Here’s Why Big Pharma and Private Equity Invest in Drug Discovery Companies

Big Pharma and Private Equity firms invest in drug discovery companies
and biotech startups due to high cost of R&D and better ROI.

By Michael Megarit.

Here’s Why Big Pharma and Private Equity Invest in Drug Discovery Companies

A recent Deloitte report reveals that the R&D returns of the 15 leading US biopharma companies are just 2.5% in 2020, down from a high of 7.2% in 2014.

The growing complexities of drug development and the increasing numbers of oncology trials are lengthening the average clinical cycle times.

In parallel, the impending “patent cliff” could see Big Pharma lose nearly $200 billion in global prescription drug sales by 2024. Expiring patents mean that competitors can produce generics and sell them at lower prices.

The silver lining is that total prescription sales are expected to reach $1.2 trillion in 2024 and $1.5 trillion in 2026, growing at a CAGR of 8.9%.  

This growth will be fueled by increasing access to medicines on a global level and novel therapies addressing unmet needs.

Thus, Big Pharma has the opportunity to generate additional sources of revenue by developing new drugs and therapeutics.

However, rather than financing in-house R&D, Big Pharma is relying on partnerships and acquisitions to access new products and deepen its pipelines.

Here’s why.

Research and Development Is Expensive

Due to challenging Returns on Investment (ROI), Big Pharma is cutting back on Research and Development (R&D) expenses.

In fact, the average cost to develop, market and win FDA approval for a new prescription drug ranges from $2.4 to $2.6 billion.

Here's Why Big Pharma and Private Equity Invest in Drug Discovery Companies
Drug development is a long and costly process

On top of that, very few drugs achieve stellar sales numbers during the first five years of commercialization. QuintilesIMS Institute reveals that over the past 20 years, only 19 drugs have reached $1 billion in annual sales within five years of launch.

Clearly, this is a big problem.

Why risk investing billions in drugs that may not generate any profits? Isn’t it smarter to let someone else take the risk and invest only once the pipeline shows clear signs of success?

Big Pharma is Outsourcing R&D Risk to Start-ups

Contrary to popular belief, the majority of Big Pharma’s leading products are not developed in-house. A 2017 study led by revealed that only 23% of Pfizer’s and 11% of Johnson & Johnson’s early drug development work was conducted in-house.

The majority of these two firms’ leading products were actually developed by third parties – usually start-ups and small-cap companies that initially partnered with and then eventually acquired.

For example, Prevnar 13, which is one of Pfizer’s best-selling drugs, was developed by Wyeth, a small-cap company that Pfizer acquired in 2009. Infliximad, one of J&J’s highest-selling products marketed as Remicade, was actually synthesized by a research team at New York University in the late 1980s in collaboration with a biotech company called Centocor. In 1999, J&J purchased Centocor in a $4.9 billion stock deal.

In 2018, Pfizer had 44 leading products generating $37.6 billion in sales. Of these, 34 were discovered by third parties and they accounted for 86% of the total revenues. Similarly, J&J’s 16 products that were developed by third parties accounted for 89% of the company’s $31.4 billion revenues, generated by its 18 leading products.

Why does Big Pharma rely heavily on drug discovery work performed by third parties?

The answer is simple: because it de-risks the R&D process.

Instead of financing risky in-house R&D that has no guarantees of success, Big Pharma can observe drug developments from a distance and decide to step in whenever it identifies a potentially lucrative breakthrough.

This approach considerably minimizes the risk of investing in experimental R&D.

The next question is: why are biotech start-ups so eager to partner with Big Pharma rather than bringing their products to market themselves?

Biotech Start-ups Need Big Pharma’s Resources

Big Pharma’s decision to effectively outsource most of its R&D is now the industry norm.

Over the past 10 years, drug development has shifted from Big Pharma to small and mid-sized companies. In 2018, nearly 50% of all approved drugs were developed by biopharmaceutical firms grossing less than $100 million in yearly sales.

