Drug Discovery and the Balance Sheet

The common wisdom is that bringing a new drug to market now takes an average of about 10 years and $1 billion, and that 9 out of 10 drug candidates fail somewhere along the way.

Bad as those numbers sound, the situation is actually much worse, according to Corey Goodman, chairman of iPierian Inc., a biotech start-up based in South San Francisco.

“If we put Genentech as the outlier and just look at big pharma and big biotech, the reality is more like 1 in 25, 1 in 30,” Goodman said. “That puts the cost up; it’s significantly over $2.5 billion. At that rate, I think that what has been the model is going to lead to extinction.”

Born just a year ago, the product of a merger of two other biotech newbies, iPierian clearly sees itself as an industry phoenix and not as a dodo — and has embraced another model to greatly better the odds. iPierian’s plan is to form a network of partnerships at a much earlier stage than is now common in the industry and to use those partnerships to aggressively develop its technology in tandem, finding winning drugs faster and thus dramatically lowering the cost.

Reinventing the drug discovery paradigm would be an audacious goal for the biggest of companies, let alone for tiny iPierian, which so far has garnered a total of $54 million in financing from such heavyweight venture capital firms as Kleiner, Perkins, Caulfield and Byers, Highland Capital Partners, Mitsubishi UFJ Partners, and Google Ventures. All this investment and iPierian is still too young to have developed any drugs.

But iPierian has two things going for it that may prove to be game-changers — its breakthrough technology and the team at the top, many of whom worked together before. Starting a company with such a team adds to the likelihood a start-up will succeed, according to research carried out by Edward B. Roberts, a professor at M.I.T.’s Sloan School of Management, and chair of its Entrepreneurship Center. Such a team working together increases the odds of success because, among other things, the team knows each other’s strengths and weaknesses, which shrinks the learning curve. This is particularly important when there is an early handoff from one leader to the next, which is the case at iPierian.

iPierian’s technology allows adult cells to be transformed into stem cells, those progenitors of life that are capable of replicating any cell in the body. No controversial harvesting of discarded human embryos is needed. And the necessary tissue samples can actually be taken from living patients with a particular disease, raising the tantalizing possibility that the resulting adult stem cells could short-circuit the normal drug screening process to speed up drug discovery. In addition, from a business perspective, accelerating the research process could make early technology-sharing partnerships practical.

The CEO of iPierian is Michael C. Venuti, a 56-year-old M.I.T.-trained Ph.D. biochemist who was the company’s former chief science officer and a former venture capital partner. While Venuti runs iPierian now, the company owes its vision, and perhaps its existence, to its outgoing CEO, 62-year-old John P. Walker, who has a long track record in the industry and deep organizational skills. With no formal training in science, Walker rose to be head of the American Hospital Corporation before successfully shepherding several biotech startups from birth to market. Walker’s decision to leave the company early was precipitated by family issues.

“He has a very strong practical sense to him,” said Robert Ruh, Korn/Ferry International’s global sector leader for medical devices, who has known Walker since their days together at American Hospital. “He’s not even close to being a scientist. He’s a business guy, and what he brings to the table is an ability to understand science and see through that to what the real business opportunity is.”

And what that opportunity is this time is revolutionary, said Walker, “because for the first time it allows you to turn drug discovery on its head by putting the patient at the front of the cycle.”

As part of the handoff to Venuti, Walker will remain an advisor to the firm.

From Magic Bullet to Scar Tissue

Drug discovery has traditionally begun with a potential therapeutic compound and worked its way back to the patient, through in vitro studies, animal models, clinical trials and many millions of dollars. But what if you could start with the patient’s disease and work back to the cure?

