the bio-venture business model possible. Will more push it to new heights or off a cliff?

Markets are currently imploding, but the global economy has demonstrated that, when money is available, it can create value faster than institutional investors can deploy it. The Alta financing reflects the impact of a super-charged economy on an industry that only recently developed its own business model and has yet to prove its durability. The odds are against any new company, no matter its size, but this one reflects a new model for the industry. Its fate could have a significant impact on the future of biopharma innovation and ultimately patient care.

How Bio-Venture Got Here

The evolution of bio-venture has been closely tied to that of the financial markets. The industry started in the 1980s and 90s with a business model borrowed from Silicon Valley’s successful IT startups. Created in the hard-scrabble world of tight money and garage-scale operations, the fiscal discipline it imposed served startup companies and entrepreneurs well, but drug development proved challenging on shoe-string budgets. The IT model and the generalist venture teams who tried to use it were mismatched with biopharma. Even when money came in a sudden rush during the dot-com bubble, they failed to use it effectively, launching too many thinly capitalized startups and making 2000 the worst “vintage” investment year on record.

To deal with the bubble, the Fed pulled back the money supply, and the mini boom quickly turned to bust. The Great Recession of 2007-8 nearly finished off the chronically underfunded industry but marked a turning point in the evolution of bio-venture.

With the illiquid economy at risk of collapse, the Fed reversed course and pumped money back into the system. Venture firms that had managed to survive found themselves awash in capital. They were able to step-up early-stage financings from single-digit millions to tens and even hundreds of millions of dollars. With more money, they able to recruit people out of pharma. In doing so, they created a model tailored to drug development.

Results over the ensuing decade were impressive. Investors enjoyed record profits, and patients benefitted from treatments for previously fatal diseases, like HIV and heart disease. A robust entrepreneurial community was ready when COVID struck. Within months, hundreds of clinical trials were started for a pipeline of new and repurposed medicines that has grown to over 850 in two years. Remarkably, the most innovative proved to be the most effective. Approved in less than a year, mRNA vaccines have saved millions of lives and trillions of dollars.

At the same time, the rise of COVID confronted the Federal Reserve with yet another impending financial collapse. The Fed responded by printing even more money. The Alta mega-startup reflects a level of available financing unprecedented in the forty-year history of bio-venture.

The bio-venture business prospered because more money enabled it to become more pharma-like. However, at the scale of Alta Labs, the industry risks taking on not only the benefits, but also the problems of pharma-style drug development. Venture managers have yet to demonstrate that they can profitably deploy multi-billion-dollar research budgets—something that the largest corporations have convincingly shown they cannot. Will more money push biotech to yet greater heights or off a cliff?

Biotech Versus Big Pharma

In recent years big pharma have originated fewer than half of the drugs that have come to market and an even smaller proportion of the most innovative medicines, far less than needed to sustain themselves. With remarkable growth in sales and size, the leading companies have come up against two factors that limit their ability to innovate: mega-scale organizations and their own established businesses.

The need to coordinate global operations causes overhead to expand exponentially as companies grow. Managers try to increase production to match, but drug development is experimental, and most experiments fail. Output cannot be predictably scaled-up. Production geared to marketing means R&D managers must avoid the riskiest, most innovative projects to insure they can fill orders. Efficiency that tries to eliminate uncertainty is the enemy of innovation.

Bio-venture can innovate more effectively because that is what it evolved to do. The measure of productivity in biotech is not a single enterprise—most fail—but the sector. The entrepreneurial community does not coordinate activities across companies; in fact, they compete. Overhead does not increase with size. The community becomes more creative, more productive as it grows. Multiple startups can test more new drugs more quickly at lower cost than can a few large corporations.

Innovation At Scale

A potential pharma-like problem with mega-startups like Alta Labs is that they put too much money in too few hands and in doing so, reduce innovative diversity. Can Alta make more and better drugs than could, say, fifty $60-million start-ups?

