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Early Stage Investing In Health Care and Life Sciences
By: Michael Eckstut and Matt Weisman, Keiretsu Forum Healthcare/Life Sciences Committee Co-chairs
Keiretsu Forum News January 2004 with update
Introduction
Life Science early stage investing has continued to boom over the last few years and the prospects for new investments continue to be excellent. New technology breakthroughs (the completion of the human genome project, the identification new disease causality factors and better modeling capability pre-clinical trial) have combined to create new opportunities for start-up companies across a variety of Life Sciences Sectors Š pharmaceutical products, medical devices, software to enable Life Science companies to be more efficient and other services aimed at improving the Health Care system, in this country and others. The overall need for new products and services has if anything increased since we wrote the original article in 2004. Large pharmaceutical and biotech companies have seen their R&D productivity decline and yet their need for new products to fuel growth has increased, several major products have lost patent protection losing billions of dollars of revenue and major products have been shown to cause problems that were identified in the original clinical trials (MerckÕs Vioxx is the prime example but recently AmgenÕs Embrel had similar issues). The Health Care system in the developed world continues to come under policy maker scrutiny as world wide policy makers are struggling with high costs and availability. Health Care promises to be a main issue in this yearÕs Presidential campaign.
The Keiretsu has had an successful investment with Napo Pharmaceutical. Keiretsu members invested almost $800,000 in 2004 and in mid-2006; Napo became the first US IPO on the London Stock Exchange. More opportunities exist out there for our members.
There are significant differences between making traditional technology investments and investing in Healthcare and Life Sciences. Some of these differences are:
- Lengthy regulatory approval process (for both drugs and some devices) which requires a long-term orientation (anywhere from 5 to 7 years from the earliest developments) and significant investment to go through the process. Even when a new drug proves to be safe it may not prove to be any more effective than existing therapies and thus unable to penetrate the markets.
- Product companies typically do not generate significant product revenues during clinical trials process though some will realize contract research or consulting revenues.
- Significant physician and hospital adoption and other commercialization hurdles for new devices.
- Qualifying for private insurance and government reimbursement.
- Exit strategies (for product companies) other than a traditional IPO large life sciences companies often buy products/devices at various stages of clinical approval.
The purpose of this article is to describe the regulatory process only and the hurdles this process creates for early stage investors. We’ll also discuss the risk implications of the process for these investors. The other issues mentioned above are also vital for investing purposes but not addressed in this article.
FDA History
The industrial revolution in health care was marked by producer, seller, and buyer no longer knowing one another. It also resulted in a surge of adulterated foods and harmful or useless medicinal products. New drugs were with a few exceptions unregulated until the 20th Century and life expectancy in urban New York and Boston actually decreased during the first half of the 19th century largely due to unhealthful food and medicines.
- In 1890, the German pharmaceutical company Bayer developed a new substance and marketed it as a cough syrup. The substance was heroin!
- Liberal amounts of morphine were marketed as Winslow’s Soothing Syrup and Kopp’s Baby Friend. Babies with colic and sleepless nights were calmed but also addicted.
- In 1901, Teddy Roosevelt was elected president, Progressivism was at its peak, and
- Writers such as Upton Sinclair wrote about the unsanitary conditions in the meat packing plants.
In 1902 contaminated diphtheria antitoxin killed 12 children in St. Louis. That same year, the U.S. Congress passed the Biologics Act of 1902 which required biological drugs be licensed and produced in licensed facilities. The Division of Chemistry of the Department of Agriculture was the regulator. The next law passed was the Pure Food and Drugs Act of 1906. The law required that drugs not be mislabeled or adulterated and meet recognized standards of strength and purity. In 1906 this law was weakened by a U.S. Supreme Court case dealing with Johnson’s Mild Combination Treatment for Cancer. The charge was for making false therapeutic claims. The court found that the law only prohibited false claims regarding the identity or composition of drugs on the label not false therapeutic claims.
The Sherley Amendment of 1912 added false therapeutic claims but left the burden of proof with the government. Through the 1920’s and 30’s almost any non-narcotic drug could be purchased without a prescription.
In 1937, the Massengill Company prepared and sold a throat medicine combining sulfanilamide, a new anti-infective agent, with diethylene glycol, a common automotive antifreeze ingredient. The product had a raspberry flavor and a pleasant pink color. It was also highly toxic. No clinical tests were conducted. 107 people, mostly children, died from taking the drug.
Congress responded with the Food, Drug, and Cosmetic Act of 1938. For the first time, the safety of drugs when used in accordance with the instruction on the label had to be proven through testing before marketing. The FDA’s enforcement authority included pre-distribution safety clearance, factory inspection, and court injunction. The FDA defines a drug as “…articles intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease in man…” and”…articles (other than food) intended to affect the structure or any function of the body of man…”
Though a manufacturer had to submit a new drug application (NDA), the NDA became effective after 60 days if the FDA posed no objections. During the next decade the FDA provided new regulations and guidelines.
Not until 1951 and the Durham-Humphrey amendment was there a regulatory distinction between over the counter drugs (OTC) and drugs requiring prescriptions (ethical pharmaceuticals). During this decade the costs of regulatory compliance were relatively minor, and the average regulatory review time was seven months.
