Purinex Inc - Case Study in Finance and Investment

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While the total development time for a drug is highly variable, it took 10 to 15 years, on average, to move a drug from preclinical development to marketing approval. The process for discovering, developing, and gaining approval for new therapeutics consisted of several distinct steps: early discovery, preclinical development, clinical trials, and regulatory filling and review. Exhibit 1 illustrates schematically the phases of development for new compound.

According to number of studies, the preclinical phases accounted for about 40% of the time and resources required to bring new compounded to market. The preclinical stage included target identification, target validation, assay development, primary and secondary screening, lead optimization, and preclinical studies. The significant challenges of the preclinical phases were exemplified by a rule of thumb adopted by Pfizer, Inc. on average; it took about 7 million primary screen candidates to produce one new chemical entity.

In the United States, the drug-approval process was overseen by the Food and Drug Administration (FDA), which required extensive testing ensure drug safety and efficacy. The drug manufacturer had to undertake three sequential sets of clinical test before applying for regulatory approval. The FDA estimated that, out of every 20 drugs that entered clinical testing, on average, 13 or 14 would successfully complete phase I. of those, about 9 would complete phase II; only 2 would likely survive phase III on average, only 5% to 10% of drugs entering clinical trials were ultimately approved for marketing, often after several attempts.

Access to Capital

Given the magnitude of R&D requirements, early-stage biotechnology firm needed sufficient access to capital. Typically, biotechnology entities were funded through seed money from individual angel investors or venture capital (VC) firms according to Burrill & Company, a private merchant bank specializing in life sciences, funding from such sources for North American biotechnology firms was $2.6 billion in 2002 and more than $2.8 billion in 2003. A recent report by Standard & Poor’s indicated that funding for most biotechnology firms would remain attractive, but “… we see deal terms remaining clearly less attractive than the valuation premiums that were commanded in 2000, when the market was in a euphoric state.”

If a firm had a promising investigational drug candidate, it could also seek an alliance with a larger pharmaceutical or biotechnology company. The larger company could provide up-front fees, R&D funding, milestone payments, royalties, and, possibly, copromotion rights. In addition, the company could supply production facilities or sales organisations, often in return of marketing rights under licensing arrangements. Exhibit 2 describe the terms of recent partnership deals between biotechnology and pharmaceutical firms. Exhibit 3 provides the median and mean values of a broad sample of those deals at each stage of the drug development process.

The number of collaborative agreements between “Big Pharma” (large-capitalization pharmaceutical firms) and biotechnology entities had increases steadily in recent years. According to Burrill & Company, such partnering arrangements have reached $8.9 billion in 2003, up from $7.5 billion in 2002. These partnering deals were expected to surpass $10 billion in 2004. Exhibit 4 depicts the relative proportion of funding sources for North American biotechnology firm in 2003.

Investment and Financing Decisions

In June 2004, Purinex had a broad range of technologies under development, two of which had applications appropriate for partnership deals with a large pharmaceutical company: a preclinical stage antagonist program for the treatment of diabetes and against program for the treatment of sepsis that has completed a phase I clinical trial.

Over the past several months, Purinex had initiated discussions with several, large, well-capitalized pharmaceutical companies regarding a possible collaboration for both compounds. Two companies have come forward with preliminary term sheets: one sought a deal for the treatment of sepsis, and the other wants a deal for diabetes. Each proposed deal would entitle Purinex to receive a combination of up-front fees, milestone payments and royalties, as describes in Table 1:

Table 1: Combinations of monies to be received for each deal.

Sepsis

Diabetes

Up-front

$5 million

$8 million

Milestones (total, undiscounted)

$108 million

$80 million

Royalties

10%

12%

Harpaz believed there was about a 75% chance that Purinex would secure a partnership with a pharmaceutical company for either sepsis or diabetes sometime during the next four to twelve months. If that partnership occurred, he estimated a 60% probability that would be a deal for sepsis. If a partnership did not occur the next four to twelve months, Harpaz believed there was a very strong chance – perhaps an application would occur about a year later. This later deal would likely have half the value of the one he was currently considering.

Harpaz thought it unlikely that Purinex would form partnership delay for both sepsis and diabetes. The company’s management believed it was important for Purinex to retain at least one of those programs in order to maintain the firm’s viability as a strategic acquisition target or as a possible IPO candidate (“so as not to sell off all of the crown jewels”, he thought). Therefore, he believed the two deals are mutually exclusive.

Harpaz remained very concerned that Purinex had only $700,000 cash on hand. The firm’s burn rate was about $60,000 a month (Purinex had no sales or earnings other than income from federal research grants, which offset about $100,000 of the company’s $150,000 in monthly expenses). Because the sepsis and diabetes partnership were uncertain in the short term, Harpaz was considering three options for his firm. Each option comes with its own risks:

- Venture-capital round: Purinex could seek to raise one-time round of financing form a VC firm. VC firms had express serious interest in biotechnology investments lately, and Purinex

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