Financings of the Fortnight Looks for Its Shadow

We are always on the lookout for leading indicators, no matter how faint the signal. If you tend an herb garden on your back porch, you might prefer the "green shoots" metaphor. Ever hopeful that the second law of thermodynamics isn't really the guiding principle ruling our lives, we humans also imbue natural events and public rituals with significance. Earthquakes as divine punishment! The groundhog's shadow! That said, we should say right off the bat that Genmark Diagnostics is no Punxsutawney Phil.

Yes, Virginia, there was an IPO last week, and its name was Genmark. But it wasn't the sort that necessarily means a damn thing. An obscure UK diagnostics firm formerly known as Osmetech that creates a US subsidiary, reverse-merges into it to reach US shareholders -- and only pulls in $28 million after shooting for as much as $45 million, for that matter -- is only that. An N of one.

Yet it came at a time when we were already thinking about diagnostics, and funding, and the funding of diagnostics. The low-profile offering, tucked just in front of the long holiday weekend, was also sandwiched between two conferences that opened different windows on the application of genetic information. At a consumer genetics show in Boston this week, funding strategies weren't explicitly on the menu, but as our correspondents noted, it's becoming ever more clear that cost breakthroughs in sequencing will lead to identification of medically significant genetic variations in patients. The question then becomes, what do you do with them?

That was the topic last week at the C21 venture conference in California's Napa Valley, where the diagnostics panel drew an eager crowd looking for ways to put money into -- buzzword alert! -- low-cost innovation. (That is, really cool stuff that doesn't cost a lot to make.)

And as our colleague Mark Ratner noted in his recent IN VIVO feature, despite the early days of most genetic research, a trio of well-known VCs -- Kleiner Perkins Caulfield & Byers, Mohr Davidow Ventures, and TPG -- have spread their diagnostic bets further, particularly into cardiology, after hitting the jackpot with breast-cancer test maker Genomic Health. Genmark isn't in their portfolios, but as we've seen on the drug side, any IPO activity after the long dry spell of 2008-2009 is worth scrutiny, not just as an indicator for current portfolio companies but for investors looking to jump in. One of the keys to diagnostics is getting pharma's attention in a variety of ways, such as using tests as a marketing tool when a drug rep is out detailing. We'll let Ratner explain:

The raison d'etre of new molecular tests is to significantly add to the information available to physicians to enable or change critical clinical decision-making. Especially at a time when the pace of new drug introductions is slowing and the opportunities to meet face-to-face with physicians therefore diminishing, as molecular diagnostics moves into new and broad markets like cardiology and metabolic disease, pharma could use this opportunity to its advantage in many settings.

In the case of a specific cardio test called Corus CAD, Ratner writes, "There's sufficient novelty and interest in genetics and genomics associated with coronary disease that [drug reps] could start a dialog with a physician about Corus CAD and at some point change to their drug-oriented message."

Diagnostic brethren such as LabCorp, Roche and Qiagen make splashy acquisitions; pure-play pharmas probably won't, though some are keeping their options open. Other deals will come from industrial giants such as General Electric and Procter & Gamble. But with massive hoards of cash to spend, any sign of pharma opening its coffers for diagnostics deals could mark a big change in the way VCs invest, which despite a few high-profile deals hasn't been that stunning. According to the Elsevier Strategic Transactions database, investment in diagnostics, over $1 billion annually for most of the past decade, is trending lower this year with $273 million through May.

Then again, life-science investing is down across the board this year. Have no fear, there's always plenty of material to bring you...



Tetraphase Pharmaceuticals: The antibiotic developer pulled in a $45 million Series C round to push its lead candidate into Phase II trials later this year, marking another step toward filling what public-health officials say is a ever-growing need: next-generation treatments to fight drug-resistant Gram-negative bacteria, as noted by our colleagues at START-UP. Tetraphase starts with a tetracycline backbone and then modifies the molecule at multiple positions to create an extremely large library. These molecules then can be screened for both their anti-infective properties and their potential to cause off-target toxicities. The lead compound, the intravenous TP-434, will likely focus initially on intra-abdominal infections. The Series C cash will also help push two more compounds -- TP-2758, for complicated urinary tract infections and TP-834, for the treatment of community acquired bacterial pneumonia -into Phase I. Excel Venture Management, a new investor for the biotech, led the round joined by existing backers: CMEA Capital, Fidelity Biosciences, Flagship Ventures, Mediphase Venture Partners and Skyline Ventures. Steve Gullans, managing director of Excel Venture Management, will join Tetraphase's board of directors. -- Carlene Olsen

