Business of Biotech 8

1. Constance McKee Yale MBA 1986 President & CEO, Manzanita Pharmaceuticals, Inc. Business of Biotech 8 Yale Biotechnology & Pharmaceutical Society 29 March – 1 April 2010

2. Constance McKee Business of Biotech 8 The Business of Biotech 8 A Non-Credit Seminar for Yale & the Biohaven Community Week of 29 March – 1 April 2010 Yale School of Management 135 Prospect Street, New Haven Constance McKee Yale School of Management, MBA 1986 Manzanita Pharmaceuticals, Inc. www.manzanitapharmaceuticals.com 2995 Woodside Road Suite 400, PMB 309 Woodside, CA 94062 constance.mckee@comcast.net m 408.348.3191 v 408.872.1094

3. Introduction Course approach – part quantitative concepts, part case studies First hour - basic concepts in start-ups Modular – OK if you can’t attend all week Second hour – micro case studies from entrepreneurs, investors & industry Speakers talk about making decisions – and how it *really* turned out Key questions What’s the opportunity? What’s the opportunity worth? How do we – founders & investors – make money? In the current environment, where *is* the money? Emphasis on biopharmaceuticals Business concepts apply to devices, tools & diagnostics companies But decision-making process similar for devices & tools Constance McKee Business of Biotech 8

4. Course Outline & SpeakersCase Studies in Decision Making “Basic infrastructure of a start-up” (Monday, 29 March 2010) Sohini Chowdhury, Michael J. Fox Foundation (Parkinson’s disease) (New York) Gregory Licholai, MD (Yale), COO, Proteostasis Therapeutics (Boston) “Strategy for biotech, big pharma and economic development” (Tuesday, 30 March 2010) Peter Longo, President & Executive Director, Connecticut Innovations (Hartford) Ron Burch, MD, CSO, Pacira (San Diego) (former CEO, AlgoRx) JC Martignoni, Director, U.S. Strategic Transactions and Alliance Management, Boehringer-Ingelheim (Ridgefield) “Case studies in decision-making” (Wednesday, 31 March 2010) Special guest speaker, U.S. Navy Jonathan Lewis MD, founder & CEO, ZioPharm Oncology (New York) Networking at Archie Moore’s following the class “Case studies in investment decisions” (Thursday, 1 April 2010) Jim Dolan, Executive VP, Purdue Pharma (Stamford) Myles Greenberg, MD, CHL Medical Partners (Stamford) Constance McKee Business of Biotech 8

5. Course Goals Explain challenges of raising capital for life sciences start-ups No previous experience required From perspective of scientist Quantitative approach Discuss sources of capital Nonprofit medical research organizations State-based economic programs Military medical grants Deal-making with pharma, private equity & angels Introduce basic concepts that drive the business of biotechnology Most good business decisions are driven by quantitative concepts Rules of the game How to play the game to increase the probability of success Develop network of Yale-centric entrepreneurs & investors Sources of information Sources of funding Career opportunities outside the lab Constance McKee Business of Biotech 8

6. MondayBasic Concepts in Start-up Business Infrastructure Patents How ownership arises (why Yale owns your ideas) How rights to patents get transferred to your start-up What is “unmet clinical need”? What is a “market”? What is a business model? What is a business plan? Understanding the global competitive landscape Constance McKee Business of Biotech 8

7. How Ownership ArisesWhy Yale Owns Your Ideas Under US law, the employer owns the ideas of employees Terms of Yale employment includes faculty, graduate students Yale Office of Cooperative Research http://www.yale.edu/ocr/ You can “consult” to your own start-up Most universities permit this, but your consulting agreement either continues to allow Yale to own your ideas while consulting, but licenses any discoveries to your start-up, or grants ownership of ideas generated during consulting period to the start-up Document who & where invention occurs Complicated with multiple academic collaborators Complicated by multiple granting sources Expect multiple co-inventors on patent application Constance McKee Business of Biotech 8

8. Yale Licenses Rights To Start-UpHow Legal Rights Are Transferred License is a legal agreement Yale’s ownership gives it right to confer some or all of its rights, over time In exchange for grant of rights, Yale may get rights to % of future product value Future product value – milestones or % of sales (“royalties”) Important concept – transfers rights, not ownership If things go wrong, Yale still owns patents Start-up licensee usually pays for patent prosecution Start-up licensee usually obligated to use “best efforts” to develop Years before Yale (and you, the discoverer) makes any money Flexible concept May have low or no upfront fee May include milestones for key development steps May include royalties (% sales) when product launched Constance McKee Business of Biotech 8

9. Constance McKee Business of Biotech 8 Deals: Trading Values & Assets Big Pharma Emerging Biotech Products Products Strategic IP Strategic IP Spin Out Spin Out Non-Core IP Non-Core IP Universities – NIH – Biomedical Foundations

