Could R&D financing keep biotech’s wheels in motion amid geopolitical uncertainty?

Australia’s biotechnology industry is facing an uncertain period, amid sweeping changes to US healthcare policy, which have already seen investors take a more cautious approach to biotech financing.

With the US representing biotech’s largest market, companies who use conventional capital raising methods, are seeing more closed doors in their bid to fund clinical trials, or progress research.

Those who are successful, are seeing higher costs of capital from the resulting market volatility.

Holly Stefl of Endpoints Capital says the climate is forcing biotechs to explore less conventional financing options.

“The change in political landscape is creating uncertainty around the regulatory approval process. Certain areas of science appear to be out of favour with the new administration, which has contributed to a more cautious stance among early-stage investors considering biotech opportunities.

“So, considering alternative capital raising methods is often key,” she said.

R&D financing

R&D financing, in particular, is helping to keep the industry’s wheels in motion.

Ms Stefl says Endpoints Capital – a leading financier in this space – has already swept up opportunities to progress early phase clinical trials not considered by traditional forms of financing.

“R&D financing is great for the current climate, because it is bipartisan, non-cyclical, and available regardless of whether the research is successful,” she said.

“The incentive is simply to do the research. Unlike more conventional financing options, it’s not payable upon the success of a particular trial or milestone.”

Under R&D financing, researchers accumulate R&D credit throughout the financial year, as they undertake and invest in their project.

The credit builds in the background and sits on the researchers’ balance sheet as an asset that is often more tangible and bankable than the IP itself.

“This can make it much easier to raise capital mid trial. An R&D financier can effectively lend against that lazy asset on your balance sheet – and do it with a lot of certainty and conviction.

“When they approve you for funding, you have ready access to it, and that can sustain your trial, your liquidity, and your cash flow, right through to when those next clinical trial results are obtained.”

Advantages over shareholder arrangement

R&D financiers usually expect less return for their investment than a typical shareholder would, which can allow for more favourable funding arrangements.

“For a biotech shareholder, the standard expectation is for around 30 to 35 percent return on capital, and that metric is used to value the future cash flows of a business to get the ‘net present value’ or a ‘discounted cash flow’.

“Our capital costs less than half of that on average, so you can fund a company with less equity.”

Equity is inherently more expensive, Ms Stefl explained, mainly because it doesn’t allow for recourse.

“You never get your money back unless there’s a dividend or a return to shareholders, which is pretty unlikely with biotechs for the first five to ten years. It’s all cost and very little revenue.”

Unlike shareholder arrangements, R&D financing is also non-dilutive, allowing founders to retain greater levels of ownership.

“Whenever you issue shares in a company, you are essentially divvying up a ‘pie’ to more and more people. Say if you, as a founder, have 20 percent of the company. You dilute the company by 50 percent, and reduce the share price.

“Then you’re left with 10 percent of the company. After three or four rounds of capital raising, you could be left with just 1 percent of the company.

“By utilising our model in tandem, you can reduce that dilution by 30 to 35 percent. So you’re holding on to more of the pie at the end of the trials; and profiting more when you do end up either commercialising the asset or selling it to a larger company.”

Addressing misconceptions

Despite its advantages, Ms Stefl said R&D financing is widely misconstrued across the industry, and often misused or underutilised.

“I’ve seen people use them like a payday lender – they borrow the money against the R&D tax refund they are expecting to get in their tax return. They get the refund, repay the loan, and then move on. Which is all very well, but it’s the least valuable way to utilise R&D finance. It’s much more valuable when you plug it in at the start of your expenditure pathway.”

Those who use R&D Finance the right way can see better financial outcomes, by decreasing their reliance on equity, Ms Stefl explained.

“I frequently speak to biotech founders at conferences and they’ll say, ‘we’re looking to raise $10 million to fund our phase two trial’. And then I say, ‘what if I told you, you only need to raise $7 million, and you can still get the full outcome of that trial?’”

A further misconception is that debt translates to financial distress – or that it’s more expensive causing some to view R&D financiers as the lenders of last resort.

“If you look at the top 100 ASX companies on the share market, they almost all have some form of debt. Debt isn’t always bad – only if you can’t sustain it.

“Debt is not free. You’re either diluting existing shareholders significantly or you’re valued based on a much higher return hurdle of 35 percent, whereas our cost of funds is half of that.

“You can’t overdose on Endpoints Capital debt, because of where it caps out. It’s not going to envelope the company by being too levered where some companies can fall prone to that situation,” she added.

Further insight

Sharing more on the funding mechanisms that are sustaining biotechs future, Holly Stefl will present at the upcoming Bio Connections Australia Conference, held 28 July at the Crown Promenade Melbourne.

This flagship event will look at the acceleration of medical research into real-world applications, covering drug discovery and development, early-phase trials, and commercialisation.

Each year, the event brings together a diverse mix of senior decision-makers from across the sector, including pharmaceutical leaders, investors, local and international biotech companies, researchers, CROs, Phase 1 units, universities, government agencies, and regulators.

Register your interest here to stay informed of speaker announcements, early bird discounts and the official agenda release.