Popular media discussion of stem cells centers on their potential use as drugs, which casts them as the latest edition of the pharmaceutical Holy Grail — the magic bullet, a canny molecule that can locate and eliminate disease with exquisite accuracy. While stem cells may one day fulfill that quest, iPierian thinks that their first best application will be as highly specific targets to be used in drug discovery, not treatment. iPierian’s stem cells are a new form of highly capable, drug-discovery tool.

iPierian was formed in July 2009 from the merger of iZumi Bio Inc. of South San Francisco and Pierian Inc. of Cambridge, Mass., both created to take advantage of these discoveries. To supplement a scientific advisory board and key hires drawn from the Harvard Stem Cell Institute and the Gladstone Institutes at the University of California at San Francisco, iPierian’s founding investors sought an experienced chief executive with “muscle memory and scar tissue,” to build the team, said Beth Seidenberg, a partner at one of the investors, Kleiner Perkins Caufield & Byers. She recruited Walker, first to be CEO of iZumi, but with a mandate to take over the merged companies.

Walker, who had recently retired, was an obvious choice. Shortly after arriving in California in 1985, he formed a relationship with Kleiner Perkins, the legendary Silicon Valley venture firm that had provided initial financing to Genentech and other industry pioneers. Walker said he shared a long-term perspective with the firm’s partners on how to create value through nurturing new companies. Together they built five companies, of which three went public and two were acquired, an enviable record in the high-risk world of start-ups.

When Seidenberg called, iZumi and Pierian already had a team of scientists in the field of stem cell research, strong financial backing, and filings on crucial patents. Walker brought leadership, organizational ability and business acumen, to stitch those elements together into a company.

The depth and breadth of the opportunity shaped iPierian’s strategy and suggested a business model based on a set of partnerships, Walker said. As a result, iPierian plans to join forces with an established maker of biological and chemical tools. By doing so, it hopes to industrialize iPierian’s technology rapidly and broadly, while partnering with biopharmaceutical companies to address specific diseases and entire therapeutic categories. In addition, iPierian’s own proprietary drug development program will focus on neurodegenerative diseases, such as Parkinson’s and ALS (“Lou Gehrig’s Disease”), which are particularly underserved by existing discovery methods.

In today’s uncertain financial environment, Walker said this partnering strategy should provide adequate capital for iPierian to advance adult stem cells as a platform technology and bring its own first drugs to the clinic without multiple rounds of dilutive equity offerings.

The Productivity Crisis in Drug Discovery

Why is the drug discovery process so difficult? The answer is that the industry is witnessing the fundamental limitations of a discovery paradigm based on two options: serendipitous finds, like aspirin and opium, whose derivatives are still among the most commonly prescribed drugs, or the screening of vast chemical libraries against targets of unknown and unquantifiable relevance. The weaknesses of this random approach are now painfully visible in the declining research productivity of the pharmaceutical industry.

The early promise of biotechnology was to take drug discovery away from such shots in the dark to a model premised upon expanded knowledge of the molecular pathways of disease. The success of Genentech and its kin is testimony to the validity of this approach, but it is limited to diseases with well-known causes. Too many diseases are the result of still-unknown pathologies.

“I know the problems of pharma and they start at the beginning: choosing the wrong biology, the wrong targets and then pushing forward whatever you choose to the tune of billions of dollars,” said Berta Strulovici, iPierian’s vice president for research and chief technology officer, who previously held executive research positions at Merck & Co. “iPierian’s objective is to streamline drug discovery by getting the biology right,” she added.

The Foundation of a New Platform Technology

The unsung heroes of the biotech revolution were the makers of biological tools and enabling technologies. Although Kary Mullis ultimately received the Nobel Prize for the development of a technique for generating thousands to millions of copies of a particular DNA sequence, the further industrialization of these processes required many advances in hardware, software and biology. The same will be true for adult stem cells.

Biotech pioneers such as the Cetus Corporation, where Mullis was employed, often had to invent and produce their own biological tools, but today there is a community of sophisticated vendors that has grown up along with the industry. These toolmakers present the first broad partnering opportunity for iPierian, which forms an element of its business model.

Walker said that iPierian plans to strike a partnership with a single outstanding company for an exclusive long-term relationship, where the partner can turn iPierian’s innovations into product opportunities, so the company can access upfront capital as well as an ongoing stream of royalty payments. The partner will enable iPierian to monetize the offshoots of industrializing adult stem cells.