10. Patents What is a ‘patentable invention’? Patents are issued by US Patent & Trademark Office, European Patent Office and patent offices of respective countries Must show your idea is “novel and not obvious” & that it works (data) When issued, confers the right to sue if an infringer sells a product in the marketplace based on your idea What is intangible intellectual property that can be protected? Copyright – software, drawings Know-how – protocols for synthesis of a small molecule drugs Also known as trade secrets (“secret sauce”) Almost always key to real value in the product, never disclosed in a patent application Constance McKee Business of Biotech 8

11. Why Are Patents Important? Worthless unless a product made from it, sold & making $$ Does not keep others from stealing your ideas Just gives you the right to sue them if they do steal Formidable barrier to entry if you succeed In pharmaceuticals, can charge a premium price Confers exclusivity Means you’re the only one legally authorized to sell product Can be US only, EU only, ROW only or combination When patent expires for pharmaceuticals, generic drug makers take over & premium-priced drug revenues decline ~ 60% in one year post-expiry Strong patents are enormously valuable to pharma Constance McKee Business of Biotech 8

12. Constance McKee Business of Biotech 8 RoyaltiesPercentage of Cash from Products Sold • Wait years until product developed & finally sold • Industry standard – 2% of net revenues of Rx • Royalties increase as drug price increases, number of patients increases

13. Constance McKee Business of Biotech 8 What is a Market?Can Describe Both Place & Total Value Sold • Place = pharmacy, stock exchange, flea market, souk, eBay • Total value = number of units sold X price per unit • Drug market = number of scrip written X price paid by patient • Example: Exubera (inhaled insulin developed by Nektar, marketed by Pfizer) • TRx = total prescriptions; NRx = new prescriptions written • Exubera sold $14 million after it was launched • Merck sells Januvia for $4.86 per tablet (100 mg 1X 7 days) x (22,475+48,685) = $2 million per week, $125 million per year just weeks after launch • Pfizer pulled Exubera from the market in October 2007 • Depends on who can afford Rx, who actually takes their meds • Doesn’t quantify potential Rx with better effectiveness that addresses unmet need http://seekingalpha.com/article/50788-pfizer-four-lessons-from-the-exubera-failure

14. Constance McKee Business of Biotech 8 Unmet Clinical NeedNumber of Patients X Cost of Under-treatment • Example: 25 million Americans with chronic pain • No drug of choice – many classes of Rx prescribed, but only 30% effective • Direct cost - $1,000 per patient per year • Rx relatively inexpensive, but patients keep going back to the doctor • US Army - $340 BN total cost of treating pain in returning veterans from Operation Enduring Freedom, Operating Iraqi Freedom

15. What is a Business Plan? Proxy for future value Estimates for market size & market opportunity Estimates risk (amount of $ to product vs amount of potential revenue) Patents How much can you expect to sell vs competitors’ products? Proxy for reality Has team done *it* before? (developed this kind of product) Have other companies tried to address this problem before? Did they fail? Have other investors made money in this sector? With this business model? What are the “comparables” (value of deals done in this sector)? What are the “comparable exits” (value of deals in this sector that were acquired by other companies, or went public) Constance McKee Business of Biotech 8

16. > 800 Drugs in Development for CancerKnow your competitive landscapeOnly 50% trials complete due to failure to enroll patients (includes 500 biologics) Constance McKee Business of Biotech 8 www.PhRMA.org 2008 data includes overlapping trials

17. Constance McKee Business of Biotech 8 WW Pharma Revenues (in US$ BN)14% Growth in Brazil, Russia, India, China, South Korea, Mexico, TurkeyGrowth in the U.S. in 2008 – 1.0%

18. Constance McKee Business of Biotech 8 Pharma WW is growing at 3%-5%Growth in cancer biologics & biosimilars is off the charts 89% biosimilars (WW CAGR 2014) 48% cancer biologics (US CAGR 2009)

19. Constance McKee Business of Biotech 8 Industry patent cliff in 2012: $67 billion

20. Constance McKee Business of Biotech 8 Global competitive forces • Revenues: down as patients stop taking Rx in economic downturn • Revenues: US revenues flatlined in 2009 – growth is ex-US • Generics: 60% of Rx in America are generics – new Rx must show significant clinical benefit (no more “me-too” products) • Generics: biosimilars legislation expected in 2010 • R&D costs: China’s & India’s investment in education paying off now as they attract pharma’s drug discovery & clinical trials (future) • Competition: regenerative medicine competing directly against small molecule approach (example: AMD – Pfizer) • Funding: collapse of historical funding mechanisms for innovation • Funding: rise of philanthropic organizations to fund innovation • Pricing: healthcare reform in U.S. should increase competition • Regulatory: FDA hypercaution in evaluating risk:benefit ratios

