How to find a Biotech winner

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When is the perfect time to invest in a company, and how do you decide? Jumping in with an early-stage company that is burning with potential can bring enormous rewards but an even greater risk of leaving you burnt. 

"We have focused on later-stage," says Horizon 3 Biotech's CIO Matt McNamara "because it de-risks it if you have achieved a lot earlier on, and it also means that you can return earlier because the portfolio companies will reach their exit point quicker than early-stage company."

In this wire, McNamara explains how Horizon3 Biotech use milestones and returns to define "late-stage". He also explores the commitment to identifying a company’s Achilles Heel that allows the firm to find, from the approximately 500 companies they review each year, that special five that will stand the test of time. 

Edited transcript 

Why does your investment strategy call for later-stage opportunities /
“closer to exit”? How do you define “later stage”?

The team - and everyone in this sector - has had a lot of experience in investing in early-stage companies. The first fund I managed was a pre-seed fund, super early stage. The problem with early-stage is the risk is enormous, the failure rate is very high, and the returns take a long, long time to eventuate.

We have focused on later-stage because it de-risks it if you have achieved a lot earlier on, and it also means that you can return earlier because the portfolio companies will reach their exit point quicker than an early-stage company. 

And our definition of later-stage is that, because there is no one definition and this is just the Horizon3 Biotech definition, is we will invest in a company that we believe has only one or two milestones to achieve over a three to four, maybe five-year period and can deliver a 1x per annum of investment and reach an exit point where we're confident we can trade sale or have an exit on market.

You have a strategy you call an Achilles Heel approach. What is the Achilles Heel approach?

As you might imagine, fund managers are pitched a lot of investment opportunities. Our team is on track to review around 500 per annum. There is no way we can do full due diligence on all 500 and manage our portfolio companies. So we have to try and pick holes, fail fast each company that we look at. 

Your audience will be aware of the Trojan Prince Paris who killed Achilles, the great warrior, by shooting an arrow into his heel, the back of his heel. Now, he knew where Achilles' weak spot was. In our case, we have to try and identify where the weak spot of each portfolio company is, and so we try to identify that as quickly as possible and move on. If we can't identify it very quickly, then we start doing serious initial due diligence. And so that 500 might become 80. And so we will do thorough due diligence on 80.

Can you walk us through a case study? 

The first example I'll give you is valuation. If we're looking at a company and they feel that they have one or two milestones to achieve over a four-year period before it will be attractive as an exit, if they've got a pre-money valuation of $100 million, then we have to look at comparables, what the interest in that technology is in the market, DCF analysis. 

And if we can't see that it's going to deliver us, potentially deliver us, four times, because of four years, four times our initial investment, then we have to leave it alone. So if it's pie in the sky number that would reach, we just leave it alone. The valuation's too high.

Another example is a little bit similar.

 A company might present a very cogent investment argument with one or two milestones. In our initial due diligence, we might say, hang on, those two milestones are fine, but in our experience, there are a couple of extra milestones you need to achieve prior and before a regulatory body would look at it and take it seriously or a company would want to acquire it. 

So we would have to decline that investment and say you need to hit these couple of milestones first before we would invest and then you can hit the last couple.

The last example I'll give you is on the positive side for a change. 

We might look at a company and identify three areas that we think are a potential concern. For instance, the mechanism of action of the drug. We might look at intellectual property. Another one we might look at is manufacturing. 

You know, the problem with manufacturing is quite often a product produced in a lab and used at a small scale achieves very interesting clinical results in tens or hundreds of patients. 

But when you try to scale up that manufacturing of that ingredient, you cannot get the same efficacy. And so, unfortunately, that has happened many, many times over the decades that I've been involved. 

And so we need to try and work out whether there is a manufacturing mechanism to scale up. Now, if all three of those things are positive in our review, then we will proceed onto initial due diligence.

Investing to improve lives globally

Horizon 3 Biotech is uniquely placed to find, develop and deliver health science innovations that will make a positive difference to people’s lives on a global scale. Visit our website for more information.

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