May 7, 2007

Volume 85, Number 19

pp. 19-26

Sowing Seeds Of Cures

As venture capitalists' priorities shift, venture philanthropists fill the gap in funding of drug discovery by biotechs

Lisa M. Jarvis

IN 1989, when scientists found the defective gene that causes cystic fibrosis, it seemed that a cure, or at least an array of better treatment options, was just around the corner. Research efforts, largely funded by the Cystic Fibrosis Foundation (CFF), gained momentum, and by the mid-1990s, scientists had pieced together much of the complex biology behind this debilitating and eventually deadly disease.

Yet nearly 10 years after the discovery of the gene, the pipeline wasn't exactly overflowing with promising new treatments. A roadblock stood in the way of translating the basic biology of the disease into tangible results for patients. "We had knowledge of the disease and ideas of how to move to the next steps, but we needed to figure out how to expedite that into drug development," recalls Robert J. Beall, the foundation's chief executive officer.

Because cystic fibrosis affects only about 30,000 children in the U.S., it doesn't attract much interest from big pharmaceutical companies. So in 1998, CFF made the bold move of adding a new component to its research-funding strategy: enticing for-profit companies to get involved in cystic fibrosis research by absorbing the early financial risk involved in developing new drugs. The foundation would receive a financial return, such as a royalty on a drug, that would be plowed back into the foundation to keep the drug development cycle going.

"We decided to push the envelope because we really felt there was a void, especially with a small disease like cystic fibrosis," Beall says.

What Beall could not have known at the time was how critical this model would be to maintaining a robust early-stage pipeline for the pharmaceutical industry overall and, in particular, for keeping biotech companies in business in the critical early years. Venture philanthropists, as such nonprofit funders are now known, have become an important source of money for the earliest stages of discovery, when the seeds of ideas that could eventually grow into drugs are first sown.

"There has been a significant shift by venture capital firms away from early-stage discovery investment toward the later stage," says Neil J. Sandler, managing director of the life sciences venture capital firm Symphony Capital. In fact, the portion of overall funds that venture capitalists allocate to a new company's "seed round"—the initial fund-raising for an influx of cash to start a project—dropped from nearly 10% in 2001 to just a sliver of total funding in 2006, according to a recent Ernst & Young report.

The result is a funding gap in the middle of the drug discovery and development spectrum. On one end, government finances the basic science with which potential drug targets and compounds are discovered, and on the other end, investors, drug companies, and venture capitalists pay for further development and commercialization of drug candidates that have made it to the various phases of clinical trials. Investors are shying away from the in-between stages, when academic researchers, entrepreneurs, and start-up companies are looking for money to validate their ideas.

"Back in the mid-90s, if you had an idea, you could raise venture capital," Beall says. "Then the focus moved to Phase I, then to Phase II, now onto Phase III. Who's going to fill the void? It's not going to be the U.S. government."

This funding deficit is a concern across the therapeutic spectrum, but it is particularly acute for "orphan" diseases that affect small patient populations. At a time when it can be challenging to get funding for potential treatments for highly prevalent diseases, patient advocacy groups fear that projects addressing orphan diseases will fall through the cracks.

Several forces drive this funding gap. One problem for traditional investors is that drug discovery and development is like a "black box in its workings and binary in its outcome," says William Mills, managing member of EGS Healthcare Capital Partners. An investor can sink tens of millions of dollars to get to the day of reckoning, when results from a late-stage, blinded clinical trial are revealed. "To invest all that money and then break open the data sets at the end and find out that things did not work out, well, that's sort of catastrophic failure mode," Mills says.

For other industries that attract venture capitalists, such as information technology or even medical devices, investors have a good idea whether something works even at the earliest stage of development. The end product may not live up to the commercial success it was likely hyped to be, but the investor at least can take comfort that it will actually reach consumers.

In the drug industry, on the other hand, investors don't always win even when the data bring good news, because the metrics of performance have shifted. In recent years, venture capitalists have been measuring their portfolios' performance by how much money an investment makes relative to the time required to make it. In other words, generating 10 times an initial investment isn't great if it took 15 years to get there.

Typically, venture capitalists investing in a start-up drug company get their money back through an initial public offering (IPO) or the licensing of a drug to a big pharmaceutical maker. But compared with the gung-ho investors during the heyday of biotech IPOs, investors today want to see a lot more data from clinical trials before they will buy shares in a new firm. "The public markets that have historically been employed as an exit vehicle have been far more selective than they were during the 1990s and early 2000s," Symphony Capital's Sandler says.

