Biotech and Biomedical Failure: It’s Not the Science
By Dr. Barbara Handelin, Ph.D., and Karyn Polak, Guest Contributors
The biotech and biopharmaceutical (biomedical) industries are failing us, medically and economically. We have the science to serve us better; we need the right market participants in order to truly deliver greater coverage, access, and outcomes.
You’ve seen the headlines: Drug pricing in the United States is out of control. Few technologies for early detection of life-limiting diseases (e.g., cancer and heart disease) or low-margin products like vaccines and antibiotics are receiving adequate investment, despite evidence that these inventions have saved more lives than novel therapies. Drug shortages in the United States are at a record high. And pharmaceutical companies are saying the quiet part out loud and proud now – that some expressly choose to hold back one promising drug in favor of another already-patented one in order to maximize profits.
The biomedical industry has received steadily greater investment since its origins in the 1970’s. In the United States, venture capital investment alone in biotechnology companies steadily increased from $1.5 billion in 1995 to $16.8 billion in 2020. Yet despite benefiting from billions in capital investment, the biomedical industry produces products that address less than 10% of all disease conditions: primarily those that can generate blockbuster profits and spectacular returns for private or public shareholders. This critical industry is overlooking, or leaving behind, 90% of society’s medical needs and the steady long-term profits that could flow from addressing those needs under the right market conditions.
Below we set out a framework under which for-profit corporations that lead the current biomedical industry could be among those stepping in to help fill the capital. What is required is a demonstration of commitment and accountability by those companies to their public positions on ESG matters (environmental, social, and governance).
The “Why”
It isn’t because physicians are holding medicines back.
As long as the evidence of effectiveness is openly available to physicians and as long as their patients can afford a test or treatment, physicians are of course anxious to offer any and all new ways to diagnose and treat disease.
It isn’t because the public health agencies don’t recognize the need.
In fact, public health agencies and other health care advocacy organizations (e.g., The American Cancer Society) track and publish data on the positive and negative effects of early detection and standard treatment protocols on overall health and wellness. They’d much prefer, and indeed they advocate for, more vaccines and other preventive or early detection methods to catch cancer, heart disease, and other major diseases before they become intractable.
It isn’t because we lack knowledge or technology to solve far more medical needs.
In the late 1970’s, breakthrough discoveries of genes and molecular processes were beginning to reveal the biological basis of disease. From then on through the early 2000’s, biotech companies were founded on highly speculative discovery science, which required huge leaps of faith that glimmers of insight into human molecular physiology could be translated into safe, effective medicines, diagnostics or preventives. The science was so nascent in those days that selection of target investments was later recognized as little more than breathing on dice at the craps table: the probability of success of any given invention/discovery being translatable into approvable products was unchanged by the careful selection of one idea over another, since there were too many unknowns for rigorous prediction of success.
Where to find such high risk capital? A few inspired venture capitalists recognized a new speculative investment opportunity in those promising discoveries. High-stake bets on high-risk ideas coming out of high-profile universities could be fertile ground for rapid wealth creation. Venture capital providers were happy to oblige for this potentially high reward.
As a consequence of 30 years or so of free-flowing (albeit high-cost) capital, our scientific understanding of molecular and physiological systems of disease advanced significantly. What resulted was a tsunami of data, discoveries, and understanding, flooding academic and industry journals with overwhelming knowledge. By the mid-2000’s, the global biomedical research and development (R&D) system was not just robust but was in fact drowning in millions of potential treatment, detection, and prevention candidates. With a much more mature and deep pool of scientific and technology knowledge in medicine, and the potential to meaningfully addressing a wide swath of the molecular mechanisms of human disease, the biomedical assets available today are much less of a ‘wild card’ bet for funders.
So what’s the problem?
It's the financialization of the biomedical system that is failing us.
