Biotechnology, once a hot market for investment, is now facing financial and regulatory challenges. Participants of a Turnaround Management Association panel share insights on the unique financing agreements, regulatory hurdles and ethical considerations that lenders and advisors must consider when working in this space.
The biotechnology sector is rife with complexities, especially when it comes to financial structuring and managing insolvency. This was a central theme of a panel discussion at the Turnaround Management Association Mid-Atlantic Symposium this summer moderated by Rachel Jaffe Mauceri, partner at Robinson & Cole in Philadelphia.
The panel featured George Schuster partner at Wilmer Hale; Lorie Beers, managing director, head of Special Situations at Intrepid; Jim Gansman, founding partner at Rock Creek Advisors, and Morris Alhale, partner at AlixPartners. The panel shared insights on the intricacies of biotech financing, the unique challenges the industry faces, and the innovative solutions being implemented.
NAVIGATING A FINANCIAL TIGHTROPE
Biotech companies, which use organisms and molecular biology to create products for medical, agricultural, industrial and environmental use, operate in a unique environment where they balance enormous financial inflows with substantial outflows.
Schuster noted that many biotech firms, despite functioning like startups, often go public early and attract substantial equity financing. However, their high burn rate, driven by costly clinical trials and highly paid specialized staff, can present risk.
The financial model for biotech is particularly challenging because even with significant investment, success is not guaranteed. “Sometimes the technology just doesn’t work, and sometimes the business model about trying to develop that technology doesn’t work,” Schuster said, adding that within the last 24 months, the market “evaporated” for many biotech companies, even those with functioning technologies and business models.
In some cases, biotech companies may have technologies or drugs in development that could lead to life-changing outcomes for patients in clinical trials, but Schuster said they may face investors with no appetite to continue funding trials until they achieve profitability.
A UNIQUE BUSINESS LIFECYCLE
Gansman said it’s important to understand the unique lifecycles that exist in the biotech industry, which are based on clinical trials. He noted the following FDA1 milestones and statistics in his remarks:
Phase 1 trials, designed to assess safety and dosage, generally involve 20 to 100 volunteers in a study lasting several months — 70% of drugs move on to the next phase.
Phase 2 trials, designed to assess efficacy and side effects, include up to several hundred people with a specific disease or condition in a study lasting several months to two years — approximately 33% of drugs move on to the next phase. According to Gansman, funding a Phase 2 trial can require anywhere from $10 million to $100 million.
Phase 3 trials, administered to measure efficacy and to monitor adverse reactions, involve 300 to 3,000 volunteers with a specific disease or condition for a period of one to four years — 25% to 30% of drugs move on the next phase.
Phase 4 trials, the final phase that assesses safety and efficacy, usually involve several thousand volunteers with a specific disease or condition.
According to Gansman, a trial can fail at any stage, even after a drug has been proven. “We’ve seen people that get through phase three, they think that they can go it alone and are out in the marketplace, hire a salesforce and all of a sudden they have no sales,” Gansman said.
Schuster mentioned that many biotech companies falter when they shift gears from development to commercialization, since the two goals require vastly different skill sets.
Large pharmaceutical companies looking for their next acquisition target have traditionally created an exit path for biotech companies, but this exit route has been impeded recently as pharmaceutical companies have become more selective with acquisitions, driven by market contraction and a heightened focus on the most promising and strategically aligned assets. This shift is forcing biotech companies to reconsider their strategies, as the once-reliable option of being acquired is no longer guaranteed.
REGULATORY HURDLES
Recent regulatory changes have added significant complexity to the biotech development process, which Alhale discussed. These changes have created new hurdles for companies, particularly those in the critical stages of drug development. Even when a drug shows promise and is progressing through clinical trials, the shifting regulatory landscape can derail it by imposing additional requirements or limiting market access.
Alhale cited examples in which regulatory changes from the FDA reduced the potential patient population for a drug and caused setbacks in moving from one phase of development to the next. These external factors underscore the vulnerability of biotech companies to forces beyond their control, making it even more challenging to navigate the already precarious path from innovation to commercialization. Turnaround managers can work with biotech companies in this position to cut costs and extend liquidity to effectuate a sale.
DECREASED ACCESS TO CAPITAL
When it came to raising capital, biotech enjoyed an “absolute heyday” until late 2023, according to Beers. But when the collapse of Silicon Valley Bank sent shockwaves through the industry, leading venture capitalists became more cautious and tightened their investment criteria. The ripple effect made it increasingly difficult for biotech companies — particularly those in the early stages of development — to secure the funding necessary to sustain their operations.
