Achieving the Exit with Michael Gilman & Stromedix

Shareholder Representative Services’ latest Q&A features Michael Gilman. Gilman led Stromedix to an acquisition by Biogen Idec valued at up to $562.5 million. Stromedix was created from a program spun out of Biogen Idec that was not being pursued. Biogen Idec ultimately recognized the value created by the startup and bought the company in February 2012. Gilman discusses the challenges of extracting valuable intellectual property that has been shelved at a big pharmaceutical company, the emotional ramifications for a CEO selling a company, and the importance of negotiating earnout milestones that are resistant to interpretation.

Q: What was your thesis when you started Stromedix?

I started working with Atlas Venture in 2006 and we came up with the idea to start a company focused on fibrosis. The investment hypothesis was based on the idea that if we spent $20-30 million to prove that we had an anti-fibrotic drug, we would have an asset that would be worth 10 times that on the market.

At the time, big pharmaceutical companies were skittish about developing treatments for fibrosis, which is a big problem that affects millions of people. Fibrosis is the pathological scarring and consequence of chronic cycles of tissue injury and repair that can impact the body’s internal organs, such as your liver, kidneys and lungs. Over the course of years it can lead to the accumulation of scar tissue and eventually organ failure. We knew that if we could figure out how to address the challenges around clinical development of an anti-fibrotic drug for treating scarring of the lungs, the large pharmaceutical companies would come around quickly. They would recognize the tremendous commercial opportunity in treating this medical need.

Stromedix was organized around a program that came out of Biogen Idec, which they had chosen not to pursue. Prior to the company’s formation, I had worked at Biogen as Executive Vice President of Research, and I’d left without any specific plans in mind. There were four other companies that started in a similar timeframe and space. All but one have been acquired in the past year and a half.

Q: What problems did you encounter in the company’s early days after Stromedix secured its Series A Round in 2007?

While the biology of fibrosis is quite well understood, the problem has always been how to prove a treatment through the clinical trials process. No one had been able to figure out how to run a Phase II clinical trial that provided enough information to determine whether it made sense to invest in a Phase III trial, where you’re writing a $100 million check. The business question was whether there was a way to understand if the drug was working with $20 million of capital, rather than spending $100 million later, only to learn that you shouldn’t have spent a penny in the first place.

We deduced that we could work out these issues in the setting of kidney transplant patients. If you transplant a kidney, it typically lasts from 10 to 12 years before the kidney fails due to fibrosis. That would give us a way to monitor whether our drug was impacting the key pathways of the tissue. But, when we were ready to begin our Phase II trial in early 2009, the FDA raised a safety concern that delayed the launch of our trial and forced us to rethink our drug development plan. Ultimately, the FDA asked us to run a pretty complicated additional safety study with kidney transplants in monkeys that took us all of 2010 to complete and drained capital from our Series B round.

Q: A significant portion of the consideration in the Stromedix and Biogen merger was structured in the form of an earnout. Can you talk about the role it played in getting the deal to the finish line?

The upfront payment allowed the investors to take some risk off the table, and they relieved themselves of any further obligation to fund Stromedix. They also retained most of the upside of the drug, so if it really works out, they can make well over 10 times capital invested.

The investors’ expectations were actually less aggressive than mine. I felt that if we waited and generated positive data in the Phase II clinical trial that we could have had a transaction worth $200 million to $400 million upfront, but our investors were really happy with this deal. At the end of the day, it was what everyone wanted to do.

During the transaction with Biogen, I came to understand that an important part of my job was to make money for my shareholders, but at the same time, finding a good home for the drug and a company that would aggressively invest in its development was critical.

Q: Did you have concerns about issues that might arise post-closing?

Thousands, especially because the economics of the deal are tied to achieving future milestones. We spent a lot of time negotiating around those issues, but we tried to make our merger agreement as unambiguous and as resistant-to-interpretation as possible. For example, we originally wanted the first milestone to be paid upon the successful outcome of the Phase II trial. At the end of the day though, we defined achieving success as when you start the next clinical trial since by definition you start a new trial when the previous one has been successful. That was a tangible event that everyone could agree on.

The other thing that is important is the language around due diligence. One way that the acquirer can insure that it doesn’t have to pay on milestones is simply by not doing what it takes to achieve them. So, it’s in the interest of the selling company to put strong language in the merger agreement that compels the buyer to accomplish certain things. Of course, there’s equally strong interest on the other side to resist including such language and that’s where a lot of the back and forth comes from.

Q: Can you share any advice with other executives who might be thinking about selling their companies?

Be prepared for a really intense emotional experience, even though it’s business. Even when everyone wants to do a deal in the end, especially in a case like ours where five out of six members of our management team came out of Biogen, it is still a contentious process. Everyone looks out for their respective interests and exercises every bit of leverage that they have.

The thing that surprised me, though, was that after the deal was done, my own feelings were quite bittersweet. Everyone came up to me to say congratulations on the great deal, and I wasn’t sure that I felt the same way. I loved being CEO at Stromedix. It was the greatest adventure of my life, and I was sad that it was over. CEOs and founders should prepare themselves for some unexpected emotional feelings.

Q: In hindsight, is there anything you would have done differently throughout the deal negotiation, such as hiring an M&A advisor?

We had an asset that was valuable to more than one party, and we had multiple parties interested in acquiring Stromedix, but at the end of the day it was very difficult for them to get them caught up sufficiently to create real competition for Biogen. An M&A advisor can be really valuable, whether it’s a bank or a boutique consulting firm, with drumming up competition for the asset and running a formal process to maintain a sense of scarcity and urgency on the other side of the deal. But that is just not where we were at the time. The outcome entirely boils down to how much leverage you have in the negotiating process. When you have five people competing for the same deal, then you have much more control over milestones and language. At the end of the day, it’s all a matter of who’s got the leverage at the table.

Q: Do you think there are opportunities out there for other entrepreneurs to find programs that have been shelved by other big pharmaceutical companies? Would you do it again?

The answer to your first question is yes, absolutely. There are dozens of drug development opportunities wasting away in the caves of these big companies. But let’s face it, licensing out a drug development program is not something that this industry is very good at. Once a program is dead, nobody wants anything to do with it. It took us 10 months, but I was able to get Biogen Idec to agree to license it to us, and it was a license that gave them no rights to get the program back. They did get some equity in the company and the right to potential downstream economics if the drug made it to market.

The answer to your second question is a little more complicated. In our case, the program came from Biogen and went back there, but that was never the plan. The context of how that happened is important. Biogen had undergone a complete change in management and brought in a new CEO. Together, they reshaped the drug pipeline, R&D strategy and the theory of fibrosis, which they had gotten out of six or seven years ago, but were interested in exploring again. That gave them a huge leg up on any other party that we might have tried to bring to the table. Also, their equity position as one of our shareholders helped. Ultimately, if I were to do this again, I would try to start with something that is really completely unencumbered because it gives you more options in the future.

Q: Are there other management lessons that you can share from your experience as an entrepreneur?

My take away from the whole experience of starting a company is that you have really got to love being hands on. I’m not talking about being a micromanager, but being able to deal with whatever issue is blowing up, because there is always going to be something that blows up, and you are always going to be understaffed.

Stromedix had only six employees. Everybody had to know how to un-jam the copier and reboot the router. That’s a very different kind of work and lifestyle than being in a large company with substantial infrastructure. Some people really dig it and some people really hate it. I loved it. It’s important to figure that out from the start.

Image Credit: Biogen Idec

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