In an earlier post, I set out some of the reasons why patents are so critical to early stage life sciences companies. In many respects, they are their most valuable asset. Now I will turn to the reasons why investing in this asset class can be so attractive.
Early stage life science companies develop new commercial techniques for dealing with health related problems. As such, they have the potential to provide enormous social benefits as well as generating the possibility of greater returns for investors. The new techniques are often developed from basic research undertaken by publicly funded organisations such as universities, hospitals and medical research institutes. The field can be divided into therapeutics or therapies (treating or preventing diseases), diagnostics (identifying or characterising diseases using, for example, less invasive techniques), and medical devices.
The development of new therapeutics is often termed the drug development life cycle.
Drug development proceeds through many stages in order to produce a drug (pharmaceutical) that satisfies the regulatory requirements for safety and efficacy. At each stage, there is the potential for the drug to fail and although the risk is reduced as the drug proceeds through each stage, there is always a risk that it will not be successful. The following is a brief explanation of the various stages.
- Disease Research. The basic science of determining the pathway to a disease (such as a cancer) and mapping out critical points in the pathway which may be affected by drugs. If the pathway is affected or blocked then the disease may be treated. Usually, this type of research is conducted in public institutions.
- Discovery. The process of trialling hundreds or even thousands of compounds to determine which have the potential to impact on the disease process, then focusing on a few that have the best chance of success. This stage may include modifying the compounds to make them more “drug-like”. Typically, this research will be initiated by public research institutions but on-going research will often be funded in a commercial vehicle. In my view, this stage in the life cycle is a good point at which to consider making an investment.
- Pre-clinical. The most likely compounds are put through various models to assess their potential as a drug including whether they can be administered easily and whether they may have side effects or toxicity. This is followed by conducting animal trials to analyse the impact of the drug in live models of the disease. This Drug Discovery and Pre-clinical stages are often called the “valley of death”. This is because these stages mark a transition between the government funding available for basic research and the type of commercial funding that can be made available for clinical stage assets (Phase I onwards). In most instances, as basic research does not have a commercial focus, the effort required to take the results of basic research and place them in a commercially investable position is difficult. This is also a high risk stage as many lead compounds fail to proceed to Phase I. Investing at this stage requires in-depth experience.
- Phase I. After some merit is proven through pre-clinical data, a small Phase I clinical trial is conducted with either healthy or diseased patients to investigate whether the compound is tolerated and safe. The costs of such a trial are usually less than $10 million.
- Phase II. A Phase II clinical trial is designed to assess whether the compound works to treat the disease. The trial may also provide information on the appropriate dosage to use and how to best manage side effects associated with the compound. The trial is typically conducted on a small patient group. The costs of such a trial can be up to $50 million.
- Phase III. A Phase III clinical trial assesses the performance of the compound against the current standard of care for the relevant disease and to decide whether it is effective enough to replace this ‘standard of care’ or whether it may become a second line therapy in treatment of the disease. These trials are conducted on large patient groups in order to establish statistical significance. Sometimes the drug provides insufficient benefits to be a useful therapy when compared to the current standard of care used for the treatment of the relevant disease. The costs of Phase III clinical trials can exceed $50 million.
- Regulatory submission. In this stage, the data accumulated during the various studies and trials is compiled into a data package and submitted to a regulatory authority (such as the Federal Drug Administration in the United States or the Therapeutic Goods Authority in Australia) for marketing approval. This can involve multiple rounds of discussion with the relevant regulatory authority and potentially require conducting one or additional clinical trials in order to obtain approval.
If the regulatory authority decides the drug is effective and safe enough for distribution and use by patients, it will be approved for marketing.
There are a number of inflection points in value during the life cycle of drug development. At each of these points, there is the potential to exit the drug discovery process by selling or licensing the rights to develop the drug to a third party.
It is common for early stage companies in the life science sector to have a project at the drug discovery stage or the drug development life cycle who are seeking to take it through the pre-clinical stage and then to Phase I (ie. first in human studies). These projects are typically derived from basic research originating in a university or medical research institute.
Australia has substantial public investment in life science and generates high quality basic research with enormous potential for translation to commercial results. However, the translation of this knowledge into potentially commercial treatments and diagnostics is not generally publicly funded.
Funding from the private sector can be sparse and haphazard. This is generally attributed to the fact that finding early stage life science companies and assessing their prospects and their value is beyond the capacity of most investors and is the bailiwick and comparative advantage of only a few specialised funds and sophisticated investors.
- is one of the top five bio-economies globally;
- is ranked in the top 10 in OECD for total expenditure on life science R&D;
- has the fourth highest proportion of innovative SMEs in the OECD+;
- produces the 12th highest output on the Nature Index in 2019;
- has enjoyed early life science industry growth in excess of 16% in two years; and
- has had A$52.2 billion spent between 2012-2016 on R&D within Australian universities, medical research institutes and major publicly funded research agencies.
The value of an early stage company that has taken a potential therapy from a concept to pre-clinical validation (i.e., before it is tested in humans) can be many multiples of the initial investment. This is because the reduction in risk involved in successfully taking the therapy some way along the path to regulatory approval has value to larger pharmaceutical companies who have the resources to take the therapy further along the path to development.
The investment period between discovery to pre-clinical stage therefore presents an opportunity to generate significant capital growth when the sums of capital required to progress the drug candidate through the development pathway may be significantly less than the capital required at later stages of the pathway. Few fund managers to have the experience of taking on investments at these specific stages and progress assets through to possible exits at with the potential for deriving earnings at many multiples of the original investment.
 Data from: Nature Index, Ausbiotech Snapshot 2019, National Survey of Research Commercialisation 2000-2016, Innovation and Science Report 2016