Drug discovery is exploration, limited only by imagination. Not even the smartest drug developers know what will work in advance or whether their chosen technology, be it mRNA or CRISPR, will work in the target disease. The weakened or killed vaccines that made the world safe from polio were less effective when the Chinese tried them against COVID and totally unsuited for HIV.

Rather than guess, the best strategy is to try as many different ideas as possible, particularly those that challenge orthodoxy, to maximize the odds of finding one that will work. That is what startups do well and why they fail. Most new ideas don’t work. In a sense, venture startups are disposable. Every experienced fund manager expects most, occasionally all, of the companies in a portfolio will fail.

Most companies can fail and the industry still prosper if the payoff is great—10X or more—and cost of failure not too high. How high is determined by financial markets and the potential payoff for investors. The realization that venture firms could afford to lose $50 and $100 million startups led to the bio-pharma model. Can investors write-off $3-billion-dollar enterprises without inflicting fatal losses on themselves and serious damage to industry returns?

Venture capitalists move away from the lean startup concept at their peril. The bio-pharma model succeeded because the financial environment changed following 2008, and the limits of “manageable losses” dramatically increased in the era of easy money. It is hard to imagine that the current economy, battered by inflation and Vladimir Putin, will be able to sustain a community of multi-billion-dollar startups any time soon.

Siren Song of the Mega-Startup

Mega-startups have great initial appeal for managers and investors. While more money doesn’t change the discovery risk, it can reduce financing risk, at least in the near-term, and that is important. Small companies fail from too little, rather than too much, money.

Risk is highest at the outset, which makes it hard to recruit the best and brightest. A strong bank account allows managers to pay salaries competitive with the largest pharma. In a conventional startup, the stock granted to executives has little value, until they can prove the technology and products. In company launched with $60 million, five percent ownership would amount to something more than $3 million. A similar portion of Alta stock would have a value of over $150 million. Alta’s recruiting power is evidenced by the ability to lure superstar drug developer Hal Baron from GSK where he was just getting started on one of the most high-profile and ambitious R&D makeovers in the industry.

But too much money can make drug developers risk averse, cautious. Manageable losses are key to financing innovation; insupportable losses are a professional disaster. It is hard for financiers and managers to take serious innovation risk when they can’t afford to lose. To find more drugs, venture capitalists must accept that they will fail more. Better to walk away from a “failed experiment,” take the lessons learned and start afresh, than try to carry the cumulative burden of losses that accrue in a $3-billion drug discovery program.

In Favor of the Mega-Startup

Of course, to the outside world founders and their venture backers talk, not about how much money they stand to make, but the opportunity to improve patient care through the pursuit of novel treatments at a scale far beyond that of their peers. With years of funding in-hand, they can reach much farther upstream and take on unexplored new technologies that might someday treat the most wide-spread and debilitating conditions. The researchers at Alta have set their sights on­­ reprogramming cells to roll back the effects of aging and repair tissue. They are not alone in the field but might argue that their immense war-chest will give them the staying power to succeed where others are failing.

Rather than risking all on a single molecule with a 90+% failure rate, a mega-startup can improve the odds by developing multiple products. Ground-breaking research could give them the ownership, not only of products but the technology from which new classes of medicines are made. They could own the entire field.

Rejoinder

Unfortunately, platforms suffer from the same fundamental problem as product companies: the inherent uncertainty of drug discovery—unknown unknowns—and no amount of money will change that. As large pharma has learned, drug development does not scale. The risks of platforms are different from those of products but no less daunting. The multi-product companies have no better track records.

Platforms face systemic risks that cannot be managed away. Some areas of great promise prove just too difficult to develop, or a key piece of technology is missing. If a technology is not ready for market, multiple drug candidates will not improve the odds. Every cancer vaccine attempted in the 1990s and early 2000s failed because developers did not realize that they first had to block tumors’ ability to masquerade as “self.” After three decades, would-be makers of HIV vaccines still don’t know why they consistently fail.

