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January 25, 2020

How to Invest in Biotech Series – Phases, Stages, and Pitfalls

Emily Whitehead was 5 years old when she was diagnosed with acute lymphoblastic leukemia…

Her cancer was resistant to traditional treatments and her prognosis was poor. In a final effort to save their daughter, her parents enrolled her in a clinical trial study at Children’s Hospital of Philadelphia for a new type of therapy called CAR-T.

Emily Whitehead was 5 years old when she was diagnosed with acute lymphoblastic leukemia, a serious yet the most common type of childhood cancer. Her cancer was resistant to traditional treatments and her prognosis was poor. In a final effort to save their daughter, her parents enrolled her in a clinical trial study at Children’s Hospital of Philadelphia for a new type of therapy called CAR-T. The therapy utilizes Emily’s own immune cells, reprogramming them to target her cancer. Miraculously, the treatment worked, and Emily has since made a full recovery.

Thousands of life-saving stories like Emily’s taking place everyday because of the astounding scientific breakthroughs in biotechnology in recent years. Cell therapy, like CAR-T, has revolutionized cancer treatment. Gene therapies, altering DNA, are curing previously untreatable diseases. New viruses engineered to target microbes are fighting resistant bacteria. What is the best way for family offices and foundations to invest in this rapidly evolving landscape of biotechnology, capturing opportunity for outsized economic returns and making significant positive social impact? Over the course of a series of short articles, I will attempt to shed some light on many of the key factors that need to be considered. One important consideration is the stage of drug development in which you are investing. At a very high level, there are four major phases of drug development: 1) Discovery 2) Preclinical 3) Clinical 4) Commercial.

Discovery is the first stage of drug development. During this stage of research, academics attempt to identify interesting molecular pathways that could influence the course of a disease and possibly design or discover some potential drug candidates. For example, one gene receiving a lot of attention right now is called KRAS. It provides instructions for cells to make a protein called K-Ras. This protein is a part of a complex cascade of signaling molecules that influence functions like cell proliferation or specialization. When the KRAS gene becomes mutated, it has the potential to cause many forms of cancer. Many researchers have spent considerable effort trying to understand the different molecular elements that play a role in this pathway. In the discovery phase, researchers work to identify areas along such a pathway where new molecules can bind and alter the pathway in a way that would have a potentially positive impact on the disease.

However, most of the discovery stage is before a drug candidate has even been discovered. It typically takes place in labs of universities and non-profit research institutions and is funded through grants, for example, from the National Institutes of Health. Sometimes for-profit organizations, such as pharmaceutical companies, will contribute small amounts of money to such research projects, but usually it is just a mechanism to help build a relationship with an important academic. Since there are so many directions such research can go and there is a lot of trial and error involved, this stage of development can be extremely expensive. Additionally, since there is often no data to rely upon beyond some rough scientific hypotheses when making investments, the failure rates will be very high. I would advise for-profit investors to steer clear of this stage of development and leave it to academic institutions, non-profits and government sources.

The next stage of development is preclinical. This stage involves a series of tests known as IND enabling studies, since the final milestone is the filing of an investigational new drug application (IND) with the Food and Drug Administration (FDA). During this stage, the R&D team generates enough data to show that there is an interesting pathway important in the treatment of a particular disease. They also evaluate at least a few potential drug candidates. During a process called lead optimization, this pool of potential candidates is narrowed down to a single lead drug. This lead drug is then put through a wide range of tests to determine toxicity, the drug’s impact on the body (pharmacodynamics), and manufacturability. Since much of the de-risking occurred during the discovery stage, the success rates in preclinical can be very high (often north of 70%). Typical costs per molecule range from $5-10 mm, though multi-drug platforms can be more expensive. Although this stage of investment historically was very difficult, recent technological innovation and market changes have improved the outlook for investors. In terms of technology, the ability to screen thousands of molecules quickly using high-throughput screening methods, have lowered the costs considerably of identifying potential lead molecules. Optimization of molecules has improved through innovative software tools like Schrodinger. The emergence of large, preclinical contract research organizations (CROs) have allowed small biotech companies to conduct the requisite studies at a much lower cost. Successful exit events for investors at high multiples have led to an influx of money into preclinical biotech companies, both through the growth of large VC funds and from the receptive public markets in IPOs. Investors looking for a high return on capital should strongly consider allocating a portion of their biotech dollars to venture funds focused on the preclinical stage.