Again tragedy played a key role in new regulation. The disaster was the prescription of thalidomide for pregnant women and the following births of malformed children in Europe brought on the Kefauver-Harris Amendments of 1962. The U.S. was spared the consequences of the thalidomide babies by the tenacity of a FDA medical office, Dr. Frances Kelsey. The new statute required drug manufacturers to demonstrate proof of effectiveness as well as proof of safety. It also required conformity to Current Good Manufacturing Practices to assure the quality of products. New investigational drug procedures were established including informed consent by human research subjects and review of advertising. In 1966, the FDA contracted with the National Academy of Sciences and the National Research Council to evaluate the effectiveness of approximately 4,000 drugs that had been first marketed between 1938 and 1962.
The Medical Device Amendments of 1976 extended FDA authority to medical devices. Advances in science and technology have brought forward a wide array of new medical devices.
The FDA definition of a medical device is any health care product that does not achieve its primary intended purposes by chemical action or by being metabolized.
It can be "an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article that is intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease, in man or other animals.”
Congress passed the Orphan Drug Act of 1983 to entice manufacturers to bring drugs to the market that benefited only a small population of less than 200,000 persons in the U.S. or if greater than 200,000 persons that there is no reasonable expectation that the costs of development would be recovered.
The economic incentives are a 7-year marketing exclusivity that begins when the FDA approves the drug, the product need not be patentable.
The Drug Price Competition and Patent Term Restoration Act of 1984 abbreviated the new drug approval process for identical versions of off-patent drugs. The offset was an extension of patent based upon a formula related to time during development and FDA approval.
The Prescription Drug Marketing Act of 1988, among other things, restricts the reimportation of prescription human drugs produced in the U.S.
How exacting is the drug approval process? It is a dynamic process and may vastly differ in requirements between two new drugs. Each of the FDA drug review divisions has their own internal policies and philosophies. Even the most basic outlines of the FDA’s approval process can be excepted and modified.
Regulatory Process Pharmaceuticals
The Drug Approval Process Is Lengthy and Expensive…
The drug approval process is about two main criteria: safety and efficacy in humans. The Food and Drug Administration (FDA) regulates the process
Before the FDA allows a new substance to be administered to humans, the FDA requires evidence that the substance is reasonably safe for humans. This can be done by: (1) compiling data from existing non-clinical data derived from past animal studies and extrapolating the results to the proposed human use; (2) compiling data from previous clinical testing of the substance in the U.S. or another country whose population is relevant to the use of the substance; and, (3) conducting a short-term toxicity study (from 2 weeks to 3 months) of the substance.
FDA regulations state in general terms the pre-marketing approval criteria for new drugs. For a new drug to be marketed in the United States, the new drug developer must obtain an approved new drug application (NDA). The NDA must contain data and information of the new drug’s safety (Non Clinical and Phase I, II, and III, clinical trials) and “substantial evidence” of the new drug’s effectiveness (Phases II and III) and for specified uses (the “Label”). There is no statutory requirement specifying the structure and design of clinical trials. Yet, new drugs frequently fail to obtain approval due to a flawed clinical trial design. The dominating process is a three-phase trial which can take anywhere from 2 years to 8 years, depending on the drug and the disease being addressed. The clinical trial phases and their associated times and estimated costs are listed below.
Phase I
- Determining safety and safe doses of the drug in human volunteers (about 20)
- Monitoring for side effects that may not appear in animals
- Measuring for drug distribution and residue in body
Phase II
- Determining optimum dosing of the drug
- Establish length of treatment
- On-going safety demonstration
- Human trials (100 to 200), tightly controlled
- Determine target group
Phase III
- Large scale trials (several thousand) for effectiveness and efficacy
- Looking for side-effects not previously observed
- Effectiveness analysis
- Result reproducibility
- Continuing safety monitoring and demonstration
Regulatory Process Devices
The Medical Device Approval Process Can Be Shorter and Less Complex . . .
The medical device regulatory process has some similarities with the pharmaceutical process but the FDA recognizes that medical devices are different in that they often do not cause any biological or physical changes in the body and thus can be treated differently in the regulatory process. However, the overriding driver is still safety so that different categories of devices can be treated differently based on potential harm to the body.
Thus, the FDA has established three categories of devices and the first two, Class I and II can often be brought to the market relatively quickly by obtaining a 510(K) Pre-Marketing Notification (PMN). Devices that fall into these classes can often be marketed in 3 months or less. Devices that require a PMA (Pre-Market Approval) will typically require some kind of clinical trials, similar to a Phase 2 clinical trial for pharmaceuticals, with a similar time line and expense commitment.
Summary
In summary, early stage investors need to be aware of the regulatory process, the timing of obtaining marketable products, the funding requirements for the various tests and trials and most importantly, the implications for generating commercial product revenues including adoption of use by physicians and patients and approval by third party healthcare payors. However, these considerations should not come at the expense of some of the tried and true criteria for technology-based businesses Health Care and Life Science opportunities have the same requirements for management competence as in other businesses and investors should make sure that management’s needed science and clinical skills do not come at the expense of excellent business and management skills especially since scientific founders tend to underestimate the business skills needed to successfully bring products to commercial fruition.
As an early stage investment group with an interest in Healthcare and Life Sciences we have developed a set of criteria for investing in this field recognizing the time line and investment requirements for both pharmaceutical products and medical devices.
- Shy away from pharmaceutical products and medical device products that require extensive clinical trials beware of on-going research activities that will not turn into commercial businesses!
- Focus on health care services/IT, life science equipment/diagnostic equipment (that do not require significant clinical trials).
- Look for opportunities where clinical trials are not required or are completed (don’t use our funds for clinical trials).
- Finally, we recognize that suppliers to the health care industry can be very successful businesses in their own right without the capital needs and market risks associated with pharmaceuticals or medical devices.
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