At the core of every biopharma deal is the question of how to assign value fairly to assets whose future success or failure is often very challenging to predict. Consequently, strategies have been adopted that address this challenge by staggering payments based on future out- comes. Deals often involve some combination of an upfront payment that is made immediately, development or regulatory (DR) milestone payments that are paid once defined goals in the development of assets are achieved and royalty payments once a product resulting from a deal is marketed.
DR milestone payments are very important in the allocation of value in biopharma alliances because most alliances do not result in commercial products owing to failure at some point, but do achieve one or more DR milestones. Conceptually, it is useful to think of DR milestone payments as upfront payments that are escrowed by the licensee of the asset such as a research and development (R&D) program for a drug until achievement of the associated milestone event, and are then released to the asset’s licensor. This enables risk and value to be shared between each party. For example, although a licensor may be confident that the R&D program will commence phase 3 trials some- day, there is often a significant risk of failure. The licensee can mitigate this by holding back a substantial portion of the total agreed payment until phase 3 trials actually commence.
To help understand how DR payments are used, Bioscience Advisors has undertaken a comparative analysis of such payments for bio- pharma alliances over the past decade, which it presents key findings from here. Details of the dataset and analysis methods are described in Box 1.
Historical context of milestone payments
From the early 1980s until the mid-1990s, the most contentious issue in value allocation during biopharma deal negotiations was the cost of capital. Biotechs were small, venture-backed and in constant need of cash infusion, and so their cost of capital was high. By contrast, pharma companies were large, cash-rich and also able to raise funds via debt, and so had a low cost of capital. However, for an R&D alliance between a pharma company and a biotech, the R&D program itself has a cost of capital, raising the question of what this should be in financial projections used in biopharma alliance negotiations. This is important because the higher the cost of capital, the less valuable downstream payments become and, conversely, the lower the cost of capital, the more valuable milestone payments and royalties are in value allocation between the alliance partners.
Until the mid-1990s, pharmas typically argued that a high cost of capital be applied to financial projections during alliance negotiations. This had the effect of minimizing the incentive of biotech companies to negotiate for higher milestones and, especially, royalty payments. In addition, using a high cost of capital for alliance valuation gave credence to the idea that partnering an R&D program was a biotech financing event—like a venture round or public offering, in which biotech’s cost of capital was indeed high—and that upfront and sponsored R&D payments for an R&D program partnered ‘out’ might thereby be made available to support one or more additional R&D programs that remained ‘in’ the biotech.
However, this negotiation dynamic changed in the late 1990s, as codevelopment and regional alliance structures increased the visibility of substantial profits from successful biopharma products.
As a result, the cost of capital in alliance financial projections declined substantially from the 30% or higher that had been used to the mid-teens—much closer to the 10–12% typically used by pharma companies internally. This had a dramatic impact on royalty rates and overall deal size—‘biobucks’—as pharma companies began to offer more one-off payments such as DR milestones and payments for additional indications instead of greater royalty or profit sharing. Importantly, such milestone payments are one-off, unlike royalties or profit splits, which are annuities. DR milestones are also second only to upfront payments in timing and are the most likely to be paid of all downstream payments. So, how have deal participants allocated value via DR milestone payments in biopharma alliances in the past decade?
Trends in milestone payments
Average total DR milestone payment terms have increased across all stages of development at signing over time (Fig. 2). Discovery and phase 1 deals in particular saw substantial increases, with average payments almost doubling in value from the 2009–2013 to the 2014–2018 period.
Looking specifically at the subset of deals involving corporate licensors (Fig. 3) (defined as for-profit companies, therefore excluding the 50 alliances involving research institutions), average total DR milestone payment terms have increased for selected stage alliances in the 2014–2018 period compared with the 2009–2013 period. (There were few deals in the dataset from the 2014-18 period for each of the other three development stages and so these were not analysed.) Discovery-stage alliances had the largest gains in deal payments: Table 1 shows that average total deal size increased fivefold, as did the average upfront cash payment. Total DR milestone payments increased by 83% for recent discovery-stage deals, of which the payment for first approval had the largest gain (from $19 million to $48 million). Total DR milestone payments for preclinical-stage deals increased by 49% between the two periods, with the average phase 3 start payment increasing by 55% (from $9 million to $13 million).
In conclusion, DR milestone payments have increased substantially over the past decade in response to a flattening of the cost of capital used in alliance negotiation. Total DR milestone payments have continued to climb the most in recent years for discovery alliances, with the greatest gains coming at first approval.