NormOxys: The developer of small-molecule oxygen-enhancing drugs to treat a variety of diseases announced on May 24 a $17.5 million Series B financing. In addition to existing backer Index Ventures, Care Capital participated in the most recent financing round, with partner Argeris "Jerry" Karabelas joining the start-up's board of directors. It brings the firm's total funding to $30 million. With its novel platform technology and top-notch scientific pedigree, NormOxys has raised a sizeable but not extraordinary amount of additional cash from A-list backers and avoided too much dilution. It can now also aim for a more lucrative big pharma partnership -- whether it's a licensing deal or acquisition -- once the lead molecule, and thus the company's platform, have been derisked. The lead molecule is OXY111a, which the firm calls an "oxyren," for its oxygen-releasing capabilities. It changes the offloading capacity of hemoglobin so that more oxygen can be delivered to tissues where needed. If all goes to plan, it shouldn't result in excess oxygen delivery to normal tissue, which can cause damage because of free radical production. Equally important, say officials, is that the molecule triggering the actual physiological changes is oxygen itself, not the oxyren. Thus, potential off-target side-effects that have scuppered artificial blood substitutes such as Biopure's Hemopure, Northfield Laboratories' PolyHeme, and Baxter Healthcare's HemAssist, should be less problematic. OXY111a is entering Phase I trials with a later goal of testing it against chronic heart failure and an undisclosed cancer indication. -- Ellen Foster Licking

Exelixis: The San Francisco Bay Area public biotech is no stranger to all kinds of financing deals, and now it's turned again to debt to help expand the late-stage development of lead candidate XL184. Exelixis said June 3 it has secured loans worth $160 million from two lenders at an aggregate cost of capital under 10%. Part of the cash will pay back a loan from GlaxoSmithKline, a remnant of the firms' broad, six-year license-and-option deal signed in 2002. It will also fund XL184, which should enter Phase III trials for second-line glioblastoma by the end of 2010, with more Phase III trials possibly coming in 2011. XL184 was rejected by GSK before the six-year deal expired in late 2008, but Exelixis pivoted into a lucrative deal with Bristol-Myers Squibb, which pays 65% of XL184 development costs. It is currently in Phase III for medullary thyroid cancer and earlier-stage trials for glioblastoma. Exelixis is tapping Silicon Valley Bank for $80 million with a seven-year term loan at 1% interest. It's also borrowing $80 million from Deerfield Management, a five-year term with a maximum principal of $124 million. Interest is $6 million a year. Exelixis opened a line of credit with Deerfield in 2008 that, at the time, officials said they hoped never to draw down from. But with a 40% cut in staff in March the firm is shifting resources to late-stage development, which is still expensive even with big-pharma partners footing much of the bill. -- A.L.

Constellation Pharmaceuticals: Epigenetics pioneer Constellation added a corporate venture backer, GlaxoSmithKline's venture arm SR One, in a $22 million Series B financing announced June 2. In addition to SR One, previous investors Third Rock Ventures, The Column Group, Venrock Associates, and Altitude Life Science Ventures, which led the company’s $32 million Series A in 2008, all participated in the round. SR One’s cash should help Constellation keep pace with its main competitor, Epizyme, which obtained backing from Amgen Ventures and Astellas Venture Management in its own $40 million Series B last fall. Neither company has reached the clinic. Both are focused primarily on cancer, but Constellation of Cambridge, Mass. hopes to move eventually into diabetes, autoimmune, inflammatory and neurological diseases. Epigenetics focuses on chemical modification to chromatin, the proteins that package DNA, to create therapeutics that influence gene expression. Two classes of such drugs already are on the market: Celgene’s Vidaza and Eisai’s Dacogen, both DNA-methylation molecules approved for myelodysplastic syndromes, and Merck’s Vorinostat, a histone deacetylase (HDAC) inhibitor for T-cell cutaneous lymphoma. At least two other HDAC inhibitors are in late-stage development for oncology indications. -- Joseph Haas

Extra thanks to Mark Ratner for help with this week's post. Photo courtesy of flickr user avmaier.

Venture Debt in Europe: Opportunity Missed?

