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An Interview with: Matt Megaro
Share some trends in life science exits you have witnessed
during the course of your career.
My career in bio-med goes back about 24 years or so, so there have been several ice ages equivalence in that time frame in terms of shifts in the dynamics of the biotech market. But going back to the very beginning, and not to dwell on this particularly to point out that at that time biotech was brand new, there was not a sophisticated investor group out there. I don’t think people generally understood what they were buying. The analyst that worked for the major cell side retailers like Payne Webber and Cure Peabody at the time were all PhDs who appeared to be gods in their understanding of the business only because they knew at least a little bit more than everyone else.
As a result, these folks would recommend a stock, a stock would become popular, a company could go public and it was quite an active almost frenetic pace of points of stock offerings and these were very complex subjects that these guys distilled down to, “here’s why I like it” and “here’s why you should own it.” Because it was volatile, it was exciting to people and it looked representative.
A guy names Stelios Papadopoulos who is now the head of investment banking there for biotech with Cowen and Company put it best. Stelios’ comment when he took Athena public, back in 1990-1991, was “There ain’t nothing like a bull market.” And that’s the point. When the market was strong, bullish and positive, 20 years ago you could float anything. So every 4 or 5 years you would have these episodic openings of the window and everybody would rush out and go public.
Many of those companies shouldn’t have been public, yet they were able to do it and raise a lot of capital. Some of them put it to good use and survived. Some of them squandered it and didn’t do well. But the point is that there was a receptive market, which is probably more important than just about any condition for a company to be able to find exit strategies. Even IPO’s and acquisitions, but particularly IPO’s.
I think the best example of Stelios’ wisdom and the triteness of his comment, not withstanding, can be found in the 1990s when Saddam Hussein invaded Kuwait. All the markets shut down. My team and I got into a limousine at John F. Kennedy airport to begin our road show six months after the Iraqi Invasion of Kuwait. The limousine driver picked up our bags and he looked at us and said “Hey! Are you guys on a road show?” When we told him that we were, he responded, “Aw, man I haven’t seen a roadshow in ages.”
And that told us it was going to be a long, hard fight. It was very difficult to raise the money; we raised a fraction of what we were looking for in 1990. A year later, and our story hadn’t really changed, but a year after that, the war had been won, everything was happy and robust, and we were the second hottest IPO on Wall Street for biotech. So, what happened? Favorable conditions and bull market.
I think that the exits will always go through these periods where they are more or less receptive in their marketplace and to their market, but I don’t think we are going to see the same wild swings that we saw once just because I think we’re smarter investors, smarter businesspeople, bankers, etc. Now the trends, in terms of these deals, there is another way to look at this: IPOs.
The obvious shift now is to mergers and acquisitions. The reason for that is two fold: one, the IPOs are a lot less accessible and a lot less available, because, frankly, most of the companies shouldn’t be going public. I think the market has wisened up to that. The second reason is big Pharma and big medical device companies have now accepted reality, which is they don’t innovate very well overall relative to their experience, their money and their opportunity. They should do a lot more than they do. There are a lot of complex reasons and very simple reasons for why they don’t, but they have really gotten wise to the fact and have gotten very sophisticated with their strategic acquisitions.
If you look at the numbers, the return rates for small company investors (the private stage companies, venture capitalists, private investors, angels, if you will), are much higher for companies that succeed in M&A, maybe 5 or 6-fold of investor capital as opposed to going public, which is maybe less than two. So, if you invest a dollar and get back two or less in the IPO venue, as opposed to getting back five or six in the M&A venue, then clearly everyone is going to notice a phase shift here.
I don’t see that going away. In fact, I just see what most little companies who face very large development budgets and capital requirements are going to have to orient their business so that it becomes favorable to a strategic acquisition or merger opportunity. M&As are, I think, the wave of the future and will continue to be.
Can you explain why partnerships between large
pharmaceutical companies and biotechnology companies are such a big trend? How
long do you think this particular trend will last?
Well, let’s define what a partnership is. You know, when I was doing this 20 plus years ago, the deal of the day was “collaborations.” We’d often call them partnerships, but they really weren’t. A collaboration was, “ok, well you give us money, you give us an up-front payment (and they weren’t as big as some of the numbers have gotten of late, they were small, but could be sizable), and we’ll make an equity investment in your company, and we’ll pay for $2-3 million of the research each year, and if this product succeeds, we’ll pay for the development (this is the big company speaking),and you guys can get a royalty.”
The royalties would vary from anywhere from 2-7 or even 8 percent. On a very rare occasion, you saw 10 percent royalty. So in those days a company would say “okay, well lets go out and do two, three or maybe four deals, and if we could do four deals, even though the royalties aren’t big, we have got a diversity of revenue stream that leaves some potential, which is going to make us look good. That’s what we used to call “window dressing” in order to go public.