Though “industrialize” is a tidy sounding verb, the actual task of scaling up stem cell processes from laboratory quantities to commercial production will be far from trivial. Yields must improve by at least an order of magnitude, if not two, coupled with a concomitant improvement in purity. “Working closely with a company that is in the business of turning innovation into ready-to-use products will benefit iPierian directly by cutting the time we have to spend reducing science to practice,” Walker said. “And the collaboration will also benefit the broader life sciences community by making the fruits of our labor widely available.

Two Models for Pharmaceutical Partnerships

The same philosophy informs Walker’s, and now Venuti’s, partnering strategy with pharmaceutical and biotechnology companies. Walker foresees two distinct models. One model is for specific diseases that iPierian is focusing on internally, like spinal muscular dystrophy, a neurodegenerative disease that is the leading genetic cause of death in infants and toddlers. A second model will serve companies working in broad therapeutic areas, such as metabolic disease, cancer and cardiology.

In both cases, however, iPierian will seek to partner much earlier than is common practice today, where collaboration is usually deferred until proof-of-concept, which may not be achieved until a molecule is well advanced in the three stages of human clinical trials required by the U.S. Food and Drug Administration. That risk-averse approach makes sense to small companies seeking to maximize the monetization of a core asset, and to large companies looking for product candidates with near-term potential. But with a breakthrough technology like adult stem cells, the company can create real value and receive proper compensation for partnering far earlier in the process, much the way the first biotech companies did, said Dushyant Pathak, iPierian’s vice president for business development. “We see stem cells as a product-enabling platform, as opposed to a pure technology play, because it enables an entirely new way of approaching drug discovery,” Pathak added.

With such a broadly applicable platform, iPierian could have built a business as a pure biological tool company. But Walker and Venuti believe iPierian can create greater value for shareholders and deliver much-needed new therapies to patients by also employing stem cell technology in the discovery and development of the company’s own drugs.

Nevertheless, Walker concedes that a small company is limited in the medical markets it can address. Even after the science is proven, after a candidate drug successfully passes through clinical trials and approval by the F.D.A., the company faces immense logistical and financial hurdles in building adequate manufacturing, marketing and sales capabilities to bring that drug to market. In truth, very few biopharmaceutical start-ups grow into successful operating companies.

Walking the Risk/Reward Tightrope

One obstacle to iPierian’s success is that the cells differentiated from adult stem cells do not absolutely duplicate the actual somatic cells in the human body, and there is currently no reliable measure of the relative accuracy of the reprogramming process. But iPierian’s scientists say that the differences are minuscule and inconsequential compared to the difference between a cell from a specific Parkinson’s patient and a cell from a research or laboratory animal. They expect the predictive power of a drug test based on a motor neuron generated from adult stem cells will be so much better than one done traditionally, with animal cells.

A more compelling obstacle will be scaling the technology. It is one thing to reprogram a few sample cells in small dishes in a lab, entirely another to create an automated system that can produce millions of cells to order, day-in day-out, within specific tolerances and with a guaranteed level of purity. Yields have improved exponentially — early experiments reprogrammed fewer than one in 10,000 cells — but the company has a long way to go to achieve production volumes. The biology needed to grow neurons is vastly more complex than growing generic tumor cells in a dish, so simple off-the-shelf solutions will not be adequate to the task, which is why iPierian and its partners will be inventing new systems and processes as they progress.

There will also be a specific scientific challenge with each disease, which is coming up with a suitably predictive model. It’s not enough to produce reprogrammed cells for a test if the particular cell type is not conclusively implicated in the disease. In many cases, several different cell types will have to be created for one disease.

A Solid Intellectual Property Portfolio

Beyond the science and engineering, biotechnology companies all typically face a level of legal risk associated with intellectual property. Most scientific discoveries have multiple parents, and determining custody rights is often a long, litigious process. If the intellectual property underlying a new process is split between too many parties, any one of them may have a difficult time building a viable business.

