Biofinancing

Biotech IPOs

Springboard for Success

Mark Edwards Mark Edwards
Reports of the death of biotech initial public offerings (IPOs) have been greatly exaggerated. Since January 2010, 42 biotech companies have completed IPOs in the US. Of these, 34 were venture backed.
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With apologies to Mark Twain, reports of the death of biotech initial public offerings (IPOs) have been greatly exaggerated. Since January 2010, 42 biotech companies have completed IPOs in the US. Of these, 34 were venture backed — 14 in 2010, 9 in 2011 and 11 in 2012. This analysis examines the financing strategies that have been followed by these 34 companies & tests several hypotheses about the most attractive way to fund a biotech company under current capital market conditions.

Although often overstated, there is no dispute that launching a biotech successfully into the public market has become increasingly difficult in recent years. Despite raising on average $133 million in private equity prior to IPO, almost a third of the 34 venture backed IPOs were valued at IPO below their aggregate private investment, and, for the group as a whole, the IPO itself was priced 8% lower than in the last preceeding (mezzanine) financing.

Before testing several specific hypotheses regarding biotech financing strategy, however, it may be useful to understand the financial trajectory of the group as a whole. The 34 venture backed companies raised an average of $28 million ($21M median) in initial (Series A) financing, at a pre-money valuation of $10 million. The resultant post-money valuation of $38 million was then “stepped-up” by 74%, on average, to a pre-money valuation of $66 million in the second (Series B) financing, wherein the group raised an average of $32 million ($25M median) to achieve a $98 million post-money valuation. Though pricing varied by company, and most companies undertook reverse stock splits prior to the IPO, one can think of the 74% step-up as $5.00 Series A shares, with Series B then being priced at $8.70/share.

Similarly, the group raised an average of $44 million ($38M median) in third round (Series C) financing, at a pre-money valuation of $99 million. The average Series C round was priced at close to the same valuation as the prior financing, with only a 1% step-up. The resultant post-money valuation of $143 million was then stepped-up by 24%, on average, to a pre-money valuation of $177 million in the mezzanine (Series D) financing, wherein the group raised an average of $39 million ($23M median) to achieve a $216 million post-money valuation. Again, one can think of the 24% step-up as the $8.79 Series C share price jumping to $10.90/share.

Finally, as noted above, the group as a whole priced the IPO at a 8% lower valuation than Series D post-money — $216 million valuation after Series D became $200 million at IPO — akin to $10.90 Series D shares being priced at $10/share in the IPO. The IPO itself raised an average of $71 million ($67M median), resulting in an average post-IPO valuation of $271 million.

When the group of 34 biotechs is sorted on the basis of whether a specific biotech’s pre-money IPO valuation was greater or less than the sum of its aggregate private financings, we see that the two cohorts have very different trajectories across multiple financings. In particular, the valuation step-up was 42% between Series B and C for the more successful cohort of 23 companies, versus a step-down of 10% for the other 11. Similarly, in the IPO itself, the more successful cohort experienced an 8% drop in valuation, versus a 33% drop-off for the lower valued cohort.

From a financial perspective, a successful biotech IPO requires, at a minimum, a positive return on the aggregate capital invested in a company to date. Otherwise, it would make little sense for venture backers to undertake the risk and illiquidity associated with investment in private biotech companies. Four distinct approaches to achieving a successful biotech IPO have been suggested by various venture capitalists, and these can be stated as testable hypotheses, as follows:

  1. Raise at least $100 million in aggregate private rounds.
  2. Raise a large ($40+ million) mezzanine round.
  3. Raise a large ($25+ million) first round.
  4. Dive into an available pool of IPO capital early.

As the accompanying slides demonstrate, we tested each of these hypotheses by re-arranging the group of 34 biotechs into cohorts that did or didn’t meet the relevant criteria.

Raise at least $100M in aggregate private rounds

19 of the 34 biotechs raised at least $100 million in aggregate private capital. This cohort raised an average of $182 million ($149M median) versus $71 million ($71M median) for the 15 companies in the other cohort. In terms of valuation, the better financed cohort outperformed its counterpart in step-ups as well as capital — with round-by-round step-ups of 83%, 6% and 29% versus 60% and step-downs of 10% and 9%. Both cohorts dropped 3% in the IPO pre-money valuation. Overall, the better financed cohort obtained an average post-IPO valuation of $373 million, versus $142 million for its counterpart. Of this $241 million differential, $111 million was additional capital raised in private rounds, $33 million was incremental capital in the IPO itself, and the remaining $97 million was the result of higher valuation step-ups.