Now if you accepted that the trend is away from IPOs, companies are no longer “window dressing” with these pretty lousy deals. I hate to see little companies today say, “hey we have done this great deal,” and they don’t want to talk about the essence of real value. They may have received $5, $10, or $50 million up front, but they are going to spend that. It’s gone. The only sustainable value, the only thing that grows franchise value over time is a share of the action. And that’s the size of your royalty. And in the case of a partnership it’s the share of the profits. Now the deal that we did at Trimeris, which is a deal I designed and my team negotiated and implemented, was very much driven by my desire to see 50/50 profit sharing. With them, with Roche taking the entire product development burden on, finishing the clinical trials, and taking the product marketed. If they could do that and drive the product to a high profit, then Trimeris would receive 50 percent of the profits. That makes your little company very valuable over time. If all they had offered was a 6 or 7 percent royalty, it would not have excited anybody in the public markets. Wall Street is going to say, “That’s not a lot of growth prospect.” And Wall Street only wants to know about growing revenues and growing earnings in the future.
So I think the partnership trend is here to stay. I think it’s the only way that small companies in a waning sort of IPO market can hold out the promise for an IPO to placate the growth desires out of Wall Street. The partnership also creates a higher propensity for acquisition. The people that gave you this good deal, they see this product is working, and then it’s just a spreadsheet exercise for them to say, “Look, we can pay you 30 percent and its an item, or we can figure out what that 30 percent is worth today and pay you that.” But they are more likely going to value at a higher amount the higher that share is. So partnerships do two things: they catalyze prospective M&A prospects for you, and they also enhance your value perceptively with Wall Street. So I guess Main Street and Wall Street together.
From your perspective, what makes a company attractive when
looking to exit?
I’ll tell you, whenever we got “no’s” from somebody, “not now’s” (which is the same to a “no” to an entrepreneur who takes these to heart) we developed a thick skin. I always used to describe the process as kissing a lot of frogs and try to hope you find Prince Charming. It also teaches you not to be naïve. You have to go out there and look at it very realistically. Listen to their “no’s”. Listen to their reasons, and try to learn from that, saying, “Maybe we need to do another test; maybe we need to take a different approach.”
The other thing that makes you more attractive at times is to look rare. When we did the deal with Trimeris and when we did the deal with Quill, we were always the same story, we always looked good, their scientists would always say “I love this”, and the businesspeople would always say, “It’s too soon, we’re not sure, and we are still working on it.” It was always the same menu selection. It doesn’t matter if its biotech or biomed, or whatever you like, it’s always this point you need to reach, which is the tipping point of interest and credibility.
These people are always going to say, “give me more, give me more,” until something changes. And what I have found changes, and makes this most attractive, isn’t just the obvious of developing things in their market that makes sense. It is something that has strategic value and something helps them protect their current franchise, or helps them take away franchise from their main competitor. And all that’s true, but what really seems to get these guys off the dime to make a move is the sense that they are going to lose you.
It’s like competition. When you are doing deals you have to try to talk to as many prospects as you can and keep those talks open, even of they see we do not want to do it now. Try to stay in active touch with everyone. Try to cultivate their continuing interest, because I find when you get somebody who is a live player, suddenly you smell like you are for real, and when you go back and talk to the other parties you have been put on hold with, suddenly the fear gene kicks in and they have got to get involved.
I had a party I talked to for almost four years. They had company issues; they were a big medical device company. They sat on the fence with this the deal for years. It wasn’t until Angiotech stimulated definitive risk possibilities in their mind that they suddenly got very anxious and very credible and really started coming at it. The numbers were phenomenal, and the level of engagement in this company went up to their number one person. Suddenly they look at you differently; they see the whole risk profile differently.
Is there an ideal timeframe, financial position or other
milestone which signifies the best time for a company to exit?
A lot of times you can sell your company or be acquired if you are looking for that exit strategy, yet you don’t like the values they are proposing, and that’s when it is never right. So a lot of my investors would have rather I didn’t sell my company, but we explained to them that there was probably a greater return prospect of doing it this way than taking continued risk in trying to remain independent.
It’s a jungle out there and I don’t want to lose it all when I had a pretty good risk-adjusted solution for everybody. So it’s always a question of when is the right time. What is the right value at a given time? It’s interesting how value can change dramatically if people perceive you as a fleeting opportunity. So what should they do, and what’s the right time for an exit for a company? I guess I look at it and say, the time is when you and your investors have taken a very sober look at the risk-return ratio. That is, if we don’t take this deal now, can we raise the additional capital, and at what cost to dilution will that be to push the value of this company to an even greater proportion of return?
The right timing has always got to be looked at in the context of the alternatives to grow value. For example, at Quill Medical we had an opportunity for every ball the investors would get four-fold of their capital back and another 16-17 fold on what I call the “come line,” which is the gambling game craps. It’s the term of craps that means what might come in the future.