Shinya Yamanaka’s 2006 creation of adult stem cells from mouse cells was a watershed event for biology. The production of human adult stem cells less than two years later, by Yamanaka’s lab at Kyoto University and others, opened a new era in drug discovery. While Yamanaka’s breakthrough work in mouse cells generated the headlines, the first patent filings in human adult stem cells were made in June 2007 by a team at Bayer Japan, whose work, because it was done without fanfare inside a private company, went largely unnoticed. Indeed, as late as October 2007, Yamanaka publicly stated that it was unclear when, if ever, human adult stem cell research might succeed. In a review of its operations following its merger with Schering, Bayer elected not to continue the stem cell work in Japan, and iZumi, iPierian’s predecessor, was able to acquire all of the related intellectual property.

iPierian’s intellectual property also draws upon filings generated by the Gladstone Institutes in San Francisco; Pierian, prior to merging with iZumi; and by iPierian, since combining the companies. In January 2010, the Intellectual Property Office in the United Kingdom issued a Notification of Grant to iPierian for its first patent related to adult stem cell technology. This is the first patent related to adult stem cells granted outside Japan. U.S. patent applications are pending.

Nevertheless, for such a broadly applicable and potentially powerful technology, there will be competition, and inevitably, competing patent claims. Already, Cellular Dynamics International, based in Madison, Wis., and founded by stem-cell pioneer James Thompson and three university colleagues, has agreed to supply Roche with beating heart cells for toxicity testing. In San Diego, Fate Therapeutics is collaborating with biotech toolmaker Stemgent to form Catalyst, a venture that will make adult stem cells for other companies in a consortium.

Finance Beyond the Term Sheet

In the glory days of biotech finance, which began roughly with the initial public offering of Genentech in 1980 and extended through the genomics bubble of the early 1990’s, the public equity markets poured capital into any number of risky scientific ventures. But for other than a handful of winners, the cumulative return on investment over the life of the sector was negative even before the financial markets’ collapse in 2008. In today’s risk-averse market, even the most promising company cannot count on an initial public offering, so iPierian will have to find creative ways to fund its future.

“Business development deals will be crucial,” said Bob Higgins, a general partner with Highland Capital. “I’m not a huge biopharma investor; I like only really unique situations, and this one rang my bells, but if this is going to require hundreds of millions in private equity, it will be very hard. So we need to prove that this is not only very valuable to us, but also very valuable to others. If we can’t raise hundreds of millions in a combination of strategic money and an IPO, we can’t succeed.”

At its current burn rate of about $1.3 million per month, iPierian has adequate capital to operate through 2011 without partners. Matthew Plunkett, chief financial officer, estimates that the company will need $125 million from 2010 to 2014. He believes the partnership strategy should begin to provide non-dilutive capital as early as next year.

“The assumption is we can partner on three therapeutic programs and take the spending on those off our books,” Plunkett said. “The more that we have, five to eight true programs, each of which we can partner for $10-$20 million up front, the more we can make an attractive proposition for investors. But the other challenge is if we give away too much too early, there won’t be a lot of retained value here. And that will affect us as a public company, and as an acquisition target.”

Indeed, many biotech companies have discovered that promiscuous partnering can be the most dangerous dilution of all because it fritters away future profits. Also, the more complicated a web of relationships a small company weaves, the less likely it will be acquired due to potential conflicts between partners and the acquiring company.

Moving Forward

Walker and the team he assembled at iPierian believe the shift from random screens, surrogate animal models and serendipity to a patient-based, cell-specific approach will be the most compelling development in drug discovery since the introduction of recombinant DNA. And indeed it is nearly impossible to imagine a scenario where it would not be to medicine’s advantage to have relevant biological studies and population-based disease cells for drug screening and discovery.

“Considering the billions of dollars now spent on drug discovery efforts that lead to suboptimal results, a new paradigm that reduces those costs and increases the number of leads that turn into drugs will substantially improve the returns on biopharmaceutical investment,” Walker said. “Biotech companies have been built upon one or two successful molecules or upon production of essential tools for the work of others. iPierian has the chance to do both.”

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Lawrence M. Fisher has written for The New York Times, Strategy + Business and many other publications. He is based in San Francisco.