It is extremely rare for a small-cap company to take a drug candidate from first principles through the arduous process of pre-clinical testing and clinical development right through to regulatory sign-off and market launch.
In the US, doing this is called hitting a home run.
Such success stories in the States are more frequent than they are here in the UK.
Indeed, it is the origin story for early biotech pioneers such as Amgen Inc. (NASDAQ:AMGN) and Gilead Sciences Inc. (NASDAQ:GILD) which were ultimately able to grow into multi-billion dollar giants of the drugs arena.
It is fair to say US backers of emerging businesses in the life sciences arena tend to be more knowledgeable and patient than their UK counterparts - mainly because they know what success looks like. America is also host to deeper pools of capital.
Some spectacular failures in the 1990s and early noughties left their scars here in the UK.
Partnering is key to success
This side of the Atlantic, success in the sector is typically measured by whether a drug developer can find a partner willing to do the heavy financial lifting associated with late-stage clinical trials.
Deals of this ilk are by far the biggest value catalyst for the ambitious drug developer.
We have seen transactions that are worth hundreds of millions of dollars.
Of course, not all that money is paid upfront.
DMD Pharma: A hypothetical case study
So, let’s take the hypothetical example of DMD Pharma, which is developing a drug for a rare cardio-vascular ailment for which there is no current treatment.
The end-user group may be small, but analysts and the company believe that if the drug gets regulatory sign-off, the once-a-month injection will be widely adopted.
Not just that, insurers in the US have indicated they will pay a premium for the new treatment.
Knowing this, analysts reckon peak sales of the drug will be US$2bn a year. Add to this an abbreviated filing protocol if its phase III results are as strong as the early indications suggest and there’s little wonder discovery is hot property.
This is reflected in the licensing deal it inked with a larger rival in the same field based on some compelling from DMD Pharma’s phase II clinical trial.
The headline figure was pretty significant and saw the share price double in the space of an hour after terms of the agreement were released to the market.
Nasdaq-listed Arrowhead Bio, with a market cap of say US$15bn, will make US$1bn of staged payments and fund a phase III clinical trial of the new potential wonder potion in return for exclusive access.
The figure is huge as DMD is worth less than US$100mln. But, the devil of this deal is very much in the detail.
The big kicker is the US$20mln Arrowhead is handing over as an ‘upfront’ payment covering some of the costs of getting the drug this far, and, this is the only portion of the headline US$1bn that is guaranteed.
DMD will get a further US$20mln once recruitment for the phase III trial begins in a years' time.
That sum is fairly much nailed on. The remainder of the cash will be wired when significant landmarks during the phase III trial are completed, including the successful conclusion of the study.
Staging of the payments this way helps share the risk, which is why the biggest windfall, around US$500mln, is received in one final blast following sign-off by regulators in the US.
DMD will also receive a percentage royalty on sales of its new wonder drug, which the press release tells us is high single digits. Let’s guess at 8%, which at peak revenues is a kick-back of US$120mln a year.
Now, at the point of approval, with Arrowhead having to fork over half a billion dollars, the American giant might as well acquire DMD. And in fact, this is what often happens.
Smaller firms are often swallowed up.
When does it make sense to partner up?
Some lucky companies in hot areas of research will feel the tap on the shoulder at the pre-clinical stage. But these sort of agreements are rare.
They tend to be the Hail Mary throw of a large pharma playing catch-up in an area where its research pipeline is empty.
The rule of thumb goes something like this: the earlier a company partners up, the less it receives in licensing payments.
This makes sense and relates back to the paltry value ascribed to drugs in early stages of development.
The optimum point in the process to find a financially well-endowed sugar daddy at the end of phase II.
Remember, phase III is where the big bucks are spent. And companies want definitive, clinically persuasive results and they can’t afford to scrimp.
So, end of phase II balances risk, reward and cost.