Biotechnology companies in need of cash have struggled to find financing in recent years—pushing many toward PIPE (Private Investment in Public Equity) deals and follow-on offerings. Yet only one of these options may be viable in the long-term.
When the market for special purpose acquisition company IPOs crashed in late 2021 after leading IPO market volume to unprecedented heights, biotech IPOs fell hard, too. Annual deal count plummeted nearly 89% from 2021 to 2023.
The biotech IPO market has improved modestly since but remains well below other recent market busy periods. The slump has been deeper than other slow periods, such as 2016.
Many public biotech companies have turned to follow-on offerings to keep both the lights on and their scientists researching. Other companies have turned to private investments in public equity for relatively quick infusions of capital.
Biotech’s Constant Cash Struggle
Investing in biotech tends to be a riskier proposition than putting one’s money into other startups, such as technology. The tech business is known for often having started in a founder’s garage (think Amazon, Apple, and Hewlett Packard).
Biotech is different. Its business model is centered on hiring scientists to conduct cost-intensive research on biological systems. Historically speaking, that type of research faces long odds to meet clinical study benchmarks, to clear the FDA process, and later to yield a product accepted by the medical community that health insurers are willing to pay for.
Even if ultimately successful, a biotech startup can take many years to really pay off for its investors. Companies like Amgen, one of the most successful biotechnology companies today, are proven commodities well known to investors and, as such, enjoy a much easier time obtaining financing when sought than small startups.
Biotechs Turn to Follow-on Offerings
The continual need for additional capital on favorable terms has made going public, then conducting follow-on offerings when needed, a well-worn financing path for biotech. That is, except when the IPO market turns a cold shoulder to biotech startups, as it is prone to do from time to time. This can happen when, for example, investors turn more risk averse, or their investment time horizon shortens. It’s a reflection of the normal ebb and flow of the market.
Companies that have IPO’d have the opportunity to do a follow-on offering when they need more capital. Follow-on offerings are simply a public offering of a company’s shares subsequent to the company’s IPO (or direct listing).
Unlike a PIPE transaction (discussed below), a follow-on offering must be registered with the SEC with an additional prospectus prepared under the Securities Act of 1933. Companies that have IPO’d in strong markets often seek to do follow-on offerings to raise more money while interest from biotech investors is high. These offerings can also assist company insiders who want to sell their (restricted) shares. Companies that have been through the IPO process where the business and its prospects are scrutinized by SEC staff and industry professionals offer a less risky investment opportunity than pre-IPO companies.
Given the incentives to do follow-on offerings and the downturn in the IPO market in recent years, the volume of biotech follow-on offerings and IPOs have diverged significantly since the start of 2022.
IPOs have zig-zagged since Q1 2022, generally trending lower. Follow-on offerings shot up in 2022 and again in early 2024, though those offerings fell in the most recent quarter.
Furthermore, biotech IPOs raised $775 million in Q1 2022 compared to $2.28 billion for follow-on offerings, a ratio of nearly 3-to-1 ratio in favor of follow-on offerings.
Last year in the first quarter, IPOs raised only about $430 million, while follow-ons increased their capital raise to $4.4 billion, increasing the ratio to 10.3-to-1.
IPOs modestly increased to $1.3 billion in the first quarter of this year, but follow-ons zoomed to $10.3 billion, maintaining a roughly 10-1 ratio. Both offerings dipped in Q2 but the ratio between them widened to over 15-to-1. In the latest quarter, IPOs reversed direction while follow-ons continued to slow, perhaps signaling a more historically normal ratio between them.
PIPEs Keep Capital Flowing During Funding Drought
The difficulty encountered by biotechs in finding financing through the public markets has pushed some to try their luck with PIPEs. Traditionally, PIPE financing, a form of private placement, was relegated to companies experiencing difficulty raising money and for whom other methods, such as debt or an initial public offering, were difficult or closed.
Since initial public offerings have been depressed in recent years, biotech companies have most frequently turned to follow-on offerings and debt to raise capital—but raising capital has still remained challenging for many of these cash-burning entities.
