Expert Opinion Article contributed by Jim Neal, CEO of the biotech enterprise XOMA.
One of the world’s foremost financial economics experts, Andrew W. Lo, Ph.D., the Charles E. and Susan T. Harris Professor at the MIT Sloan School of Management and director of MIT’s Laboratory for Financial Engineering, discussed why funding for early stage biomedical research and development is declining: “Sometimes the most innovative therapies are the riskiest. Drug development is getting harder. Financial risk is getting bigger and funding is getting lower.” This was the cornerstone of Dr. Lo’s TEDx Talk in October 2015, and almost four years later, it’s still as true now as then.
Few can argue the biopharma industry continues to require significant capital supply to fund growth and development opportunities. When equity markets get tighter, sources of capital become limited – particularly for early stage drug developers, companies struggling financially to advance their drug candidates closer to the finish line, or those with assets languishing on shelves. If companies are tapped out on equity opportunities, they typically think only of debt or licensing as their financing options. Nearly a decade ago McKinsey & Company wrote that “A growing number of companies have begun to pursue novel financing and collaboration models that decouple resource commitments from financial investments.”
In response to financing challenges, new alternative investment vehicles have emerged whereby companies purchase economic interests in drug royalty streams – known as royalty financing or monetization. Companies receive non-dilutive cash paid immediately in exchange for a stream of royalty revenues in the future. Royalty monetization provides an alternative to equity or debt and offers a lower cost-of-capital source of funding.
Royalty financing a well-established model in other industries, particularly mining and energy. For example, in mining, according to a 2016 industry report, “Royalty/streaming companies offer several advantages over mining companies that make them cornerstone assets for resource investors, and this business model has been incredibly lucrative over the long term. Royalty and streaming companies now trade at fairly high multiples to cash flow, and mining companies are pricing the aforementioned advantages into their models.”
In biopharma, for companies with late-stage and commercial drug products, royalty monetization has become an accepted financing mechanism. Royalty financing offers companies attractive benefits because it derives from a long-standing existing industry practice of biotech companies licensing their innovative drug candidates to pharma companies who are well capitalized and have the capability to do late-stage development and commercialization. The economics contained in this license are monetizable. It has increased in popularity as smaller companies and academic institutions seek new revenue streams given the ongoing realities of funding early stage biomedical research and mitigating risk.
A pioneer in the acquisition of pharmaceutical royalty interests and the largest of the drug royalty investment companies focused on marketed and late-stage biopharmaceutical products is Royalty Pharma. According to a case study authored by Dr. Lo and his MIT colleague, Sourya Naraharisetti, “[Royalty Pharma’s] unique financing structure greatly enhances the impact it has had on the biopharma industry and biomedical innovation… Perhaps the most promising indication of Royalty Pharma’s future is the current low-yield environment facing fixed-income investors and the opportunity to issue large amounts of long-term debt securitized by royalty streams.” At the time of this 2013 MIT case study publication, Royalty Pharma managed $10 billion in assets; today the company manages $16 billion in assets.
An organization might monetize a royalty asset for any number of reasons including:
Interestingly, royalty financing is still a relatively new phenomenon for earlier-stage assets in pharma and biotech. Although this type of financing model has been meagerly used for early stage assets, companies are becoming more intrigued by the idea of royalty financing for pre-commercial drug candidates. This is at the heart of XOMA’s recent transformation from a drug development company to a drug royalty aggregator.
XOMA was uniquely positioned to reinvent itself as a drug royalty aggregator due to its legacy of partnered assets from its days as a traditional biotech. The company is now making these benefits available to biotech companies who have pre-commercial stage candidates. The capital that comes in is non-dilutive to equity holders and also is non-recourse, meaning the royalty financing does not have to be repaid, the company from which the royalty assets are licensed retains full autonomy in determining how it chooses to deploy the funds, and XOMA takes no ownership position.
What makes the royalty aggregator business model work is risk mitigation through portfolio expansion and acquisition, particularly of mid-stage clinical assets. This is a strategy that matches long development timelines with capital access that has less of a ‘short-term’ orientation.
Recently XOMA inked a deal with Aronora, Inc., a Portland biotech startup developing a new kind of blood clot treatment, for royalty rights to five drug candidates. “These new funds help propel our drug candidates forward even faster and develop lifesaving new therapies,” said Aronora co-founder and Chief Executive Officer, Andras Gruber, MD. This was a win-win for both organizations.
Moving forward, we expect to see an ongoing interest in this form of royalty financing from the academic and biotech sectors and are excited at what the future brings.