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Biotechs: Not Immune from Economic Downturn

Biotech Update

As financial markets continue in turmoil, companies of all shapes and sizes have been impacted by the economic downturn. With capital simply not readily available, investors are tightly holding on to their money.

Biotechnology companies, once the darling of investors, have not been immune either. It is reported that almost 40% of small and midsize public biotechs in the United States are in danger of running out of cash during 2009. Venture capital funding for biotechs has fallen 17% from that of two years ago.

With biotechs an important source of healthcare innovation at a time when the U.S. has a growing aging population, what can be done - industry bailouts, a shift in funding within the industry, or consolidation?

Pharmaceutical and medical devices biotechs both have filled the gap created by the slowdown in the research and development pipeline of major pharmaceutical and medical device companies. In fact, they have become direct suppliers to those pipelines.

When a biotech company's new product reaches a certain stage of development, it often is acquired by or enters into a licensing agreement with a larger company to complete the product's development, production and marketing.

This has become vital in the creating and testing of new products that will be needed in the future by our aging population. It is estimated that by 2010, 26.1% of sales from the 20 largest pharmaceutical companies will be derived from biotechs' in-licensed products.

Biotech Funding Issues

Since few industries require as much time (up to 15 years) and money to develop a revenue-generating product, biotechs rely heavily on investors, in particular venture capitalists - needed to bring new technologies to a point where they become attractive to a wider range of investors, major companies and initial public offerings (IPOs).

In addition to being a primary funding source for early-stage biotechs, venture capitalists also provide funding for later-stage entities in need of additional funding to go public. Behind debt service, venture capital financing remains the No. 1 private source of medical devices and No. 2 source of biotechs.

While the upside to a fledgling biotech company - and the medical benefits to the public - can be high, the biotech market, especially its pharmaceutical segment, is viewed by investors as high risk. As funding declines, many biotechs have been forced to reduce operations, put clinical studies on hold and sell off assets. Some may go out of business.

Biotechs have begun merging, pooling their remaining cash to develop the most promising products they have between them. In mid-2007, a third of the 370 publicly- traded biotechs with market values below $1 billion had less than six months of cash.

Likely (and Unlikely) Solutions

Given the role biotechs have come to play in medical innovation, many are hoping that the industry will receive assistance from the economic stimulus plan being considered by Congress - on the condition the money would be used for research and development. The likelihood of this happening, however, appears slim.

Unlike major banks or U.S. automakers with many employees and national influence, biotechs are primarily individual, smaller companies. Also not helping is the fact that the biotech industry is estimated to have lost $100 billion since its inception in the 1970s.

One positive note: not all biotech funding has come to a halt. Venture capital firms have gradually increased the level of their investment in the medical device and pharmaceutical sectors, alternating between the two and concentrating their investments in what they view to be the most promising start-up companies.

Consolidation, through mergers and acquisitions, is also possible particularly on the pharmaceutical side. Big biotechs, such as Genentech and Amgen, and traditional pharmaceuticals have cash and an ongoing need for promising new drugs. The smaller biotechs have something that they need - products to help fill their pipelines.

As such, biotech investing is not dead. The reduced amount of available funds will be narrowed to those biotechs deemed to be developing the most promising products. Meanwhile, other biotechs will have their projects shelved, be acquired or forced to die a slow, premature death.

In any event, the lack of available capital will slow the innovation necessary to develop new products to meet our medical needs. Biotech is an industry we cannot afford to lose.

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For more details or if you have any questions, please contact your local Quarles & Brady attorney.

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