Epoch 38: PART 1 - R&D Budget Neutral Externalization Strategies

NewCo Spinout & Direct R&D Investment Take Center Stage

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Hello Avatar! Welcome back for another week of biotech analysis. This week we will begin a two part series around the topic of asset externalization.  The intended audience is both pharma and biotech operators.  For pharma executives we will run through a menu of options for asset externalization. We will focus the majority of our discussion on the two most budget neutral approaches - newco spinout and direct R&D investment.  It is important that biotech operators are aware of these options as they are implemented in partnership with the biotech community.  There is a great opportunity to realize for those that stay plugged into the scene.

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R&D BUDGET NEUTRAL EXTERNALIZATION STRATEGIES 

The next two weeks are going to be super interesting.  We are going to put our big pharma hats on and explore asset externalization strategies.  For biotech operators and investors this discussion will remain relevant. As you will see pharma externalization strategies rely on a partner and that is where the biotech and investor community comes in.  

During “PART 1: R&D Budget Neutral Externalization Strategies”, we will lay out frameworks for R&D externalization and take you through the pros and cons of different approaches.

Next week, in “PART 2: R&D Budget Neutral Externalization Strategies” we will be more tactical in our discussion and walk you through exactly how to build your own financial models to assess these transactions.

OVERVIEW OF EXTERNALIZATION STRUCTURES

Before getting into the specifics of asset externalization let’s first spend a few sentences on why this is needed.  It's important to understand the R&D budget is essentially an expense.  But it's a special expense - it's by far always the largest expense on the P&L.  With that comes scrutiny as it is always a target for cost-cutting to support profit/EPS engineering. 

The R&D budget is most often expressed in terms of “% of sales spent on R&D”.  The average spend per pharma company is slightly north of 15% of sales. If a pharma company ticks up higher than this, and they are not also showing topline growth, shareholders begin to demand R&D cuts.   

With that in mind it should be clear the R&D budget is always tight and for that reason there is always more supply than demand.  By supply we mean the internal team always wants to do more than there is a budget to support.

If you are interested to learn more about this we refer you to our previous write-up: Epoch 17 - R&D Budget Setting Mechanics 

What is one to do when there is good science to pursue, but no budget to support execution?  Well projects can get shelved and that does happen. But typically companies will first consider R&D asset externalization strategies.  Below are the 6 most common externalization strategies.   

1. NewCo Spinout

2. Joint Ventures

3. Direct R&D Funding (i.e. royalty pharma)

4. Research Collaborations

5. Royalty Monetization

6. Out-license

The chart below compares and contrasts each externalization mechanism in terms of retained control over development and budget offset.  We will deep dive on NewCo spinout and Direct R&D funding today as they off two mechanisms which maximize budget offset, each with the parent company retaining varying degrees of control

EXTERNALIZATION SUCCESS FACTORS