The great genomics companies—Sequana Therapeutics, Millennium Pharmaceuticals and Celera Genomics—never succeeded commercially as purveyors of genetic information, not because they lacked value—genomics touches virtually every new drug and clinical trial in the era of molecular medicine—but because the management teams could not monetize the value that they had created. The companies were pursuing basic research, usually done in universities, on an industrial scale. They created great technology but could not find a product that would sustain the companies.

Innovation is the process of realizing value from ideas by creating unprecedented products. No one can know the challenges they will face in advance. When an innovative solution is required, big has no inherent advantage. Of the four largest, most experienced vaccine developers, two—Merck and Glaxo—failed to produce anything of commercial value and have given up; Sanofi lost a precious year due to a dosing error in an early trial and still is not approved. Only Pfizer brought a product to market, and only because it partnered its global development capabilities with BioNTech, a small German biotech, with a novel mRNA vaccine.

Innovation Models Matter

The scale of the early-stage sector is critical for the health of the industry. The extent of pre-clinical and phase I studies determines the innovative capacity of the entire pharma pipeline. For the system to maximize creative productivity, intake must cover as broad a swath of discovery space as possible, including crazy, counter-intuitive ideas that mainstream drug hunters, well acquainted with development risk, generally avoid. The best research strategy at the community level is “an-inch-deep-and-a-mile-wide” to maximize the diversity of ideas tested. A single development team, no matter how talented, cannot achieve the range that a community can. Risk-averse drug hunters tend to concentrate on a few “proven” or at least generally accepted targets. Testing the same hypothesis repeatedly can increase the likelihood of success, but it does not efficiently expand discovery space.

The entrepreneurial community was able to find solutions to the pandemic because it tested many ideas in parallel, rather than trying to figure out the most likely winner, based on experience. mRNA vaccines was one of the riskiest. No such product had ever been approved before. More familiar approaches, like viral vector and sub-unit vaccines made from a fragment of the virus, were all better characterized and battle-tested in other diseases but proved not as effective in patients.

Future of the Mega Model

Mega-startup supporters might argue that there are not 50 ideas worthy of funding, and they may be right, today. Rather than waiting for the next scientific discovery, Alta can make their own breakthroughs. By starting with basic research, they can create new targets as well as new drugs and expand the breadth of the field.

As attractive as the idea of taking initiative sounds, it misses a key element of the basic venture model: Breakthroughs are rare and unpredictable. Therapeutic areas often go decades with no major advances. While large companies are committed to their therapeutic areas, venture capitalists are opportunistic; nothing starts until a breakthrough occurs. Betting that you can drive a breakthrough is risky indeed. Researchers have no way of knowing if they are within months or decades of a commercial breakthrough. Knowing generally where a field is going is not enough. More money is lost in venture startups that are too early rather than too late.

Venture is a business with its own kind of efficiency, not that found in the time-and-motion studies of “efficiency experts.” Effective innovation finance depends on the use of tools like constructive failure, manageable losses and defined risk—development or discovery risk, but not both. By leveraging resources like academic research and contract research organizations (CROs), the industry can minimize fixed overhead. In the Bell-Labs era, corporate laboratories supplied some of the most valuable breakthrough research and won Nobel Prizes for their work. Today academic laboratories provide a stream of scientific breakthroughs that industry struggles to keep pace with. Reaching further upstream, ahead of expected breakthroughs, raises the timing risk enormously.

A greater limitation to growth than targets is experienced management teams. Venture capital and entrepreneurial management are apprentice businesses. The expansion of innovative capacity must be measured in decades. In the long run, the broader, more inclusive industry is, the more ideas it tests, the more executives and researchers it trains and the more productive it will be.

Judgment

While venture capitalists are experts in innovation finance, they are subject to the forces of disruptive innovation themselves and often as blind to its implications as any established business. They launch multi-billion-dollar companies because they can, not because mega-startups are part of a larger plan to address the question of enhancing innovation. As long as markets provide the cash, Alta will not be the last mega-startup. Only if they prove to be a better way to finance innovation will they flourish.