Despite their lowered risk profiles and high potential for medical impact, significant volumes of undervalued medical product candidates – ‘assets’ in the market vernacular – sit on a shelf or are abandoned rather than being pursued with investment support. Instead, capital continues to flow only in pursuit of products with the highest margins and biggest addressable markets, an often fatal misalignment of capital and perceived risk. The capital cost remains high both directly -- ownership, control, financial expense – and indirectly in all that it leaves behind.
Since the inception of the biotech industry, each entrepreneurial company accepting the speculative capital of venture firms has given over two critical aspects of building a business: (1) ownership control, as the early to mid-stage capital sources take preferred shares and a majority stake, and (2) control over product portfolio selection, exclusively devoted to products that can be forecast to deliver maximum profits. Maximized profits in these companies are achieved primarily through the market exclusivity granted by FDA or EMA and enforcing patent rights that together allow for unchecked initial setting and yearly escalation in prices for their proprietary drugs.
Meeting the demand for this type of capital requires short lead times to capture greatest market and investor returns, often abandoning promising medicine in favor of speed to market. Rather than valuing breakthrough biotech on medical impact, the market values it based on profit impact. And there are only so many drugs and diagnostics that will ultimately maximize lifetime profits – and so many more that we need to maximize the number of people served and diseases avoided.
Why isn’t there a vibrant marketplace filled with companies working away at the 90% gap, at an affordable cost and accessibility to all? It is because of a market failure that can be rectified, not because the market is functioning properly. However, in the absence of new laws or regulations, overcoming this market failure will require innovative and long-term thinking.
Companies engaged in producing the 90% of medical needs need lower cost capital invested with longer horizons that can reliably generate good (i.e., business sustaining) margins. What will it take to build the asset owner/managers system that seeks lower risk (yet high medical impact) investment opportunities with commensurately lower returns on their capital?
What will it take? Intentional capital: A Biomedical Industry v2.0
Seasoned biotech industry professionals and other accomplished connections including the authors formed a public benefit non-profit entity, The 90~10 Institute, to tackle the medical and economic failures by proposing to stand up a new biomedical industry: Biotech v2.0. Our vision for Biotech v2.0 activates the heart and soul of scientists, philanthropists, and investors to serve the original mission of the biomedical industry: to care for the greatest number of people and treat the greatest number of health challenges possible, in the most efficient way.
Our Theory of Change is that a new biomedical industry, comprised of emerging companies seeking to operate leanly, focus first and foremost on health, think outside patent protections, compete on quality and price, and let profits flow in measure, will produce affordable medicines for the 90%. We believe the entire process can be optimized for maximum productivity and efficiency, producing sustainable profits in a competitive marketplace.6
There are, of course, other levers that must be pulled in order to advance the work of closing the 90% gap: for example, price controls and other counter pressures on pricing applied by institutional buyers (insurers, health systems, Medicare). The 90~10 Institute recognizes the productive measures being taken by others on these fronts, including federal legislation to allow Medicare/Medicaid to negotiate prices on some (few) treatments, disruptive companies like CostPlusDrugs offering lower prices on novel buying platforms, and nonprofit companies like CivicaRx and Medicines 360 providing low-cost drugs to subscribers and to developing world populations at no cost. The 90~10 Institute will support and advocate alongside those efforts while focusing its energies on educating stakeholders on the pillars depicted above, encouraging aggregation of mission-aligned capital and amplifying the efforts of those willing to put these models into practice.
The 90~10 Financial Innovation Proposal: Biotech Financing v2.0
Companies in v2.0 will be fueled by risk-adjusted, returns-adjusted, patient capital. The 90~10 is developing novel financing vehicles to aggregate mission-aligned capital in professionally managed funds, partnerships, and other structures. The Institute will open-source as well as help activate these vehicles.
This new strategy for financing biotech starts with using what some call “regenerative finance” that focuses on people, planet, and purpose. We describe below what mission-aligned investment means and where it comes from, as well as the legal structures needed to center and maintain that mission.
Apply a Regenerative Finance Approach
Regenerative finance sees money as a means, not as an end. Healthcare by necessity requires caring, love, and passion; an intentional caretaking of people and planet; and a focus on the relationship between provider and patient, indeed on the patient as the purpose first and foremost. That’s why The 90~10 Institute positions regenerative finance as a necessary condition to advance a patient-first biomedical industry.