The result, says G. Steven Burrill, CEO of the life sciences venture capital firm Burrill & Co., is that "the whole system has crunched down the values on relatively early-stage capital." A biotech entrepreneur's idea that might have raised $5 million five years ago is worth a fraction of that in today's market. "There just isn't a lot of incentive for people to put a lot of money behind a crazy idea," Burrill adds.

Venture philanthropists, however, are willing to take a different kind of risk because they are watching a different bottom line. The primary measure of their investments' performance is a drug's impact on the lives of patients. There is a profit motive, to be sure, but only so that returns can be reinvested in other projects. "It's possible for venture philanthropists to assume risks that may not make sense in the investment world," Mills says.

Or as Burrill puts it, "The disease advocacy groups have become major players" in the for-profit world.

This foray into funding for-profit enterprises is a major departure from the traditional business model of disease-oriented nonprofit organizations. For decades, patient groups have focused their resources on funding basic research to unravel the underlying biology of a disease. This primarily meant writing checks to academic researchers looking for, say, a genetic mutation that can be linked to the disease or an enzyme that enables the disease to proliferate.

"For years, we were somewhat passive funders of research," says Peter Lomedico, director of the industry discovery and development program at the Juvenile Diabetes Research Foundation.

Foundations like JDRF and CFF have amassed a great deal of data about their diseases and are encountering a bottleneck in transferring that knowledge from academia to industry, where it can be translated into treatments and, everyone hopes, cures. "We've had to become more proactive and move more opportunistically when we see windows where we can make a difference," Lomedico notes.

Foundation managers say an active role is in keeping with their overall mission, which is to improve the lives of patients. "The cure is a pill," says Howard Fillit, executive director of the Alzheimer's Drug Discovery Foundation. "You don't find pills from doing basic research at a university. You find pills by translating the knowledge that's generated at a university into the development of compounds." And that, Fillit adds, is done within companies.

Patient groups play their most substantial role by removing some of the uncertainty of drug discovery and development???or "de-risking" in their jargon???so that investors with deeper pockets, be they big pharma or venture capitalists, will take interest. "We're trying to chaperone those ideas, pull them out of discovery, and de-risk those investments," says Deborah W. Brooks, cofounder and president of the Michael J. Fox Foundation (MJFF), which focuses on finding new treatments for Parkinson's disease.

CFF discovered early on the impact of de-risking an idea. The foundation had its first experiment with drug development in 1994, when it assembled enough preclinical data on an inhaled form of the antibiotic tobramycin to attract a licensing partner, PathoGenesis. That drug, Tobi, received Food & Drug Administration approval for cystic fibrosis just four years later.

THE POT OF MONEY it received from licensing the drug helped to fund a formal drug discovery investment program. Today, nearly 30 drugs to treat cystic fibrosis are in the pipeline. Importantly, two compounds to treat the disease rather than its symptoms are now in late-stage trials. One compound, Vertex Pharmaceutical's VX-770, originated from CFF's first major pact with a biotech company, a screening deal forged in 1999 with Aurora Biosciences.

Successes by venture philanthropy pioneers such as CFF are propagating a new culture within disease advocacy groups. Families of Spinal Muscular Atrophy (FSMA) and the Institute for the Study of Aging (ISOA), which funds biotechs through the Alzheimer's Drug Discovery Foundation, were among the first to forge into the area, and JDRF and the MJFF were quick to follow.

Like CFF, FSMA faced a lack of interest in a disease that, although devastating, affects a small patient population. FSMA first got involved with funding for-profit companies roughly seven years ago.

FSMA's first major agreement mirrored CFF's trajectory by tapping into the screening capabilities at Aurora Biosciences. However, unlike CFF, FSMA actually owns the intellectual property for the compounds that came out of the screens; it will pay a royalty to Vertex, which acquired Aurora, if any drugs are commercialized. FSMA then paid for full-time scientists at deCode Genetics to find the most promising leads, collaborating with FSMA in assay development, screening, lead optimization, and, now, preclinical studies.

Within the next nine months, the foundation hopes to outlicense one promising compound that has come out of the collaboration with deCode. Although it would see some cash from a licensing deal, its most important goal is to find a partner with the financial resources to develop the drug through commercialization, says Kenneth Hobby, FSMA's executive director.

