GSK Spinout – Great, but let’s be realistic 
Posted by Carlos on Oct 05, 2010

Today we read the news that GSK will spin out a team of fourteen scientists and patents into a standalone company. Convergence Pharmaceuticals will focus on the development of pain management products. GSK retains an 18% ownership stake in the new company.

Generally speaking, I think this is a fabulous idea. I would like to see more of these spin outs, with the “spinner” retaining a small equity position. There is precedence for this, as AstraZeneca executed the same strategy with the 2008 spin out of Albireo, a company focused on the development of products to treat various gastrointestinal diseases. Why is this such a good idea?

It is a regrettable reality that pharmaceutical companies may decide not to pursue development and commercialization opportunities simply because the economics do not work for them. Perhaps the revenue potential is too low, or the profitability may be low because of egregious sales and marketing requirements. There may also be patent expiry issues which limit the viable commercial lifespan for the candidate.

With a spin out, some of these issues are eliminated, especially the revenue potential issue. A big pharma might reject a $100 million Peak Year Sales opportunity which would be quite attractive for a much smaller company. With that constraint eliminated, the candidate has a better chance of being developed, commercialized, and benefiting patients.

However, one has to also consider that a start up pharmaceutical or biotechnology company is a start up company with start up company issues, most notably the financing challenges. It is no secret that start up pharmaceutical and biotechnology companies can be some of the hardest companies to finance, especially as the number of venture investments in health care appears to be receding.

The continuous battle to secure financing means that management is focused away from product development. Timelines begin to stretch as resources are stretched. Contracts with CROs and consultants are delayed while financing is “imminent.” The list of financing-related problems can be extensive.

Several years ago, we were acting as business development advisors to a small pharmaceutical company in the US. The company was making good progress in the clinic. However, their prospective investors wanted the company to in license or acquire additional assets to “get more shots on goal”, improve company valuation, and reduce portfolio risk.

In theory, this was a great idea. However, the company did not have significant excess cash to finance these licenses or acquisitions. Many of the opportunities presented to them were simply not possible without the next round of financing. Yet the next round of financing was contingent on a licensing or acquisition. Few licensors are understandably interested in speaking with prospects without the capital to close a transaction. The company was ultimately financed, but without the assumption of a broader portfolio and enhanced valuation.

In summary, we welcome pharmaceutical and biotechnology company spin outs. Any mechanism which increases the number of drug candidates being developed is a good thing. However, we should not lose sight of the fact that the financing environment remains a challenge, and some of these spin outs may arrive in the the graveyard, regardless of how or where they were born.

UPDATE: Looks like New Leaf are an investor.

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