Biomedicine is currently at an inflection point. Such as using gene therapy to treat blindness and AADC deficiency in infants, biomedical innovations are rapidly advancing and need the proper funding for future progress and scale. Also known as the “omics” revolution, many health and biology related fields have experienced tremendous progress but the current bottleneck is “economics”; we need better funding models.
Drug discovery faces a “valley of death” before becoming de-risked as the trials progress. The reason for this dearth of funds at the beginning of drug development is due to increasing risk and uncertainty. Increased knowledge leads to more startups in the field, which leads to risk that investors are adverse to.
There is a risk reward phenomenon. In general, the most popular investing choice is the one that has the best tradeoff between risk and reward, with high yield and low volatility, or a high Sharpe ratio.
Biomedicine has been having a decreasing sharpe ratio over the past decade, where volatility has increased due to increased complexity of innovations. The success rate for biomedical innovations such as cancer compounds is 5% — thus, such high risks lead to much lower Sharpe ratios.
Using financial engineering, a financial solution would be to invest in many programs simultaneously. Diversification changes the economics of business because the high expected returns remain while the risk drastically decreases, greatly increasing the Sharpe ratio. Thus, with this decreased risk, raising the capital needed for this diversification could be possible with debt-financing. With interest rates at all-time lows, there are tremendous resources to be tapped into if we can do it in a controlled and responsible way.
Correlation between successes of the compounds decreases the probability of positive payoff. Thus, the key for a successful investment is diversification, lowering the cost of capital. Research into rare diseases satisfies the necessary diversification. Pharmaceutical companies have low risk premiums. In contrast, biotech companies face scientific and financial risks, the latter of which usually dominates the former in terms of cost of capital.
The business model of venture capital is the wrong model for biomedical innovation. Traditionally, biotech companies have been financed by venture capital but these companies require much higher capital, longer timelines, and higher risk than VCs are typically used to. Thus, securitization and permanent capital may be an attractive alternative.
Cost of capital for biotech innovation depends on a variety of factors, including cost per shot, probability of success, duration of trials, correlation of shots, and profits per success. Thus, finance and biomedical experts must collaborate to properly find the necessary capital.