Around the same time that CFF and FSMA were making a concerted push into venture philanthropy, ISOA was starting to establish its model for funding for-profit companies. By 2002, ISOA had provided seed money that helped found two companies, Allon Therapeutics and Zaptaq, devoted to developing Alzheimer's treatments.

The Alzheimer's Drug Discovery Foundation (ADDF), formed in 2004 as the public arm of ISOA, now funds early ideas through two programs. The Biotechnology Development Program provides money to existing companies with early-stage Alzheimer's drug discovery programs, and the Biotechnology Founders Program helps academic scientists with novel approaches to treating the disease who want to start companies. ADDF also provides those entrepreneurs with strategic management assistance.

ADDF does not take a royalty fee for drugs developed through these ventures, but it does receive convertible notes, or debt that can be converted into equity in the company if an outside investor decides to step in. "We feel we've been pretty successful in getting returns that have enabled us to fund other Alzheimer's drug discovery research," Fillit says.

To date, the organization has backed 17 biotech companies. Though the total funding amounts to a relatively modest $6 million, Fillit notes that the firms have raised well over $300 million in follow-on financing.

Efforts by CFF and ADDF to forge into venture philanthropy have provided a framework for programs at other disease-oriented nonprofits. Not all operate by the same model-the funding levels and the strings attached to the projects vary widely-but the nonprofit community is quickly having an impact on the pipeline.

THE JUVENILE Diabetes Research Foundation (JDRF) started funding research at for-profit companies about three years ago. "We've been around for 35 years and have had a successful track record in raising money and investing in academic research focused on the discovery side and understanding the basic biology," Lomedico says. "Now is the time to translate that knowledge into therapeutics, medical devices, and diagnostics that, in our case, can effect a cure for type 1 diabetes."

JDRF's aim isn't to make money but to get a modest return through a royalty payment on any marketed product that will then enable it to fund the next wave of research. Lomedico stresses that the foundation does not want to be a burden to a company's commercial objectives and that the royalty it takes is less than the typical amount awarded to universities that outlicense technology. This year, about 10% of JDRF's research budget of $140 million will flow into industry partnerships.

Though much younger than JDRF or CFF, MJFF has quickly become an innovator in the way it funds research on Parkinson's disease. Since its inception in late 2000, the foundation has been equally receptive to academic and industry researchers, Brooks says. In fact, the foundation's first award, in 2001, was distributed among a handful of academic labs and one company.

The organization views the space between academic and investor interest in a project as the "sweet spot" where it can have the most impact on getting new treatments to patients, Brooks notes. And as MJFF's coffers have grown, its funding has gotten more creative in order to squarely hit that sweet spot. The foundation has annually renewed programs focused on everything from novel approaches to treating Parkinson's, to target validation, to support for early clinical studies.

The most recent program, Rapid Response Innovation Awards, which is designed to provide immediate support for novel ideas, grew out of a realization that "these kind of innovative ideas don't happen on an annual schedule," says Todd Sherer, vice president of research programs at MJFF. For example, a scientist may attend a conference and be inspired to take a new approach to treating Parkinson's, but in the past, he or she would have had to wait to act on it until funding came through.

The Rapid Response program provides up to $75,000 in funding for such projects and is open to researchers in both academia and industry. Since launching the program on Jan. 1, MJFF has already cut checks for scientists working on three different projects.

High-profile efforts to spur drug development for Parkinson's, diabetes, and cystic fibrosis have not gone unnoticed by other disease-oriented nonprofits. "There's no question this is a growing trend," JDRF's Lomedico says. "We have organizations knocking on our door asking to learn how we structure our industry program, because they're looking to duplicate this at their foundation."

In the past year, a slew of patient advocacy groups have either initiated grants for industry or formalized earlier experimental efforts through dedicated funds. The Multiple Myeloma Research Foundation made its first foray into funding for-profit companies after benchmarking the program at JDRF, says Anne Quinn Young, program director at MMRF.

The blood cancer group's program, called LEAD, for Leveraging Existing Multiple Myeloma Targets To Accelerate Drug Discovery & Development, will receive $6 million over the next three years. The first awards, to Semafore Pharmaceuticals and ProChon Biotech, amounted to $2 million, out of the organization's overall 2007 research budget of $10.5 million.

