Biotech Companies - Potential solution

Recent articles in the WSJ and FT have turned the spotlight on an interesting set of issues for the drug industry and the world of public biotech companies.

Firstly the FT states, facing an estimated drop of $100bn in sales in the next five years as block-buster patents expire and drug pipelines come under threat from generic rivals means big pharma has little choice but to consolidate. But as the WSJ points out megadeals haven't cured the problem in the past.Pfizer paid $116 billion for Warner-Lambert in 2000 and an additional $54 billion for Pharmacia in 2003, yet still needed to acquire Wyeth this year to help replenish an anemic pipeline.

Enter the other issue,180, or 45% of public biotech companies have less than a year of cash on their balance sheet according to BIO, based in Washington.

Are smaller acquisitions the answer? Perhaps, however small acquisitions of biotechs have downsides - little opportunity for cost savings and founders and scientists might leave,basically the cultural fit is tricky.

There is a solution! These types of situations are exactly what earn out deals are very good at handling. A fair price is paid today to own the small biotech but the business is kept separate, with a clear, easily understood earnout formula wrapped around future sales success. Seller management get some reward on the way up but are highly incentivized to hang around and execute their dream. Alternatively a minority stake could be purchased with put & call options around the remaining shares based on a similar formula to the earn-out. Both achieve similar results, the difference is mainly psychological for sellers. In earn-outs you sell 100% of the company on day one. Just a thought.