At some point in the coming months, Mark Gurney and directors at Tetra Discovery Partners LLC will decide which road to travel into the future for their company.
On the table for the five-year-old drug developer are three options for completing its commercialization journey. The firm could bring in a deep-pocketed strategic partner or cut a deal with a pharmaceutical maker for a structured buyout should Tetra meet set milestones in its drug development. The third option: Tetra could float an initial public offering, or IPO, to raise the capital needed to get to market on its own.
“We’re exploring all options,” said Gurney, the CEO of Tetra Discovery Partners, a firm involved in clinical trials on compounds to treat Alzheimer’s disease and memory impairment.
Backed so far with $7.2 million in venture capital and nearly $21 million in federal grant funding, Tetra Discovery Partners has been working with an investment bank on the prospects for a successful IPO and is in diligence with “multiple large pharma” about potential partnerships, Gurney said.
The company seeks to make a decision in early 2017 on what path to take, he said.
Operating out of business incubators in Kalamazoo and Grand Rapids, Tetra Discovery Partners is among a handful of life science companies based in West Michigan that are approaching the proverbial crossroads and a potential exit for their investors within the next few years.
“These companies are nearing an area where the funding and the capital they need is just going to keep increasing,” said attorney Phil Torrence, a partner in the Kalamazoo office of Honigman Miller Schwartz and Cohn LLP, who works with a number of life sciences startups.
“We have a number of companies in the state that are 75 percent toward their major milestone or development that I think will likely trigger an exit. The challenge is that it is extraordinarily expensive,” Torrence said. “It’s kind of like in a marathon, the last 25 percent of the race is the toughest. It takes the most time and energy.”
Tim Fischell, CEO of Kalamazoo-based Ablative Solutions Inc., called that point in a company’s life “like hitting the wall.”
“You get to that level in this country, and it’s not just Michigan, (where) it’s tough,” Fischell said.
A portfolio company of Michigan Accelerator Fund, Ablative Solutions developed a catheter system for what’s called renal denervation to treat uncontrollable hypertension. The company in September announced that it had received U.S. Food and Drug Administration approval to start a Phase 2 clinical trial to evaluate the combination of using its device and a chemical to deactivate renal nerves in the artery to treat hypertension in patients.
A MATTER OF RISK/REWARD
For companies considering an IPO, their big question remains when to go to the public market, Torrence said. Timing is everything. Waiting could result in a missed opportunity, but doing an IPO later could allow a company to grow its valuation further and raise more, Torrence said.
Building greater valuation is the plan for Metabolic Solutions Development Co., a Kalamazoo-based firm developing drug compounds that could treat liver, Parkinson’s and Alzheimer’s diseases, as well as Type 2 diabetes. However, the company has yet to choose a path to take for an exit.
Metabolic Solutions in February spun out a new company, Octeta Therapeutics LLC, to focus solely on a compound for fatty liver disease, which has regulatory review processes and financing requirements that differ from the other diseases, CEO Stephen Benoit told MiBiz.
“The type of investor that’s interested in (liver disease) is not the type of investor that’s interested in Parkinson’s and Alzheimer’s disease and is not the same investor that might be interested in diabetes,” Benoit said.
Octeta Therapeutics opted to pass on a licensing deal for now and closed in May on $16.4 million of the $23 million it’s seeking to raise to take the company into later-stage clinical trials and seek FDA approval in two years.
In continuing the compound’s development on their own, the backers of Octeta Therapeutics expect that they can significantly raise the valuation of the company by the time it’s ready for an exit in the second half of 2018 and generate a much higher return on investment, Benoit said.
A licensing agreement, sale of the intellectual property or an IPO are on the table for Octeta Therapeutics, “depending on how the markets look at that point in time,” Benoit said.
“That’s a significantly de-risked asset at that point,” he said. “We’ll hopefully have the option to explore which of those three routes make the best sense at that time.”
Metabolic Solutions plans to use the same model and form a spin-out company to further develop its Parkinson’s and Alzheimer’s compounds “and really take that next big step up in value creation,” Benoit said. Going to the next level with its compound would require the company to raise $15 million to $20 million in capital, he said.
The difficulty with the IPO route is that for medical device companies, capital markets tend not to look at an IPO in that sector “unless you’re showing really significant actual revenue,” Torrence said.
Drug development companies generally lack revenue at the point in time when they need a major capital infusion to finish product development and build out a sales and distribution network. That’s problematic in a public market, where investors typically are not looking to take on much risk.
“That’s the conundrum,” said Dale Grogan, co-managing director of venture capital firm Michigan Accelerator Fund that invests in life sciences companies. “You don’t have an ideal market for these early-stage companies because the market wants less risk. That means show me where revenues are.”
