Financing cures is an expensive and risky process characterized by success emerging only through a large number of failures in the journey from discovery to development. As weaEUR(TM)ve shown in a previous Financial Innovation LabA(R)t report, the translational phase (also known as the aEURoeValley of DeathaEUR?) is grossly underfunded. Only $6 billion to $7 billion is spent on translational efforts, versus $48 billion on basic research and $125 billion on clinical development. A huge multiple of that is required to accelerate medical solutions. While remarkable scientific breakthroughs are underway, business and financial models have lagged in the life sciences, ensuring that biomedical companies face potential capital flight from institutional investors who fund cures.
Another of the Milken InstituteaEUR(TM)s recent Labs in this area focused on the value of product development partnerships in addressing global infectious diseases. Two recent lessons suggest a way forward by building business models for entrepreneurial efforts and financial models to fund the development of compounds and companies.
Biomedical development requires strategies beyond tech transfer
The traditional strategies of licensing and relying on royalty payments have failed to yield adequate income for universities. According to a recent survey by Walter Valdavia of the Brookings Institution, fewer than 13 percent of U.S. universities generate sufficient revenue to cover the costs of R&D. Only potentially high-value patents get attention, and the majority of inventions are ignored. Further, only about 5 percent of intellectual property is licensed, and less than 0.5 percent generates $1 million in revenue. This is why Congress has proposed a Technology and Research Accelerating National Security and Future Economic Resiliency (TRANSFER) project, encouraging spin-outs from research institutions devoted to continuing the development of compounds and devices with an eye toward sustainable business formation.
Carving capital channels to cures
Until recently, most of our work focused on building public-private partnerships between governments (as active investors) and equity investors. But the risk and complexity of drug development undermine innovation. Equity capital commitments are small, and time horizons are shorter than those required to fund other biomedical solutions. The MIT Laboratory for Financial Engineering has made breakthroughs in designing investments aimed at curing cancer. Using lessons from portfolio theory and structured finance, they show that combining a number of drug-development projects in a single, diversified portfolio buffers risk and enables a fixed-income instrument (bond) to be constructed. These instruments can then be structured and rated for pension funds, sovereign wealth funds and philanthropic foundations.
Other credit enhancements, loan loss reserves, and innovations for risk mitigation could open larger pools of institutional money to could capitalize investments in health. Pools ranging in size from $3 billion to $15 billion could be invested in early stage work on compounds (from preclinical to Phase II) and later stages as well (Phase II to approval). In cases of low-return aEURoeorphanaEUR? diseases where there are lower development costs, faster FDA approval times, and lower failure rates, the derisking of portfolios could occur in funds of around half a billion dollars yet yield double-digit expected rates of return with as few as 10 to 20 projects in a portfolio. Dr. Roger Stein of the MIT team, an Innovations Lab participant and a regular at our convenings on this subject, succinctly makes the case in his recent TED talk on this promising way to fund drug research.
Financing cures: Transforming the Valley of Death into the Valley of Life
Sources: Research!America, National Institutes of Health, CB Insights, National Venture Capital Association, Center for Venture Research.