Apply Mission-Aligned Investment
Sourcing and aggregating investments in Biotech Financing v2.0 to deliver sustainable profit while focusing on maximizing healthcare outcomes could be called purposeful investing, impact investing, or mission-aligned investing.7
The combination of tools needed to serve the mission will depend on the challenges to be addressed. For example, developing drugs from early stages may require “patient” capital; devising one-time-use drugs may require public investments; and facilitating repurposing of existing drugs may require patent policy changes along with mission aligned capital. Below we describe different types of impact investments that may be needed in one combination or another.8
Philanthropic Capital
When seeking a people-first outcome, often the first type of investment that comes to mind is a grant or philanthropic donation rather than an investment seeking some financial return. Even within the grant structure, though, there are different types that can be brought to bear:
a straight grant or donation;
a recoverable grant that under pre-determined circumstances becomes repayable in whole or in part;
a guarantee that supports the organization’s debts; or
some combination that catalyzes – encourages or draws in – other investments.
These tools are typically deployed by foundations (public, private, community, or corporate), family offices, public or private endowments, donor-advised funds, or individuals.
On their own, though, grants or philanthropic donations will be insufficient to scale to Biotech Financing v2.0. We propose a change in philanthropy, equity and debt financing.
Flexible Debt
On the debt side there are a variety of tools, typically involving greater flexibility on the mechanism for a return on the investment:
a straight term loan, or a more “patient” loan that defers or does not pay interest over a period of time or for the life of the loan;
revenue- or royalty-based finance that pays interest only upon and as a pre-determined percentage of revenue earned;
a line of credit that provides a backstop in case it is needed but doesn’t require ongoing interest or principal payments;
market-based social impact bonds, like Green Bonds; or
a pay-for-success structure where repayments are made only as and when certain pre-determined, observable social impacts – for example, effectiveness in disease modification or eradication – have been achieved. That flexible approach to return on investment or ROI yields not only a timing benefit but also provides the space to seek sustainable rather than maximum profits.
“Patient” Equity
Equity can be creatively crafted to support a medical purpose-first model of operation. Often a traditional equity investor, e.g., a venture capital or private equity fund, seeks high growth and high returns in a very short period of time and will demand controlling interest through their equity. Controlling the equity position of these investors results in companies focusing on products that, despite long development cycles, can be projected to produce outsized profits if and when they achieve FDA approval for marketing. In the meantime, investors trade on the high scale of future profits, thus satisfying quicker returns than the products can deliver through revenue. Ironically, the need is thus for patient capital seeking modest, reliable returns. This type of investment might involve:
A SAFE, or Simple Agreement for Future Equity, that provides rights to the investor for a future ownership piece of the enterprise but for which the level of ownership isn’t determined unless and until a specified event occurs.
A variable dividend vehicle where the shareholders receive distributions (dividends) only if there is available excess cash and then only based upon a previously agreed formula.
A third, even more patient, model is one in which the investor’s exit is pre-negotiated to occur only upon achievement of a certain level of return to the company and is capped at a certain amount (e.g. 2x or 3x the original investment) -- and is often paired with an agreement that the company can buy back the investment rather than it being sold to a third party. The equity might be self-liquidating, such that it is repaid using a pre-determined formula like available free cash flow up to a specified cap. The equity may even be structured to return to the company for the benefit of its employees.
These patient forms of equity allow maximum likelihood of the enterprise retaining its mission focus rather than losing control to a profit-maximizing outsider.
Debt and equity tools such as these can be deployed not only by private credit providers (including angel investors, charitable loan funds, diversified business funds) and traditional financial institutions (banks, community development financial institutions (CDFIs), community development companies, credit unions, and faith-based institutions) but also by the very same foundations and endowments that support straight grants, because they can use assets invested to continue their mission even beyond their program-related investments or grants. Patient advocacy organizations (medical research organizations) dedicated to raising funds for diagnostic and therapeutic product development may offer investment support. Other types of institutions, like investment funds, social impact funds, research institutions and others also provide this kind of financing. Healthcare management organizations, healthcare insurance providers, and governmental entities are also players in this market for mission-driven finance.