Raise a large ($40+ million) mezzanine round

12 of the 34 biotechs raised at least $40 million in their final private financing prior to IPO. This cohort raised an average of $80 million ($84M median) in mezzanine financing and $214 million in aggregate private rounds, versus $16 million ($14M median) in mezzanine financing and $89 million in aggregate private capital for the 22 companies in the other cohort. In terms of valuation, the cohort with the large mezzanine round outperformed its counterparts in step-ups as well as capital — with round-by-round step-ups of 124%, 6% and 57% versus 41% and step-downs of 4% and 17%. The large mezzanine cohort lost 12% in IPO pre-money valuation, versus a 5% step-up for its counterpart, but this wasn’t enough to offset the gains made in private rounds. Overall, the large mezzanine cohort obtained an average post-IPO valuation of $473 million, versus $161 million for its counterpart. Of this $312 million differential, $125 million was additional capital raised in aggregate private rounds, $41 million was incremental capital in the IPO itself, and the remaining $146 million was the result of higher valuation step-ups.

Two elements complicate the impact of a large versus small mezzanine round — the use of convertible notes as well as insider commitments to purchase a portion of the IPO. 15 of the 34 biotechs had loans that converted to equity at or near the timing and price of the IPO. Additionally, all but six of the IPOs had some level of insider commitment to purchase a portion of the IPO — 14 had firm commitments to purchase an average of 40% of the offering, while 12 had “expressions of interest” from insiders for an average of 39% of the offering. It’s unclear whether the use of convertible notes and/or insider commitments should be considered strategic or reactive. As a matter of classification, notes that converted to equity prior to the IPO (or at a significantly different price) were counted in the mezzanine round; notes that converted upon the close of the IPO at the IPO price were added to the IPO proceeds. For the group of 34 biotech IPOs, use of convertible notes with pre-IPO conversion as well as firm insider commitments to purchase a portion of the IPO were both associated with lower valuations. Conversely, use of notes that converted to equity at the IPO closing as well as “expressions of interest” from insiders to purchase a portion of the IPO were both associated with higher valuations.

Raise a large ($25+ million) first round

13 of the 34 biotechs raised at least $25 million in their first private financing. This cohort raised an average of $48 million ($45M median) in first round financing and $132 million in aggregate private rounds, versus $15 million ($16M median) in first round financing and $134 million in aggregate private capital for the 21 companies in the other cohort. In terms of valuation, the cohort with the large first round underperformed its counterparts in step-ups — with round-by-round step-ups of 42%, 0% and 11% versus 137%, 2% and 32%. The large first round cohort lost 6% in IPO pre-money valuation, versus a 9% drop for its counterpart, but this wasn’t enough to offset the gains in valuation made by the small first round cohort in private round step-ups. Overall, the large first round cohort obtained an average post-IPO valuation of $245 million, versus $287 million for its counterpart. Surprisingly, raising a large first round wasn’t positively correlated with a successful biotech IPO.

Dive into an available pool of IPO capital early

The concept of an “early IPO” is ambiguous — It may refer to the timing of a specific offering within an “IPO window” or the age of the company seeking an IPO. We examined both interpretations.

With respect to timing once capital markets become receptive to biotech IPOs, the complete absence of IPOs during 2009 establishes February of 2010 as the “opening” of the current IPO window. The 14 biotechs that priced IPOs during calendar 2010 had an average post-IPO valuation of $338 million, versus $191 million for the nine biotechs that priced IPOs during 2011. However, there was a resurgence in IPO valuations in 2012. The 11 biotechs that priced IPOs during calendar 2012 had an average post-IPO valuation of $251 million — 74% of the 2010 cohort average, but 131% of the average valuation in 2011.

When the age of the biotech company is the basis of classification, 13 companies five or less years from founding to IPO had an average post-IPO valuation of $249 million, versus $221 million for the 11 companies 5-7 years from founding to IPO. However, the cohort of 10 biotech companies eight years or older outperform all its younger peers — achieving an average post-IPO valuation of $354 million.

In summary, the group of 34 venture backed biotechs that completed IPOs between 2010 and 2012 appear to confirm two popular biotech financing maxims — raise at least $100 million in aggregate private rounds and a large mezzanine round. However, this group does NOT support two other financing maxims — raising a large first round was not strongly correlated with a high valuation, nor was being “early” to IPO capital.