In the past, failed phase two trials were often able to raise funds to redo the trial, according to Gansman, but in today’s market, a failure at this stage is generally the end of the line.
“A lot of those companies have been able to attract venture debt, secured by their IP [intellectual property],” Beers said. But dysfunction can occur within venture boards, in which disagreements among investors can escalate to the point of causing severe disruptions, such as foreclosures. This internal discord often stems from conflicting priorities, with some investors pushing for additional funding while others preferring to cut losses and exit.
“When the rubber hits the road and the markets are no longer available to them to use to service their debt, we’re seeing more filings in that arena because the lenders are losing their patience,” Beers said.
RESTRUCTURING WITH A PATIENT-CENTERED FOCUS
The panelists emphasized the importance of maintaining a patient-centered focus during a biotech restructuring, particularly when drugs are already in clinical trials. In these cases, the stakes are not just financial but deeply ethical, as the continuation of trials can directly impact patient safety and outcomes.
Courts and restructuring professionals must balance the financial realities of insolvency with the moral imperative to ensure that patients enrolled in trials continue to receive potentially life-saving treatments. This patient-centered approach is essential, especially when considering the broader implications of halting or disrupting a trial, which could not only affect the patients currently involved but also delay or deny future patients access to new therapies.
“What really impressed me about the Delaware court is how, in several cases, the judge wanted to talk about the patients on the first day,” Gansman said. “You don’t usually think about that in a bankruptcy, but when you get up there and talk about continuing a phase two trial because you’ve got 16 people in it, the court understands there’s more at stake here than just financials.”
INNOVATIVE FINANCING MODELS
In biotech, financing models have evolved to address the sector’s unique risks. In some cases, financing can look like traditional secured debt, but “development finance,” which Schuster called a “strange beast” is often implemented as well.
According to Schuster, development finance products offer flexible funding structures tailored to the uncertain timelines of drug development. These agreements often resemble a hybrid of debt and equity, with investors receiving a multiple return if the drug succeeds but potentially losing their investment if it fails. The agreements are nominally secured by assets involved in drug development, such as IP, but it is often unclear if development finance agreements qualify as a debt obligation.
UNTESTED BY THE COURTS
Development finance has not been thoroughly tested by the courts. Schuster discussed the PhaseBio Pharmaceuticals case, which involved a complex development finance agreement with SFJ, an affiliate of Blackstone, in which SFJ would be paid if the drug succeeded but would receive nothing if the drug failed. When Phase Bio filed for bankruptcy protection before the viability of the drug was established, the question arose as to whether SFJ had the rights of a secured lender to the value of the unproven IP assets.
On the other hand, if the development finance agreement was not a debt, which could be concluded since its terms lacked a fixed maturity date and interest rate, arguments arose as to whether it should be treated as equity.
The PhaseBio case was ultimately settled out of court, and SFJ retained the asset. However, SFJ agreed that if the drug were to become successful, proceeds would return to the estate and would be available to other constituencies, which would not be the traditional outcome for a secured lender.
Schuster noted that the PhaseBio case will most likely set a precedent. He emphasized the need for clearer structuring of development agreements to incorporate more debt-like features to balance the interests of investors and other stakeholders while maintaining flexibility.
This uncertainty adds an additional layer of risk for biotech companies and investors as the enforceability and treatment of development finance agreements in bankruptcy or restructuring scenarios remain largely undefined. Understanding these legal gray areas is crucial for stakeholders navigating the complexities of biotech financing.
CONCLUSION
In a rapidly evolving landscape, the biotechnology sector faces unprecedented challenges that require a delicate balance between financial innovation and ethical responsibility. As the panelists highlighted, the traditional pathways for biotech firms — whether through acquisitions by large pharmaceutical companies or securing venture capital — are no longer as reliable as they once were. And investors must understand the uncertainties of development finance in restructuring scenarios.
Amidst these challenges, the importance of maintaining a patient-centered focus cannot be overstated. As courts and restructuring professionals work to stabilize companies in distress, the ethical implications of their decisions must be at the forefront, particularly when patients’ lives and well-being are directly impacted. The need for innovative financing models and adaptive operational strategies is clear, but these must be implemented with a view toward the broader impact on healthcare and the advancement of medical innovation.•
1 “Drug Development Process — Step 3: Clinical Research,” U.S. Food and Drug Administration, Jan. 14, 2018.
Rita E. Garwood is editor in chief of ABF Journal.