In the healthcare sector, $100 million of yearly revenues is insignificant.

The simple fact is that early-stage drug discovery requires extensive knowledge of manufacturing processes, clinical development, regulatory interactions, logistics, and pricing strategy.

Most start-ups are specialized in fundamental research. They lack industry connections and strategic business expertise.

This is where Big Pharma steps in.

Large pharmaceutical firms have the connections and experience to support start-ups and bring their products to market. In fact, having a large Pharma investor on board can significantly increase a start-up’s success rate. In addition, large Pharma involvement increases the market capitalization of start-ups. Studies show they rise from a median of $138 million to $332 million. Further, it helps acquisition value rise from a median of $136 million to $377 million.

Here's Why Big Pharma and Private Equity Invest in Drug Discovery Companies
Big Pharma’s involvement is crucial to biotech start-ups’ success

Thus, Big Pharma’s involvement in all stages of a start-up’s life-cycle can determine whether or not their efforts will pay off.

Healthcare is Attracting Investor Interest

Since the outbreak of the coronavirus pandemic, investor interest in all things healthcare has increased considerably. The accelerated adoption of healthtech solutions, new care delivery models and a strong interest in biopharma technologies is intensifying investment pace.

Big Pharma is not alone in wanting to invest in promising biotech companies.

Venture Capital / Private Equity (VC/PE) funds are cash rich and looking for high ROI investment opportunities. Naturally, they are turning to the red-hot biotech sector.

Here's Why Big Pharma and Private Equity Invest in Drug Discovery Companies
Global Venture Capital investments are booming

Pitchbook data reveals that venture funding for US-based biopharma companies in Q1 2021 topped $12 billion for the first time ever. In fact, the past 4 consecutive quarters broke fundraising records.

And this trend is far from over: since the start of 2021, VC/PE biotech investments reached $21.8 billion, beating the previous year’s record by 30%.

Thus, not only are investors gaining access to novel drug developments, their massive investments drive up company valuations and pave the way for blockbuster IPOs.

Biotechs Are Wall Street Darlings

Corporate and Private Equity investments are not the final steps of a biotech’s journey to success. After raising millions in funding, the next step is to go public and raison millions of dollars through highly publicized IPOs.

Over the past few years, biotechs have become Wall Street darlings.

Looking at the numbers, it’s easy to understand why.

In 2020, biotech IPOs raised a record $12.7 billion.

Incredibly, 2021 is set to break that record.

As of June 30th, biotech IPOs raised $9 billion dollars. Although the trend appears to be cooling somewhat, the 2020 record will be broken before the year ends.

Here's Why Big Pharma and Private Equity Invest in Drug Discovery Companies
Equity capital funding in biotech is on the rise.

Here are just some IPOs planned for the second quarter of this year:

  • Recursion Pharmaceuticals, a digital biology company which reached a deal with Bayer AG in September 2020, raised $436 million in an upsized IPO priced at the top of a marketed range.
  • Lyell Immunopharma, a cancer drug developer backed by GlaxoSmithKline and Celgene, raised $425 million in the middle of its marketed range
  • Centessa Pharmaceuticals, a biotech company carved out of life Sciences Venture Capital Firm Medicxi, raised $330 million in an IPO priced at the top of a marketed range.
  • Verve Therapeutics, a gene editing biotech backed by GV, Wellington management Company and Casdin Capital, raised $267 million, twice as much as expected.
  • Graphite Bio, another biotech involved in gene therapy, raised $238 million in its IPO. The company’s investors include Fidelity Management, Janus Henderson, Samsara BioCapital and Versant Ventures.

For Big Pharma and Private Equity firms, these IPOs represent extraordinary financial windfalls. Thus, it’s likely that the current trends will continue for some time.

About the Author

Michael Megarit is a partner with Cebron Group.
With over 25 years of domestic and international corporate finance experience,
he provides M&A and capital advisory to high-growth technology companies.