At Quill, we were already profitable. Our first product was selling, but the big products, the ones that were just launched this year by Angiotech, those are the main value drivers. They were approved, but not yet marketed. Did we have to wait for them to be marketed? Probably not, because we structured a deal that basically said, “Look, we are going to take time out of the equation here and let you pay us, so if these big products succeed we are going to get big payment, a big manifold return.” All we had to do was make sure we did our level best to get the product there, which we did through a contract. So the timing was right then, otherwise all the investors said to wait two or three years to get this product launched and start making even more money. And then somebody would pay a lot of money for us, if we don’t get eaten alive, that is.
But it’s tough to take that shot. So it’s really a case of, at any point in time, what’s my best relationship between those two factors and do I feel this is the best that I am going to get? Or, do I want to continue gambling. By the way, this is gambling. I don’t care what anyone calls it, it’s gambling.
How does a company ensure the best “bang for the buck”
post-exit?
There are a couple of ways you do that. The second way, and I mention it in this order for a reason, is to put a very thoughtful and detailed diligence terms into your contract. If they have to perform in the future to deliver you future payments, then you have got to have a couple of things: an assurance that they are going to ply themselves, a remedy if they don’t that is self-evident and straightforward.
What we did at Quill was we set up a holding company, and we gave it a lot of money because we had a lot of cash leftover. Thus, we had the capital to assert our rights and defend the contract. If they have been anything less than diligent, we have the ability to solve it legally, however necessary. So, you create a good contract, you make it pretty definitive, and you give yourselves the means to enforce it. You leave the capital available to enforce that contract, monitor it, audit it, do all those good things. These are all the essentials to getting a structured deal to work.
But the most important thing you do, more than all the contracts you want to write and all the money you want to put behind them to enforce them, is to set your deal up with a party who clearly needs and wants it. We had offers from significantly larger companies, but our feeling was that there was a tremendous risk, and I had a very experienced board and crews, but we had a feeling that if we went with one of the big companies, they would just stick us on a shelf. These are guys who reorganize themselves every 18 months, and when they do, the project “de jour” is no longer in favor, and gets shelved. It has no champion, and you are going to sit there and wallow away and watch this thing go nowhere, because it just doesn’t quite fit with the currently changed flavor of strategic plan.
So, pick the right partner. I am so pleased with Angiotech, because they have made this a driving priority in their organization and they have already hired 50 sales reps, they have hired some excellent people from industry. Some of the people they hired to run this thing from the senior level are coming out of very big companies. These are people saying, “Hey, I really want to do this product, and I can’t believe my guys didn’t pick this up, they should have bought this thing. I want to be part of it.” Those are the kinds of people and the attitudes you want, focused on really making it succeed.
So, it doesn’t have to be a very big, dominant player, but it has to be a smart
one who is nimble and has the means, money and sophistication to pull it off.
So I think how you prepare for the most “bang for your buck” post-exit is what
you do pre-exit. Upon exit, it’s getting the right deal set up, your ability to
monitor and enforce it, and get yourself involved with a partner who has a lot
of organic reasons why they need this to succeed.
What are some key characteristics of successful serial entrepreneurs?
You should examine yourself in all respects, but it’s almost like you have to look at it after the fact, then look backwards and say, “What, in the people that I have known that have done well, seems to be the distinguishing or defining characteristics?”
It takes a lot of creativity in the earliest stage, because you have got to be innovative to set a deal up and figure out ways to strategically control your bet. You have to cover your bets in this game. But you don’t have the money to cover them all, so you have to pick the right ones and protect them fiercely.
The other thing I find, and probably as much as creativity, is intelligence matters. A lot of people don’t act smart who win the games all the time. Some “really bright people sit there and get themselves caught up in minutia. They go down mouse holes they can’t get out of. It’s almost like they are drilling too deeply, and they don’t have developed instincts for when to just move. So I will just say that apparent intelligence doesn’t mean much to me, it’s what people do that we should judge them by in this business, their actions and not so much their words.
More so than anything, they are incredibly tenacious. I can’t tell you how much that has mattered. I criticize myself and compliment myself for that defiant stubbornness. The last thing I ever want as an entrepreneur or a CEO is to fail in achieving the goal, but to have the lingering question of, “if only I stayed at it longer, if only I tried it at a different angle, if only I persisted on a different strategy or tactic,” and the worst thing is to look at it and say, “God, it would have worked.” That’s something I can’t bear. It would tear me apart. So as entrepreneurs and CEOs say, you have to work hard.
I will tell you a little secret, and I believe this: I don’t believe that success in entrepreneurship is working yourself to death. It’s not about working 80-100 hours a week. I know this goes against all the religions and the mantras and all the chants that you hear in entrepreneurship training. But I believe it’s about really focused effort in the right plays, and that is why you have to brute over this stuff on occasion. You think about it a lot, if not constantly. Literally put yourself in a contrary position constantly.
Editor’s note: Matt Megaro has extensive experience in
starting and developing biotechnology and medical devices ventures. Most
recently, he was President and CEO of Quill Medical, Inc., a medical device
company that he co-founded in 2000 in