The next stage of development is clinical. This is the period most often associated with traditional biotech investment. It has three phases: I, II, and III, and concludes with the filing of a new drug application (NDA) with the FDA. The clinical phase is defined by hospital-driven human trials, as opposed to testing in animals or in vitro, in the lab outside of a living organism. Phase I is typically focused primarily on the safety of the drug, but also early signs of the drug’s efficacy in a small study conducted in patients of the disease or healthy subjects. For instance, the safety study would include testing different doses of a drug to figure out how high a dose can be administered without harmful side effects. Phase II is generally an efficacy study to see if the drug does what it is expected to do in treating patients. Phase III is a much larger study to validate the earlier clinical studies. Efficacy is measured through biological metrics that are called endpoints, which are determined by the company in consultation with the FDA. These endpoints need to reach statistical significance in the clinical studies in order to be eligible for FDA approval. Additionally, these trials typically need to be run as at least two parallel arms, one in which the drug is administered and one in which it is withheld, called “placebo control.” Pivot trials that are key to FDA’s approval also need to randomize the patients and “double-blind” the patients and investigators to prevent bias.

Thus, it is not surprising that with all these requirements, clinical trials are very expensive. They are usually administered in hospitals under strict regulatory oversight. Sometimes, it can be challenging to find the right patients with the exact stage or type of disease in question. Finally, the duration of these studies is often much longer than preclinical studies since the effects of the drugs need to be measured over an extended period of time (versus a matter of days when running many mouse studies). Moreover, the uncertainty and binary nature of many clinical trials means there is a non-negligible risk that the drug candidate will fail in one of the phases. There is also a real possibility that if the initial trial data is not satisfactory to the FDA, more trials might be required to gain approval. Even if trials are successful, they are very expensive and are only worthwhile if the drug that is to be approved has sufficient revenue potential to warrant the time and money devoted to development. Investors can participate in this market by buying the equity of public biotech companies directly. There are also many venture funds and hedge funds that specialize in this stage of biotech investment. By diversifying across a number of different biotech companies, they can hope to mitigate some of the binary risks of approval. They can also attempt to analyze the clinical data and talk to leading physicians in the space (called “key opinion leaders” or “KOLs”) in order to have a good perspective on whether a trial will be successful or not.

Finally, after some back-and-forth with the FDA following the filing of an NDA, a drug is either approved or rejected. If it is rejected, the program often will be stopped altogether, unless the FDA has indicated willing to approve based on new studies or for a subset of the patient population. If a drug is approved, the process of drug commercialization now begins. Commercializing a drug entails hiring a sales force to market the product to doctors, developing direct-to-consumer campaigns to target patients, and negotiating with payors so that patients can get access to the drugs through their insurance plans. This is a space in which many traditional private equity firms invest. There are also a number of large public companies competing in this segment. Companies are typically valued on generated cash flows from the drugs. Patient uptake, drug pricing, and the evolving competitive landscape need to be carefully considered. There are a number of important stages in drug development, each with their own risks and rewards. The smart investor is likely to diversify through exposure to funds and companies in a number of different stages of development. Stay tuned for the next time when we go into more detail on the different flavors of biotech investing, from venture capital to royalty investing.

About Orange Grove Bio

Marc Appel is the CEO of Orange Grove Bio, an early stage, preclinical capital allocation and asset development biotech firm focused on developing life-saving therapies in oncology, gene therapy, and a number of other indications. Orange Grove Bio accelerates preclinical therapeutic development in partnership with top tier research universities under-served by existing early stage biotech funding with the goal of closing the funding gap between basic research and clinical trials. In additional to investing capabilities, the firm has built an operating company made up of experienced biotech professionals to oversee the development of in-licensed assets internally. For more information email Marc Appel at

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