Some thoughts on the wonky world of small bio-tech (and why they make for awful memes)

I noticed I was replying a lot to comments on smaller bio-techs and figured a post might be more coherent and hopefully help some folks.

Obligatory disclaimer! I have only been trading for a few months but have worked at a pre-clinical CRO for ~7 years so this is an industry post rather than financial.

Reading that may have left you as confused as I was when learning about the industry. It almost seems like nonsense to form a company that you want to be out of business after a handful of years right? You may have noticed during the era of low interest rates that companies choose to prioritize market share over profitability became a lot more common. That's not what you get with small bio-tech - the business model doesn't care about interest rates or competition.

And that leads into the second wonky aspect of small bio-tech:

Another apparent contradiction right? You may be thinking that those aggressive cost saving measures are in place in order to allocate capital towards some secret sauce that lets them operate faster and more efficiently than others. Nope! The regulatory bodies (FDA, OECD, etc) don't care what type of company you are. There is no way to get one-up on others by burning the midnight oil; small bio-techs, like all others, can only work as fast as regulatory timelines allow for.

So where does all that money go? Turns out the skeleton crew of folks that actually need to go onto a small bio-tech's payroll are the senior level experts - who, surprise surprise, know what they are walking into! And a sadly unexciting answer of simple risk vs reward playing out.

Everyone on payroll is going to know a small bio-tech job has virtually no short term security and zero long term security.  And that the jobs only exist because it would be too risky to fill with inexperienced counterparts. Put those together and you have yourself the perfect setup for run-away compensation packages to attract talent away from stable pharma jobs.

Point #2 covered, so back to point #1!

The small bio-tech is started when investors buy the rights to one or a few potential drug candidates and then burn through cash like crazy to run the necessary trials to show a drug is safe and effective enough to be patentable. These drug candidates can sometimes be the result of independent R+D by a founder. But it is more common for the company to buy the rights from either an academic research setting or they will find one a pharma company (or adjacent industry like agriculture or chemical manufacturing)  they themselves aren't doing anything with.

Needless to say, don't expect any dividend payments in that type of company!
Once the trials have started, there are only two real outcomes: 
A) The drug candidate succeeds and passes the trials. The small bio-tech get to sell the patent to big pharma who actually have the resources to market and sell it.  Sometimes, there's an extra step involved where the patent is sold to an intermediary who intends to resell at a later point.   The insiders have a quick ROI dance party then immediately kill the company because it is no longer useful. 
B) The drug candidate fails, there is no dance party, and the insiders still kill the company because it's no longer useful. 
There are some that have more than one drug candidate in play and part of their business will stay open to work on the other ones, but not always. Either because insiders have made enough money and don't feel the need to take more risk pushing forward. Or the company simply runs out of cash before they have anything worth selling.

Definitely some oversimplification, but that's the general outline. Small bio-techs can be a fun way to speculate. I don't consider them true long-term assets though. I am not skilled enough to pull off swing trading, but that's probably the most likely way to make money on them?

I would not recommend trying to swing after news of a sale is published though. If you miss that initial window, where buying is going to be entirely reactionary, the price is very unlikely to shoot up again. It may hold value if they make a serious commitment to their other candidates and continue to operate. Otherwise, it's basically a zombie company at that point.

You can certainly make a good return if you buy into one early on and luck into already having a position when a purchase announcement is made. Though that is going to be a very boring way to take a large risk 😂. There's no legal way to actually know how the process is going outside of official regulator announcements.

I would advise caution on using company PR though. There is the nebulous risk associated with conflict of interest when you only have one compound everything depends on, etc. The far more tangible risk though is they could choose to not report or underreport the number of adverse events with the drug prior to regulatory submission. The adverse events data often end up being what can influence regulator decisions the most (in theory, the regulators already know the company can show it has an effect from having approved Phase II -> Phase III). That varies by country though. The FDA tends to have higher requirements than say, the EU for both efficacy (FDA requires better than placebo, EU can accept equal to placebo) and safety (that's more cultural and judgment based; the FDA's stance is still informally influenced by remembering its abundance of caution kept Thalidomide off the market for pregnancy women in the US)

Non-obligatory disclosure!

It became clear I let my ADHD take over halfway through and forgot about the "coherent" goal. 😬 So I rewrote the last few points. But if you are my kind of odd and find tortured and silly metaphors amusing, this was the first draft.

So where do small bio-techs come from? Perhaps it's the classic silicon valley story? A passionate worker with a groundbreaking vision meets a charismatic and eccentric entrepreneur for them to join in the sacrosanct bond of sharing a garage workspace. The worker diligently toiling away,  the entrepreneur out playing confidence games. How if they become super best buds, then just maybe,  a stork with a sash reading "VC" will drop a giant pile of money in front of them. The worker, giving into a grievous sin of "being proud of hard work", is shoved back and locked into the garage by the entrepreneur who then walks away with all money and success (obviously deserving nothing less). Ya know, that classic tale? Nope!

Small bio-tech is much more like an off track betting facility in that one very strange part of town where it will be nestled between a pawn shop with all windows and entrance behind iron bars and a luxury dog cafe selling $20 pupachinnos. And across the street from  an extravagantly restored home nestled between one that has its entire roof caved in and another where the only thing preventing the rats from claiming it is all the lead paint chips they can't help but keep eating.

Walk in and you will see that instead of listing various ridiculous names of horses, the boards are full of even more ridiculous names of potential drug compounds. Go up to the counter, stack up all the money you have, remember you didn't do your quick lap of the building yet, add the money you knocked loose on your sprint to the pile, point to one of the endless list of alphanumeric soup and bet it all. Congrats! You successfully created a small bio-tech!

Stuck waiting for the races to finish, might as well keep running laps of the building. You never know! Maybe someone new has walked in or you just need to run into people harder and the money will fall out of the deeper pockets. Whenever out of breath, walk back up to the counter and keep adding to the stack you have bet. Once the race is finished, you either walk away with a giant pile of money or with nothing at all. Either way, you no longer need the OTB to be there and so engage in some arson before heading home