21. Constance McKee Business of Biotech 8 Only 4 IPOs in 2009 in the USBut pre-IPO financings rebounded in 2009

22. Will Venture Capital Ever Invest in Early-Stage Biotechnology Again? Constance McKee Business of Biotech 8 • Total US VC 2009: $17.7BN • (worst since 1997) • 1 biotech IPO in 2008 ($5 million) • 1 biotech IPO in 2009 (Omeros) • Total US deals in 2009: 2,795 • * 37% decrease in dollars • * 30% decrease in deals • Biotech Q4 2009 in Silicon Valley • * 25 deals • * Total $133.5 million • * 5 deals < $ 1 million • * 1 pharma deal < $ 1 million

23. Constance McKee Business of Biotech 8 Early-Stage Funding Gap Source: Signals Mag; Alzheimer’s Drug Discovery Foundation www.alzdiscovery.org

24. Constance McKee Business of Biotech 8 Bioinvestment Capital Food ChainCan ‘strategic capital’ fill the preclinical funding gap? Strategic = interest in product, jobs, cost savings Financial = interest in ROI

25. Opportunity for Philanthropic CapitalHint: go where the money is….. Constance McKee Business of Biotech 8

26. TuesdayManaging Risk in Clinical Development: Focus on Pharma What is the FDA-driven development path? What is a decision tree? What is the decision tree for clinical development? What are key strategies to manage development risk? What’s a business model and why is that important? What does “venture fundable” mean? Constance McKee Business of Biotech 8

27. Constance McKee Business of Biotech 8 Clinical Development7.5 Years - $750 Million Clinical Trials $250M Research $500M Gene “HIT” Library Medicinal Chemistry Rationale Drug Design Compound identification Preclinicals/IND 1: 10,000 (.01%) Phase III/IV - 40% FDA Approval 50% Marketed Phase II - 50% Phase I - 50% Lead Candidate Cell-based assays In vitro - primary culture In vivo - non-mammalian In vivo - knockout In vivo - clinically predictive In vivo - not clinically predictive Safety Pilot - Effectiveness Effectiveness $$$

28. Constance McKee Business of Biotech 8 What risks, over what period of time?What kind of risks do your investors understand? Financial risk Regulatory risk Market risk Science risk Clinical risk Lead Candidate Cell-based assays In vitro - primary culture In vivo - non-mammalian In vivo - knockout In vivo - clinically predictive? IND application FDA Approval Sales Phase 1 Safety Phase 2 Pilot - Effectiveness Phase 3-4 Effectiveness

29. Constance McKee Business of Biotech 8 Decision tree analysis: in-house discovery or license in from university?

30. Constance McKee Business of Biotech 8 Decision Tree for Clinical Development 50% FDA approval (launch - $50M for ramp-up) 40% Complete Phase III/IV (invest - $50M) Don’t market (competition) 50% Complete Phase II (invest - $25M) Failure (50%) 50% Complete Phase I (invest - $25M) Failure (60%) Complete preclinicals (invest - $20M) .01% Failure (50%) Develop 20 compounds (invest -$500M) Restructure R&D (invest - $200M) Failure (50%) Divest division (sell + $50M) Do not develop PhRMA; (Brealey & Myers)

31. Constance McKee Business of Biotech 8 Spread Portfolio RiskVenture Investors & Pharma Measure Success as “IRR” • IRR = internal rate of return (complex calculation for both cash invested and time until investment pays off) • ROI = return on investment (used interchangeably to express increase in value of original investment, adjusted by time) • For pharma & VCs alike, “shots on goal” - home runs make up for strike-outs • For pharma – known mechanism of action; clinically relevant models shortens development time & lowers risk

32. Constance McKee Business of Biotech 8 What is a Business Model?Lemonade Stand Revenue Model, Price & Customers • Are you selling the end product? Or intermediates? • What is the cost of the materials in your product? • What is the price per unit, less the cost of materials per unit? • How much $$ does it take to develop your product & launch it? • How much $$ does it take to keep your business going?

33. Constance McKee Business of Biotech 8 What is a Business Model?Life Sciences Sector Overview • Key risk is time & money until you get to product revenue • Trade-offs between make-it-yourself and license-it-out models • Best scenario – shortest time & money, biggest payoff • Venture capital now only rarely funding drug development

34. Constance McKee Business of Biotech 8 Genzyme

35. Constance McKee Business of Biotech 8 Affymax

36. Constance McKee Business of Biotech 8 Medtronic

37. Constance McKee Business of Biotech 8 Qiagen N.V.

38. Constance McKee Business of Biotech 8 What is ‘Venture Fundable’?Venture Investors Seek Least Risk, Highest Upside • Start-ups usually begin after discovery completed in universities • So VCs focus on the $250M cost of development • Big pharma addresses large, chronic conditions • VCs focus on smaller markets, clear clinical endpoints