Getting to that point requires the kind of heavy capital investments that are hard to secure entirely from within Michigan, according to Grogan and others in the industry.
The need to invest heavily to develop a sales force is an “expensive proposition” and why Kalamazoo-based medical device company Innovative Cardiovascular Solutions LLC prefers to seek a buyer, said CEO Kevin Plemmons.
Plemmons is in discussions with multiple large medical device manufacturers to buy the company’s Emblok Embolic Protection Catheter, which is designed for use in aortic valve replacement surgery. Developed by Dr. William Merhi, an interventional cardiologist at Spectrum Health in Grand Rapids, the device collects debris in the blood during a heart procedure, preventing a potential stroke.
An asset sale, which could come in 2017, is “much easier to do,” Plemmons said.
“For the best interest of our shareholders, they would like a total asset purchase agreement. We want to sell the company outright,” he said. “It’s easier, it’s cleaner and you’re done with it and the shareholders receive a return on their investment.”
Founded three years ago and backed by a little more than $8 million in angel investments, the company plans to begin a European clinical trial late this year and hopes to receive approval next year to sell the device in Europe. Talks also are underway with the FDA for a trial in the U.S., Plemmons said.
‘QUIET’ ON THE IPO FRONT
Any company considering an IPO for its exit option faces a market that cannot exactly be described as robust, Torrence said.
Across the U.S., the IPO market “continued to be in a quiet year” through the third quarter of 2016, according to a quarterly summary by advisory firm Ernst & Young, which projects the market to improve in the next year.
“Although 2016 looks set to be a slower year for IPO activity compared with 2015, prospects for 2017 are already looking much more positive. We continue to see increasing interest by companies considering an IPO or strategic transaction. The IPO pipeline is starting to refill with a combination of PE-backed unicorns and others that have pressed the pause button but are now looking with confidence toward reduced uncertainty and more supportive conditions next year,” according to the Ernst & Young third quarter summary.
There were 35 IPOs across the country in the third quarter that raised $6.4 billion, which paralleled last year’s “traditionally weak third quarter” with 33 IPOs for $5.7 billion.
Through the first nine months of 2016, the U.S. had 79 IPOs that raised $13.4 billion. That represents a 44-percent decline in the number of offerings from the same period in 2015 and a 49-percent dip in the amount of capital raised, according to Ernst & Young.
Health care and technology deals each accounted for 26 percent of all IPOs in the third quarter. The health care sector alone accounted for 19 percent of the capital raised, versus 31 percent for technology.
The last Michigan-based company to complete an IPO was Livonia-based Gemphire Therapeutics Inc., a developer of a cardiovascular drug that raised $30 million by going public in late summer. The Gemphire IPO was delayed by six weeks and reduced by half its original target following the Brexit vote in June, illustrating the external forces that can impact a company’s capital raise.
Additionally, existing investors may not prefer the IPO route. For one, an IPO could dilute their holdings, or they may end up limited in the ability to sell their shares and get their money out of the company for some time after the offering.
“It takes a lot of fortitude to be an investor in one of these deals and it’s not easy to get out because your hands are kind of tied to the wheel, so to speak,” Torrence said.
That’s why investors in a company may prefer a structured buyout or pursuing a strategic partnership, Tetra’s Gurney said.
Tetra Discovery Partners, which has a Phase 2 clinical trial scheduled to start in mid-2017, is “in diligence with multiple large pharma” companies that have been tracking the firm’s progress “and those discussions have different business structures around them,” Gurney said.
That interest by pharma companies stems from the growing incidence rates of Alzheimer’s disease and the potential for a drug to slow its progress.
“The diseases that we’re tackling are going to overwhelm the health care system if effective new treatments are not found,” Gurney said. “If we do not find an effective drug for treating Alzheimer’s disease, it’s going to be a problem for our society given the graying of our population.”
Tetra Discovery Partners needs an estimated $15 million to $20 million in capital to move into its next phase.
A QUESTION OF REIMBURSEMENT
As companies weigh their future — whether a strategic partner, buyout or IPO — another issue they face is ensuring that their innovation qualifies for reimbursement by insurers, extending the pathway to a potential exit, said David Esposito, CEO of Armune Bioscience Inc.
The Kalamazoo-based firm developed and brought to market a blood test to screen for prostate cancer.
Armune Bioscience is presently seeking to raise $25 million in Series B venture capital to support growth.
“That reimbursement model is rapidly changing, so that just creates challenges,” Esposito said. “But still the same pieces are there — good, fundamental technology shows market attraction. Money will be there. It’s just you’re kind of hanging on holding things together a little bit longer than perhaps somebody would go. And a lot of that comes down to it’s a different world getting paid for your technology (by insurers).”