Royalty monetisation – why some biotechs are turning to royalty aggregators to help unlock the future value of their out-licensed technology

This article is part of our Biotech Review of the Year - Issue 11 publication

Ellen Lambrix and Marek Petecki in conversation with Brad Sitko, Chief Investment Officer and Nick Cole, VP, Finance & Acquisitions from XOMA Royalty.

Pharmaceutical royalty monetisation deals have been around for a long time. They first gained traction in the 1990s, as a way for universities and other non-profit organisations to turn future income from IP royalties into cash to fund capital expenditure (e.g. new buildings) or further research. They have since become increasingly popular among biotech companies who are looking for alternatives to equity or debt funding, and who have licensed their technology to partners in return for a potentially valuable stream of future milestone and royalty revenue. 

Traditionally, royalty monetisation deals involved royalties from products that had secured regulatory approval and were already generating revenues from sales. Royalties attached to products that were still in clinical development were seen as difficult to value and risky, given the binary nature of the risks involved – there are many scientific, regulatory, and commercial pitfalls in bringing a product to market, and any of them can cause a development program to fail. 

However, recent activity in the US market suggests that this may be changing. We spoke to the experts at XOMA Royalty, a leading biotech royalty aggregator, about how and why earlier stage biotech companies are now using royalty monetisation to unlock the value of their technology.

Q: In the past couple of years, there has been a significant reduction in the supply of public and private finance for biotech companies. With both equity and debt funding becoming harder and more expensive to secure, many biotech companies are looking for alternative sources of finance. Where does royalty monetisation fit into this funding mix? 

Royalty monetisation is a powerful tool for companies - even if they are not having difficulty raising capital. Typically, royalty monetisation does not come with the significant covenants and potential control risks associated with debt and is non-dilutive from an equity standpoint protecting current shareholders from diluting their position in the company. Royalty monetisation can therefore be the most strategically attractive means to fund a biotech company to its next inflection point, allowing it to raise capital with less equity dilution.

Q: What are the key criteria that a biotech company needs to satisfy if it wants to do a royalty monetisation deal? What factors most affect the valuation of royalties?

For a royalty monetisation, a company would need to have executed or be in the process of executing a royalty-bearing licence agreement for a drug or drug candidate. With this licence agreement in place, a royalty aggregator will then review the scientific data behind the drug candidate to apply an appropriate probability of clinical, regulatory, and commercial success. In addition, we will estimate the development and regulatory timelines. We will also look at the future competitive and reimbursement environments and also arrive at an assumption of launch date, sales curve, and peak sales potential. These assumptions, along with the quality of the development/commercial partner, IP life and exclusivity periods will help establish the valuation of the royalty. 

Q: Royalty aggregators will carefully review the terms of the licence agreement to make sure it adequately protects their interests in the future royalty stream, before signing up to any deal. What are the key provisions you look out for in a licence agreement? 

In general, we are looking for any sections of a licence agreement that would present a risk to the royalty stream that is out of our control, such as on-going obligations from the biotech company that could result in a breach should these obligations not be performed as required under the licence. We are also looking closely at the financial terms to understand how the royalty rates are tiered, if and when they step down, what the royalty term is, and whether there is any opportunity for extension, or risk of early termination. Finally, we look for the assignability of these licence agreements in order to understand how to structure a transaction that gives us protection in case something happens to the royalty seller, such as a change of control or a bankruptcy.

Q: Do you have any other practical recommendations for how biotech companies can maximise the potential for future royalty monetisation deals?

We would recommend that biotech companies continue to negotiate as much royalty as possible in their out-licence agreements and negotiate royalties to be assignable. Each licence agreement could represent a future non-dilutive financing for a biotech company; therefore, these economic rights should be protected and assignable to help facilitate a future deal. 

Q: How should management and boards of biotechs think about the value of the economics in their licence agreements?

We believe that there’s a tendency for companies to overvalue the “biobucks” - i.e. the development, regulatory and commercial milestones and the royalties - payable under their licence agreements. They tend not to factor in fully the time, risk and capital needed to achieve those biobucks, and focus instead on the absolute numbers that are set out in the tables of the licensing agreements.

At the same time, some companies don’t fully appreciate the cost of equity dilution. For instance, let’s assume that a listed biotech with a $30 million market capitalisation has completed an out-licensing transaction, and needs to raise $15 million to conduct their next trial. If they sell equity for that raise, they have effectively sold to the investors 33% of all assets of the company, including the future royalties and milestones in the licence agreement. If the company enters into a royalty monetisation transaction, however, the company could potentially raise the funds it needs by selling just a part of the royalties and milestones under the licence agreement, and nothing else. In our experience, many companies fail to carry out a proper assessment of the economics of royalty monetisation as compared to other forms of financing. Our role therefore often involves providing an explanation of the value of royalty monetisation, and the math behind it.

Q: We have seen proportionately fewer royalty monetisation deals in the UK and the rest of Europe as compared to the US – do you expect this to change?

The pharmaceutical royalty monetisation industry as we know it started in the US and Canada, but has certainly expanded in geographic scope. XOMA Royalty has executed numerous deals with European companies and has seen a recent uptick in inbound interest from Europe. Given the feedback and excitement for non-dilutive financing options, we would expect an increase over time, especially from companies like XOMA Royalty that are willing to take on the risks of a drug candidate from early clinical development onward.

Q: It sounds like the royalty monetisation market is now accessible to a much wider range of companies than was once the case – how have providers brought this about? 

Correct. For example, our model is different than many of the royalty buyers. We focus on providing capital in amounts that can be meaningful to most of the pharma and biotech companies operating in the sector – not just the rarified few that are holding economics to a blockbuster product. Our check size is generally smaller, and we are willing to underwrite the development risk - meaning we’ll look at royalty and milestone economics for programs that are in clinical development too, not just commercial products. XOMA Royalty’s novel form of royalty financing protects the value of the shareholders, allowing them to maintain more value in the long term. This is more relevant than ever in today’s capital environment.