39. Wednesday1 – Valuations2 - Sources of strategic capital: defense research grants What is a valuation? for companies? for products? Why is this important to founders? How are valuations determined in the private (venture) market and in the public markets? To what quantitative factors are valuation models sensitive? Founders make money when…. Founders lose money when…. Wounded warriors & veterans – unmet clinical need & funding gap Constance McKee Business of Biotech 8

40. Constance McKee Business of Biotech 8 Valuation Determined by (1) Value of Latest Round of Financing & (2) Market Conditions • If 25% is worth $1 million, then 100% is worth $4 million • ($1 divided by 25% = 4) 25% valued at $1 million

41. Constance McKee Business of Biotech 8 Pricing RoundsVenture Valuations Affect Founders’ Ownership (“Dilution”) • Begins with pre-money valuation • Pre-money valuation driven by • (1) absolute amount of cash needed and • (2) target post-money valuation • New price-per-share calculated as (valuation/new $$ required = price/sh) • New price/sh calculate as (# new shs issued = % owned) = “dilution”

42. Constance McKee Business of Biotech 8 ValuationsMarket Drives Pre-Money Valuations • Model sensitive to time to exit (acquisition, IPO, product launch) • Model sensitive to cash required for each milestone • Pre-money valuation is whatever investors believe & insist on • Pre-money valuation + funds in = post-money valuation • Next round of investors want a “step up” (assumes you meet your milestones & your technology is now worth more)

43. Constance McKee Business of Biotech 8 ValuationsExit Assumption Drives Pre- & Step-Up ValuationsBut “Liquidity Preference” Dominates Cash Paid At Exit

44. Constance McKee Business of Biotech 8 Founders Make Money When…Valuations Are High & Keep Ratcheting Up to Exit

45. Constance McKee Business of Biotech 8 Founders Lose Money When…Valuations Remain Low, Exit Is Low…….and Later-Stage Investors Have Liquidity Preference

46. Constance McKee Business of Biotech 8 What’s a Valuation ‘Comparable’?Similar business model, similar products • Valuations of venture-backed companies • Subscription-services • (1) Venture One • (2) The Venture Capital Analyst • (3) your lawyers (without naming companies….”we’re seeing deals like this right now at valuations of etc”) • (4) your friends • Small cap public companies • Valuations may be affected by major investors’ portfolio concerns, may be unrelated to company’s future – or inside information? (PTIE) • Valuations may be affected by global market conditions (MAKO) • Similar class of drugs progressing through clinical trials • Pfizer torcetrapib failure

47. Constance McKee Business of Biotech 8 Product Valuation: ‘Expected Future Earnings’Public Company Valuations Fluctuate with Price • For public companies, investors buy on future expected value of earnings • Torcetrapib failed in Phase 3 • Pfizer spent $850M to develop the drug to that point • Conducted trials in 20,000 patients • On 4 December 2006, stock price dropped from $27.88 per share to $23.00 per share (x 7.2 billion shares, from $201 BN to $166 BN total company value) • Means investors removed value of future earnings from stock price

48. Constance McKee Business of Biotech 8 What happened on October 7?Venture investors Montreux & Skyline do $60M PIPE on October 29, 2008 at $6.25 per share* Montreux bid $6 per share in 2006 in a venture round before MAKO went public, but were outbid by hedge funds. MAKO later went public at $10 per share, has received FDA approval and started marketing its products. Montreux invests later in the company’s development with minimum science, clinical and market risk in a PIPE (Private Investment in Public Entity)…but what is VC doing investing in public companies….?

49. Change the Math for Early-Stage Investment Strategies to Accelerate Exit & Minimize Dilution Constance McKee Business of Biotech 8

50. Constance McKee Business of Biotech 8 Sources of Funding for Early-Stage and Translational Medical Projects • U.S. Army Medical Research & Materiel Command (USAMRMC) • Small business $524M (FY08) • Telecommunication and Advanced Research Center (TATRC) www.tatrc.org • Broad Agency Announcement (BAA) • Congressionally Directed Medical Research Programs (CDMRP) • 1992 – 2009 ~ $4.8BN in programs www.cdmrp.mil • Limited funds for military medical research - $300M for TBI & PTSD (2007 only) • FY09 - $374M total • Defense Related Medical Research Program - $235M ($92M 2008) • Department of Defense (DOD) • Small Business Innovation Research (SBIR) • Defense Advanced Research Projects Agency (DARPA) www.darpa.mil • Biomedical Advanced Research & Development Authority (BARDA) www.hhs.gov • Defense Threat Reduction Agency (DTRA) www.dtra.mil • Armed Forces Institute of Regenerative Medicine (AFIRM) • Two consortia fully funded at $300M • AFIRM 2? - “fully intend to renew”