European biotechs may bemoan their funding disadvantages relative to US counterparts—the lack of specialist investors, fragmented public markets, poor liquidity and meagre or non-existent PIPEs—but some of the trouble is of their own making.

They’re simply not seizing the alternative funding options available to them—such as venture debt, for instance. At least, that was the message from a panel of—you guessed--venture debt providers, speaking at the UK’s BioIndustry Association's BioFinance Europe 2007 meeting last week.

Venture debt has been going strong in the US for at least 20 years; it offers VC-backed companies the opportunity to leverage their equity capital by borrowing quickly, non-dilutively, without affecting valuation, and usually without relinquishing any board seats or voting rights. Last year the US life sciences sector borrowed about $1 billion of this kind of money, according to executives at venture debt providers ETV Capital and GE Financial Services. In Europe, the equivalent figure was less than $50 million.

So what’s going on? That's what the debt providers wanted to find out.

Emotions and ignorance were the top two answers from the panel discussion. The emotional barrier is that these debt providers need to secure their loan—naturally enough—and typically do that against a company’s IP. At a minimum, borrowers may have to sign a “negative pledge” promising not to use their IP to raise debt elsewhere during the course of the loan. But since IP is what the CEO-founders have often spent several decades creating, they’re not, in general, keen to mortgage it, the panellists suggested.

Lack of confidence is another way of putting it: European biotech management and VCs see venture debt as too risky, was the suggestion, because they don’t think they will be able to create sufficient value to pay back the loan—and thus fear that their assets will be seized.

And indeed, venture debt isn’t a lifeline for struggling companies. It’s intended for firms that expect to create value in the near to mid-term and need tiding over—for “high return” situations, as one debt-provider explained in his presentation. If the borrower isn’t in a (relatively) strong position, the deal gets too risky for the lenders. “Companies must have VC support and more than 12 months’ cash” to qualify for venture debt, noted the panellists.

They’ll need enough cash to pay back the loan, too—plus up to 14% interest, and the legal fees associated with the loan. As in any business sector, creditors take priority over the shareholders if things go pear-shaped, which is why management does need to be pretty sure the next round is an up-round, or that the exit they’re after comes at a nice premium. The debt providers require that confidence, too: none will lend without taking share warrants so that they can participate in the hoped-for value creation and meet their return criteria.

Still, for any company not on its knees, venture debt offers “an option to use someone else’s money to create equity value,” the debt providers argued, at least if you think you can create more value than the cost of the loan, and do so before you need to pay it back.

But on to the other reason venture debt hasn't caught on in Europe: management and VCs in Europe just don’t get debt, according to Peter Keen, a partner at VC firm Esprit Capital Partners, chairing the panel. “When you start talking about debt, their eyes glaze over,” he says. Apparently your average European biotech board meeting doesn’t often include a discussion of cost-of-capital, either—and if it does, “that goes right over their heads,” Keen continues.

Here’s the thing: equity is more expensive than debt in many situations. Equity investors expect a 20-30% return (or they used to). Even expensive debt may not cost half that—provided, of course, you can pay it back. So sometimes it’s cheaper, and therefore makes sense, to use debt rather than equity to fund capital expenditure and working capital.

A few European firms have cottoned on. Arrow Therapeutics took a £4 million venture loan to help tide it over while considering its exit options—it was in the end acquired by AstraZeneca for $150 million, so had no trouble with repayments. UK firms Vectura (now public) and Domantis (now part of GlaxoSmithKline) have also used venture debt in the past, according to the panelists, both in order to buy time during financing negotiations.

But these are exceptions. So far, the rest of the UK and European biotech sector either doesn’t like debt, doesn’t get debt, or doesn't feel confident enough in future value creation to take it on.

This may soon change. Public investors, the conference heard, are exiting biotech, not entering. The few specialist funds that exist in the UK and Europe by and large haven't made great returns on that portion of their holdings. US and foreign investors are blocked by pre-emption rights, granting existing shareholders the right to maintain their ownership share in any capital increase. PIPEs are frowned upon (and not easy to do, also because of pre-emption rights).

So soon enough UK and European biotechs may have no choice but to look more pro-actively at alternative financing sources, including venture debt. Especially as M&A continues to offer the prospect of future value-creation.

Meanwhile the inexorable rise of private equity, across all sectors, may help change attitudes too. If anyone knows how to do debt, private equity does. And they’re all getting rich, so eventually perhaps the love-debt message will trickle down to biotech.