ESG Capital
Even the for-profit corporations that lead the current biomedical industry (v1.0) should be among those willing to step in to help fill the capital gap through patient-first financing in order to demonstrate commitment and accountability to their public positions on ESG matters (environmental, social, and governance). The arguments for doing so are clear:
The social considerations underlying such investments align with the long-term business interests of those corporations in fostering the overall success of the biotech industry.
The leaders of the current biomedical industry could contribute not just capital, but also expertise, to further the purposes of these efforts.
Participating in patient capital efforts will benefit these companies by increasing job satisfaction for their workforces through participation in the long-term efforts.
Similarly, participation in these efforts would show social commitment to other stakeholders, including customers and regulators.
The investments could pay off in the long-term.
The more examples and successes demonstrated by the use of these tools, the more likely they will be to spur further innovation and thus additional arrows in the quiver there will be to access. The key to all of these tools is the mission-preservation and independence from the conflicts and pressures that profit-maximization presents. By aligning ownership, governance, and financing with purpose – often called “steward ownership”, founders can create a resilient, enduring force field against those common obstacles and advance the development of Biotech Financing v2.0.9
Mission-Aligned Capital in an Example Medical Impact Fund
To make the picture of Biotech Financing V2.0 visible, we offer one example of how impact-oriented funding sources can participate in this next generation of biotech investing. In this example, wealthy individuals, donor-advised funds (DAFs), private foundations, government treasuries, and impact investors can impactfully use their ‘benevolent assets’, collectively and at-scale, as mission capital for fueling the Biotech v2.0 industry. Such aggregation and professionally managed funding can deliver appropriate risk/return generated from affordable and equitably accessible medicines.
Medical Impact Funds are designed to reduce the cost of capital for biotech/pharma companies across their business life cycles. The key element for this new generation of biotech funds is a governance structure that is aligned to appropriate financial incentives for the limited partners (LPs) and Managing Partners in order to deliver the highest possible medical impact.
Figure 2 below shows a simplified structure chart for a “stacked deck” fund. The key aspect of a stacked deck fund is that certain investors serve as first-loss capital or provide concessionary capital through another mechanism. The added security can de-risk the investment for other investors, unlocking capital for riskier investments or investments where a lower return is expected.
This general fund structure is intended to bring investment capital into alignment with the capital requirements of companies in Biotech v2.0:
Scale of capital suitable for biomedical products
Reduced risk/reward balance
Duration of investment
Flexibility re debt vs equity
Mission ‘lock’ to align investor interests to company interests = health outcomes
Alignment of financial rewards for LPs, Fund managers and investee companies
Sponsor: Governance is modeled here to be organized by a Fund Sponsor, which could be an existing management firm, a nonprofit 501(c)(3) entity, or a Public Benefit Corporation (PBC). The Sponsor would provide ‘mission lock’ by having a ‘golden share’10 position in the Manager or appropriate governance mechanics could lock in guideposts for how investments and returns are managed by the Manager.
The Management Company and General Partners: A Management Company provides the investment management services to the Fund. The Fund, through General Partners, will make investments into portfolio companies. While limited partnerships are the most common vehicle for organizing US funds, it can also be organized an LLC or a Public Benefit LLC (“PBLLC”). If organized as a PBLLC or LLC, there is less of a need for separate GP and Management Company entities. The Management Company will manage the fund’s investments pursuant to an investment management agreement, and the fund may be charged a fee for such services. The Fund can be limited in duration or evergreen/permanent11.