The ALS Association, which is searching for a cure for amyotrophic lateral sclerosis, or Lou Gehrig's disease, recently initiated its first round of funding for its program called TREAT-Translational Research Advancing Therapy. The association says the program broadens earlier relationships with industry.

Meanwhile, in July, the Leukemia & Lymphoma Society will kick off its first trip into funding for-profit enterprises. The Therapy Acceleration Program, or TAP, will get a $4 million allocation this year, but the organization hopes to increase that budget to $32 million in the next four years, says Louis DeGennaro, the society's senior vice president of research.

Although more and more organizations are adopting the venture philanthropy model, it is not for everyone. Nonprofits considering a similar shift in strategy should take a serious look within, CFF's Beall says. He believes organizations need three key qualities to succeed: financial fortitude, a strong understanding of the basic biology of their disease, and a culture that can stomach risk.

Without those qualities, making the funding leap beyond basic research will be challenging and may not produce the returns nonprofits expect. CFF, for example, had a strong financial base from which to accelerate its funding activities. The organization collected $17 million by selling its future royalty rights to inhaled tobramycin. Coupled with funding from donors and the Bill & Melinda Gates Foundation, the money has enabled the support of a broad pipeline of projects.

And any nonprofit moving toward venture philanthropy has to have high tolerance for risk. "We could have screened millions of compounds on the Vertex deal and not gotten anything to work, and we would have spent millions of dollars getting there," Beall notes.

Particularly for an organization with a small budget, financing for-profit research can involve trade-offs. Hobby says FSMA's decision to fund Aurora Biosciences back in 2000 required nearly half of the group's research budget, which could have funded 10 to 20 academic researchers.

Meanwhile, companies applying for grants need to be aware that they are working with a different kind of financing partner. A start-up sidestepping the venture capital world at the early stage requires some internal business acumen, industry observers warn. Entrepreneurs launching a new company face a steep learning curve that traditional venture capital investors can help surmount. Venture capitalists can also provide guidance in navigating the business world and assistance in finding experienced management as a company grows.

"The overall challenge for venture philanthropy investors is really to replicate the success of the venture capital model," says Gautam Jaggi, a managing director at Ernst & Young. "Venture capitalists do more than just provide money; they really provide smart money, and they provide experienced money."

Furthermore, venture capital is relatively unrestricted; in addition to funding research, it can pay for the day-to-day costs of running a business. Nonprofit dollars, on the other hand, are meant to fund a particular program related to a specific disease, Fillit notes. For example, at least 65% of the funds that ADDF provides to start-up companies must go to a scientific program focused on Alzheimer's.

On the other hand, patient groups can offer other invaluable resources, such as access to their patient network during clinical trials or assistance in getting a drug or device covered by Medicare.

Access to patients is especially important. As clinical trials get larger, it is becoming difficult to find patients who have not been treated with a product that is in a trial or on the market, says Neill M. MacKenzie, senior vice president of corporate strategy and business development at MediGene, a German biotech company that recently received funding from JDRF for an antigen-specific immunotherapy for type 1 diabetes.

THE SITUATION is further complicated in the case of diabetes, because patients who are doing well on insulin are essentially healthy, he says. It can be tricky to put patients whose disease is under control onto a novel therapy, he says. "The backing of the JDRF not only provides access to patients but also helps with any potential ethical issues related to treatment."

Another factor in favor of venture philanthropists is that applying for funding from nonprofits is often far easier than applying for government funds. The application for MJFF's Rapid Response program, for example, is a mere three pages and comes with a guaranteed review within six weeks. "There's much less administration and hassle with these than if you went for a government grant," MacKenzie says, adding that the application for a European Union grant for a small- to medium-sized enterprise is "huge and scary."

In the end, if a nonprofit can handle the risks of working with start-up companies, the payoff for patients can be tremendous. For example, FSMA is now poised to file an Investigational New Drug Application for a compound that came out of its collaboration with deCode. "This would be the first novel treatment for spinal muscular atrophy to reach this stage," Hobby says, noting that patients today are treated with drugs that are intended for other diseases. "It would be a huge step for the community."

Likewise, the cystic fibrosis pipeline now boasts nearly 30 drugs, 10 of which are in Phase II or beyond. "It's all about shots on goal," Beall says. "Our bottom line for our performance metric is the cystic fibrosis pipeline, and it would not be where it is today without our venture investments."

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