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Cover Story

May 7, 2007
Volume 85, Number 19
pp. 29-32

Thinking Outside The Big Pharma Box

Novartis Option Fund takes the traditional corporate approach to investing in early-stage research to a new level

Lisa M. Jarvis

SOMETHING RATHER UNUSUAL was happening on the fourth floor of One Cambridge Center. Behind the closed door of the Cambridge, Mass., offices of Novartis Venture Fund, three businessmen were lying on the floor, ties off, shirts undone, while a visitor hooked wires to their chests to test the electrical activity of their hearts.

Jesse Ross
Idea Lab Novartis Venture Fund's Cambridge offices.

Though the scene might have been cause for alarm to the casual passerby, this was no health emergency; it was a meeting of minds. An entrepreneur had come to convince the fund to invest in a new electrocardiology technology.

"We talked for three hours, and at the end of the discussion, I said, 'Now I want to see it work,' " recalls Reinhard J. Ambros, executive director of Novartis Venture Fund. "We took off our shirts, and he did the measurement. That was the best due diligence!"

Novartis is betting that such an adventurous spirit, not automatically associated with big pharma, will help it get first dibs on innovative technology and also fill its drug development pipeline. To fully take advantage of investing in other companies as a way to find new drugs and other products, the Swiss pharma major recently launched Novartis Option Fund. This fund goes one step beyond the traditional corporate venture capital model. With this fund, Novartis acquires not only a stake in the company but also an option—an exclusive right to later license a drug or technology—on one of the company's programs.

With a pot of $200 million, Novartis Option Fund is devoted to making seed investments to help biotech and other start-up companies move from an idea to a validated technology. The hope is that the fund will serve as a breeding ground for smart, innovative ideas and give them the best chance to become the drugs and devices of the future.

"We are realizing that sometimes $100,000 can make a much bigger difference than $10 million if you want to do one or two experiments to get to the next round of funding," Ambros says.

The option fund may be just the experiment the industry needs right now. Big drug companies are paying biotech firms top dollar for products that have been validated by late-stage trials. Yet funding for early-stage research, particularly at the "crazy idea" stage, as Ambros calls it, is much harder to come by. Several years down the road, this funding gap could translate into a paucity of late-stage drugs (see page 19).

Indeed, overall funding by venture capitalists in the life sciences has grown, but seed money and the subsequent round of early-stage investment has steadily eroded. According to Ernst & Young, seed and first-round funding represented more than half of total fund-raising by biotechs in 2001 but less than one-third in 2006. The situation has led many industry observers, both within and outside the venture capital community, to declare that the system for early-stage funding is "broken."

Arguably, the major drug companies themselves have the greatest interest in finding a fix. Traditional venture capital funds can always turn to other industries, such as information technology or energy, to make their money, but a corporate venture capital fund has an underlying business development goal. Corporate funds may be willing to take a greater risk on a project if it has the potential to translate into new products or some other advantage for the parent corporation.

"Corporate venture investing is not new, but it is becoming an increasingly accepted and significant part of the fund-raising process" of new companies, says William C. Mills, a managing member of EGS Healthcare Capital Partners. Novartis is clearly upping its commitment to investing in start-ups with the option fund, Mills notes.

Novartis Venture Fund was launched in 1996, when Sandoz and Ciba-Geigy merged to create Novartis. The fund's original allocation of about $60 million was intended to help scientists who lost jobs in the merger start their own businesses. Eleven years later, the fund now has more than $550 million.

"It quickly became clear that there was more behind the fund than just a means to help ameliorate the situation created by the merger," Ambros says.

One benefit of corporate venture capital funds is that they expose big drug companies to firms with unique ways of discovering and developing new therapies. The drug companies gain an intimate technological understanding of the firms they invest in, so when it makes sense to license a product or otherwise cement the relationship, "they are many steps closer to doing that," Mills says.


INDEED, Ambros believes that the relationships created through Novartis Venture Fund could give Novartis a leg up when it is competing to license technology from a biotech firm in which it has an equity stake. In a scenario where the offers from various interested parties are virtually equal, the hope is that the biotech will choose Novartis because of an existing level of comfort.

Novartis Option Fund's option agreement includes an option fee, paid in two installments, that is separate from the equity investment. The fee provides the company with cash that does not water down other shareholders' stakes and that can help attract other investors. The option, good for a period of five years or until the first patient enters the clinic, includes licensing terms that Novartis can exercise at different milestones in the development of the product.

"We're trying to offer a validating deal at a very early stage," Ambros says, adding that the option fund will continue to finance the company regardless of whether Novartis decides to exercise the option.

To qualify for the option fund, biotech companies must meet two requirements, Ambros says. First, the fund is interested only in companies with the potential to significantly improve patients' health or change how a physician would treat a patient. "We are not interested in me-too drugs or marginal improvements," he adds.

Second, the company must have an innovative technology platform that could lead to three or more new drug programs. "Generally, we do not want one-trick ponies," Ambros says. "If there are only two potential drugs or programs, and one fails and the other is linked to Novartis, we would be holding the company back."

Ambros concedes that these criteria limit the investment candidates for the option fund, but he says his team has seen plenty of opportunities in the six months that it has been out scanning the field.

Companies that do end up in the fund's portfolio will then benefit from several advantages through their connection to a corporate venture capitalist, Ambros says. For one, his team can serve as a bridge between the biotech world and business development teams within both Novartis and other drug companies. Ambros relates that executives of his fund's companies often tell him they have tried unsuccessfully to reach counterparts within the larger Novartis organization. "If I think it's a good company, I will just call a meeting and bring them together," he says.

And with financing by the option fund, a new biotech company starts out, in a sense, with a validating partnership with a major drugmaker. That seal of approval "is the most valuable thing that can happen to a biotech company," Ambros says.

Whether the program will work remains to be seen. The Novartis model is unique, says EGS Healthcare's Mills, and he points to some potential catches to the plan that could turn off some partners.

"Most corporate investors have tried to fit as seamlessly as possible," Mills notes. "The notion of taking an option adds an extra wrinkle into the equation—you're going to have to get a set of people to agree that this option stake is acceptable."

Indeed, this latest experiment from Novartis has yet to prove its mettle. Ambros expects the fund to make its first two investments later this month. Thereafter, the plan will finance roughly three ventures per year, with the potential to commit between $10 million and $20 million over the lifetime of the biotech company.

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