The Activation Energy of Innovation
Or: The Difference Between Tech and Biotech.
Recently, Yahoo agreed to acquire Summly for $30 million, the product that resulted in apparently 18 months of time for 17-year old Nick D’Aloisio.
A few months ago, This Week in Startups episode #333 featured Jim Louderback, CEO of Revision3. He described how he sold Revision3 for around $35 million to the Discovery Channel, a modest outcome for notable investors Greylock Partners, Marc Andreessen, and Mark Cuban, but a positive outcome nonetheless as they had chipped in only $10 million.
You don’t see this happening in biotech. You don’t really see biotech companies coming out of parents’ basements or people’s garages. This only happens in tech because the barrier for entry is so low. Have access to a computer, then just learn to code (can be done for free online) and you can start a business with real, actual revenue. Heck, you don’t even need a college degree and you can become a billionaire, just look at Zuckerberg, Jobs, and Gates. Paypal co-founder Peter Thiel is even giving kids $100k not to get a degree.
Thanks to many decades of technological innovations from pioneers such as Fairchild Semiconductor, Intel, Tandem, Cisco, and Apple, the barrier of entry for embarking on an entrepreneurial career in tech today and ultimately achieving a successful exit has been lowered.
There are also a number of tech startup incubators, such as 500 Startups, Techstars, Founder Institute, and Y Combinator, that see a few of their graduate companies obtain “small” exits in the $10 to $30 million range. Obviously no Facebooks, yet, but certainly minting millionaires or near-millionaires.
For biotech? See Arr Oh of the Just Like Cooking blog has a great post wondering where all the under-40 biotech billionaires are. First, you need a solid educational foundation in chemistry and biology. This takes about a decade of your life. Assuming you’re not burnt out from the 4 years of poor college student life, the ~5 years of just-barely livable $20k/yr grad student stipend working 80 hour weeks, and the 1-3 years of a $40k/yr academic postdoc, perhaps you still have that fiery, entrepreneurial spirit and are willing to embark on the high risk endeavor of a startup.
Second, consider that the average cost to bring one innovative, life-saving drug to market is estimated to be between $4 billion and $11 billion when you consider previous R&D failures, according to an excellent article written by insightful Forbes contributor Matthew Herper (highly recommend a follow #FF). Biotech is a cash burn business that requires extensive capital to even just get an idea into the clinic. There are the costs of lab space, reagents, chemical and biohazard waste disposal, personnel, and instrumentation.
Clinical trials themselves are expensive as there is the manufacture of enough product to dose all your patients, the documentation of data points and compliance, and of course the overhead of paying your employees. And if your drug fails in clinical trials? Welp, would have been quicker to just take your $100 million and burn it.
Recently Sanofi had to halt development of Iniparib, a cancer treatment drug candidate, after it failed late-stage trials. Sanofi must now deal with a $285 million charge and nothing to show for that cash.
Because of the extensive capital investment required to achieve success in biotech, the exit multiples for life science VCs are suppressed. Take for example the recent acquisition of Omthera (OMTH) by AstraZeneca (AZN) for up to $443 million. Omthera’s lone asset, Epanova, is a combination of omega-3 fatty acids (ELA and DHA) and currently in Phase III trials for the treatment of hypertriglyceridemia. Omthera had reportedly raised $140 million prior to the sale, so VC backers Sofinnova Capital and New Enterprise Associates, having held onto their shares through the IPO, saw ~5x and ~2.5x, respectively, for their investment.
With a deal potentially valued at around half a billion dollars, it’s certainly a win for the investors and founding team. However, because Omthera was required to raise over $100 million, the multiple on invested capital wasn’t as high as it could have been. If the capital investment required to see a biotech company to a successful exit could be lowered, the exits would see much better multiples allowing for more cash to be infused in the startup ecosystem enabling even more innovations.
Allow me to invoke the Curtin-Hammet Principle.
The Curtin-Hammett Principle states that if a reaction has two rapidly interconverting intermediates that each go to a different product, the ratio of the products will depend on the transition state energies (ΔG1‡ and ΔG2‡), not the ground state energies of the intermediates. The product ratio is therefore controlled by the difference in free energy (ΔΔG‡) of the transition states of both intermediates, even though the intermediate and major product may be thermodynamically less stable. In other words, the reaction will proceed through the path of least resistance potentially affording a less-stable product than the path of most resistance.
If we apply the Curtin-Hammett Principle to the startup world, the result would be something like the above diagram. We start from one of the middle two wells: founding a ‘Tech Startup’ or a ‘Biotech Startup’ (our interconverting intermediates). We then move outward to the left or to the right toward realizing the ‘Tech Innovation’ or the ‘Biotech Innovation’, respectively. However, we must overcome the activation energy (ΔG1‡ or ΔG2‡), which is the capital investment required to realize a successful innovation.
I argue that the difference in capital investment required between a tech and biotech innovation (ΔΔG‡) pushes both entrepreneurs and investors towards the left since it’s much easier to achieve some semblance of success in tech, despite it being less beneficial to society in the broadest sense.
The above diagram has many implications. One is that we need cheaper ways of doing science. Science is darn expensive; from the reagents, to the equipment, to brain-power, to clinical trials, the costs are astronomical. Lowering the barrier would enable more innovations to reach the populace, which would have an immense benefit for society, including lowered healthcare costs and more lives saved.
The second, non-obvious implication is that our bright, young minds are being steered by lucrative careers into the low-barrier-of-entry computer science fields of developing dating/picture-sharing apps and away from the core sciences. Of course it’s nice to have an app that’ll give me 10 places to eat, but I question the broader benefit to society. Now, I’m not here to debate the apparent “shortage of STEM workers”, because there is no shortage for those of us in the “S” fields of chemistry, biology, etc. In fact, there’s a glut. What I would like to see, however, is a scientifically literate society, and it would help to not scare away bright, young minds from contributing to scientific innovations because the costs of achieving success are so high.
When the barrier is lowered, you enable anyone with a great idea and a will to execute it to contribute to the body of knowledge. The low barrier also augments the exit multiple allowing for better exits and more cash infusion for sustaining the startup ecosystem.
I am therefore bullish on any technology that effectively lowers the activation barrier for biotech innovation. This includes robotics that enable high throughput screens, genetic screens that identify patients most likely to benefit from a clinical trial, and models that can predict liver toxicity of drugs in development.
I am most intrigued about SeaChange Pharmaceuticals. Based on a computational approach as described in high-impact papers, SeaChange seeks to predict drug side effects and uncover new uses for existing drugs.
I believe that right now biotech is where tech was in the 90s, web 1.0. Since the early days of Fairchild, Cisco, and Apple, high capacity data storage has gotten cheaper, internet speeds have skyrocketed, and cloud computing is a reality. These advances, and others, have enabled the tech boom of the past decade, and now that we are in web 2.0, the barrier has never been lower.
The biotech sector has been on a tear this year as the Nasdaq Biotech Index Fund (IBB) and Market Vectors Biotech ETF (BBH) are up around 30% for the year to date. And there have been a number of hot biotech IPOs so far this year. But as technology drives down the costs of bringing a biotech product to market, it will soon become biotech2+.