Enter PIPEs. RBC Capital Markets, a New York-based subsidiary of Royal Bank of Canada, said in April that in the first quarter of this year, a dozen PIPE deals worth “at least” $50 million took place in biotech, more than the total capital raised in biotech PIPEs transactions in the prior two years. (Since PIPEs deals are private, information about them is typically not made public.)
PIPE financing is a private sale of a company’s unregistered shares, meaning that it’s a private transaction and doesn’t occur on a public exchange, even though the company’s shares are publicly traded. PIPEs became a much-used financing tool by SPACs that needed additional financing during the period before its de-SPAC (merger with a target company).
PIPEs are somewhat controversial and have previously been less favored by the industry—but hard times have forced many biotech startups to look for cash in alternative places. PIPE investors require companies wanting their money to share information that isn’t available to the public—or even to the company’s current shareholders.
Companies also often must give up more than simple equity for that cash, as PIPE investors will typically expect warrants (the right to buy more shares at a specified price within a particular time frame) on top of the shares they’re receiving. A warrant (or “convertible debt to equity,” if applicable) dilutes the PIPE issuer’s share price, harming existing shareholders.
However, there are benefits to PIPE financing, not the least of which being that PIPE financing may be available to biotech companies—particularly smaller, less-proven biotech companies—when other avenues for capital are not. With PIPE financing, “a fixed number of securities are sold at a fixed price, not subject to market price or fluctuating ratios, to accredited institutional investors,” according to a paper in Biotechnology Investors Forum - America by attorneys Anna T. Pinedo and James R. Tanenbaum, as cited by the SEC in its discussion materials for the 2006 SEC Government–Business Forum on Small Business Capital Formation.
The authors go on to explain that the financing differs from a conventional private placement in that the transaction won’t close, including money and shares changing hands, until the SEC “advises the issuer that it is prepared to declare effective a resale registration statement covering possible future sales of such shares by the investors.”
Taysha Gene Therapies Litigation Clouds PIPEs Deals
The outcome of a lawsuit filed in April by shareholders on behalf of biotech company Taysha Gene Therapies has the potential to disrupt the way PIPEs are done. The suit alleges that the company and its shareholders were harmed by alleged breaches of fiduciary duty and insider trading involving company insiders and select investors.
Those individuals used their access to material nonpublic information (MNPI) about positive data from a Taysha clinical trial to profit personally, with the PIPE purchasers realizing gains of $205 million, the plaintiffs allege. Had the information been disclosed just one day later, these gains would have instead been realized by the company’s existing shareholders rather than those insiders and investors, the plaintiffs claim.
The sharing of MNPI by a biotech company with prospective PIPE investors could potentially represent a breach of fiduciary duty by the company’s executives to their existing shareholders. It might also violate the SEC’s Regulation Fair Disclosure (FD), which mandates that if a public company discloses material nonpublic information to private individuals—typically prospective investors and market professionals, such as analyststhe company must also provide that information to the general public. A public company may not engage in selective disclosure.
If there’s an outcome in the case that’s unfavorable to PIPE issuers providing MNPI to PIPE investors, PIPE financing could potentially be chilled. PIPE investors are unlikely to reduce their demands for key information from biotech companies seeking financing, particularly about the trajectory of critical clinical trials the company is conducting.
Workarounds are possible to mitigate information-sharing issues, such as the public disclosure of the same MNPI in a contemporaneous or nearly contemporaneous manner and adjustments to company policies on executives and their shares. Contemporaneous disclosure to the public for MNPI is already routine for earnings calls with financial analysts where a press release will be issued or a Form 8-K will be filed right after the call.
Biotech IPO Market Set to Improve Late 2024, 2025
After much anticipation by the market, on Sept. 18, the Federal Reserve cut interest rates by half a percentage point, with a more cuts expected—albeit possibly more slowly than investors would like.
This new stance in favor of rate cuts should improve the outlook for biotech IPOs as it increases investor appetite for risk. How much conditions improve will also depend on how well prices for shares of biotech companies perform post-IPO.
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