GPs are otherwise compensated and incentivized by earning ‘carry’12 a percentage of total profits of the Fund’s returns. Since Medical Impact Funds are intended to reduce the capital costs for investees, each of the participants in the investment flow need to be aligned to reduced costs of Fund administration, including the GP. Carry may, for example, be tied to the achievement of the fund’s impact goals, e.g., the general partner (or its members) will not receive all or a portion of the carry if the fund fails to achieve its impact goals. The carry can also be recycled into new investments or new funds. If the Fund Sponsor is not a charitable organization, for mission lock purposes, the General Partner and Sponsor could consider including a nonprofit as a member of the GP.
The Fund takes in capital from concessionary investors who provide guarantee of ‘first loss’ in order to facilitate investment from investors seeking market returns. Note that this scheme assumes that the first loss capital will invest as an LP and will serve as the first loss capital by sitting at the bottom of the waterfall13. For example, the governing documents can provide that the “market LPs” receive their capital back and some set preferred return prior to the first loss capital receiving its money back. As an alternative, the first-loss capital could provide a guarantee or other de-risking measures. We think federal or state funding programs could be well suited to serving in this role. In any event, concessionary investors will typically require the fund to produce robust impact metrics and reporting, especially if they are foundations making Program Related Investments.
Investors seeking market-rate returns who, by virtue of their position in the waterfall, have their investment de-risked by the presence of the first loss capital. Note that this simplified structure chart assumes two classes of LPs (first loss and market), but variations are possible. For example, there could be multiple classes of “market” LPs, with varying levels of seniority in the waterfall and shares in the fund’s upside. Additionally, there could be concessionary LPs who expect their capital back plus below market rate of return, thus balancing the combined rate of return.
Incorporate More Women into Leadership of Biotech Financing V2.0
It may surprise you to learn that often the best stewards for this kind of ownership are women. No, we’re not arguing to take down the patriarchy or to exclude the millions of others who operate in this space. The simple fact is that women are the new face of wealth, the new force in business and asset ownership, and their (our) presence is only growing.
Today, women control more than $10 trillion (about 33%) of total U.S. household financial assets, and research by McKinsey found that in the United States that percentage will rise to more than 67% by 2030. Women are also the largest beneficiaries of the current transfer of wealth, living an average of five years longer than men. As a consequence, an unprecedented amount of assets will likely shift into the hands of U.S. women over the next three to five years, representing an estimated $30 trillion by the end of the decade.
Moreover, women are more likely to invest in ventures that have positive impacts on society and the environment and more likely to consider and seek to influence collective outcomes. Triple Pundit offers some clear markers from two of the most influential leaders in the space for why this is the case. As Jackie VanderBrug of U.S. Trust has said, “Women have a more holistic view of investment. Yes, they do care about returns, but they also care about the role of their investments in society.”
They’re doing so by exercising their asset agency outside of their retirement accounts: according to Fidelity, as of 2021, 67% of women invest outside of their retirement accounts, up from 44% only five years ago. They do so when they control the investment reins in private equity and in other investment institutions. And they certainly do so in philanthropy and government roles. The Case Foundation produced a thorough accounting of the extensive influence of women in these arenas almost a decade ago – so you can imagine what the picture would look like today.
Conclusion:
Biomedical Financing V2.0 + The Power of Women = Biomedical Industry v2.0
Heartbreaking articles in the press regularly appear these days about better drug options being sidelined until every last dollar of profit is extracted from the existing, protected patents; about therapies being ignored in favor of more profitable (and yet less effective) options; and about exorbitant drug prices being charged simply because they can be. We must begin to shift the dialogue from big corporates to individuals, shift the balance from profits to patients. And we can: there is purpose-driven capital in the hands of people who care about others, who want to see a different result. Whether via a stacked-deck fund [such as the one we’ve posited here], or another structure that equally empowers mission-aligned asset owners and utilizes efficient development and manufacturing processes, we can manifest a sustainable, equitably accessible, and medically effective biomedical system that works for all.
That 90% gap in diagnostics, drugs, and preventatives is not getting any smaller. We can no longer wait for others to build the shelter while the world is deluged by the tsunami of healthcare demands. The need is urgent, and the time is now. Join us in creating Biomedical Industry v2.0!