Venture capitalist Boca Raton, Florida Barry Honig is well-versed in helping start-ups and growing businesses acquire the capital needed for growth and expansion, and after more than two decades in the profession, he knows exactly what to look for, especially in the unique and challenging world of biotech.
Did Johns Hopkins dropouts just deliver the paradigm shift in disruptive biotechnology, a new model for public launch, and the beginning of a biotech boom?
“You realize this is irreversible — right?” Were the last words that Drs. Denver Lough MD, PhD and Ned Swanson MD heard as they handed in their resignations from the world-renowned Johns Hopkins Hospital Department of Plastic and Reconstructive Surgery.
It was really hard to walk away — I had put 17 years into becoming a plastic and reconstructive surgeon and was finally in the foremost program at the world’s greatest hospital, surrounded by amazing leaders in the field,” said Lough. “How could I possibly justify giving that up to everyone who had sacrificed so much for me to get there.
But on December 1st of 2016, Lough and Swanson were catapulted instantaneously from coveted Plastic Surgery resident positions to the CEO and COO of Majesco Entertainment Co. (Nasdaq:COOL) in hopes that a merger between a 31-year-old failing gaming company and their own revolutionary technology would provide the field of medicine with the ability to regenerate new tissue — skin, bone, muscle, etc. Lough and Swanson are taking a huge gamble because the culture in the medical community is that you don’t leave to try a start-up and then come back if it doesn’t work. Indeed, in 92% of the last 100 life science start-ups to go public, the MD inventor of the flagship product didn’t work for the company. This is startling because in virtually 100% of high tech start-ups that go public, the founder-inventor does work for the company and is viewed as a valuable resource (can you imagine Amazon without Jeff Bezos? Tesla without Elon Musk? Facebook without Zuckerberg?). But the risks of leaving a medical institution are so high — because there is no way back — that most life science inventors don’t take the risk. As a result, most inventors turn their technologies over to VC firms to take them forward — and consequently they typically end up with less than 5% equity in the start-up. Of the last 50 biotech startups, only about 14% launched without funding from VC firms (and only 4% without either VC or Angel investors). PolarityTE was one of only four life science firms that went public immediately without an Initial Public Offering (IPO). So why were Dr. Lough and Dr. Swanson willing to take the huge risk of leaving lucrative plastic surgery positions with no way back? And is the way they launched PolarityTE a new superior model for launching a biotech start-up?
“Name one company that regenerates anything. Anything at all. Name one,” is a probing request that Lough often makes of those who ask about the company and its vision. The question immediately unveils the reality of the current state of tissue engineering and regenerative medicine. Considering the “regenerative medicine market” is growing with a CAGR of 22.3% and is projected to hit a worldwide market size of around $60 billion by 2020, you would think it would be easy to identify at least one company that can regenerate at least one tissue reliably. But the fact is that no one has yet figured out how to regenerate full functioning tissue. Lough, and PolarityTE, wants to change all that.
Disruption is the word of the moment. It gets applied to new technologies and new business models all the time —often when they are not really a disruptive technology that can overthrow incumbents with a completely unique value proposition. But PolarityTE’s technology — if it works — will be extremely disruptive to incumbents. Ironically, even with hundreds of products generating significant revenue on the market, the best solution we have in treating a burn or wound remains a technology that has existed for 3,000 years — a skin graft. But skin grafts aren’t possible with many burn patients and the skin from one part of the body doesn’t match other parts of the body (a skin graft on someone’s face doesn’t grow facial hair, doesn’t breathe and sweat in the same way, and doesn’t match the surrounding skin). Today, one of the most advanced methods to treat wounds is a product named EpiFix® made by the company Mimedx®. EpiFix® is made by taking amnion and chorion (the tissues that make up the amniotic sac that surround a fetus while it’s developing in the womb), processing it using specific methods, and placing the manufactured product into the open wound. This idea evolved with the notion that amnion and chorion are involved in fetal growth, development, and formation, so they could potentially help wound healing. Lough puts the technology in perspective swiftly, “Tell me one time in human or even mammalian history when amnion or chorion ever grew skin. It’s never happened, it doesn’t happen. Why are we trying to outsmart the most complex and advanced system that evolved over the lifespan of our planet — the human body?”
Following this logic, Lough points out that the only way we are ever going to regenerate the largest most intricate organ in the human body, skin, is to start with the most obvious component — skin. Skin grows skin, and the only skin a patient’s body is going to accept, without altering the immune system response, is its own skin. PolarityTE uses its proprietary technique developed by Lough that pulls specific stem cells and surrounding tissue from a patient’s body to create the a first of its kind skin regeneration product, SkinTE. The technology then induces what is called polarization, which is the process through which skin forms, and it is placed immediately back on the patient within 24-48 hours from the initial harvest biopsy. All layers of the skin regenerate — epidermis, dermis, appendages, and even the hair that grows from the skin. The stem cells get their “polarity”, their instructions from the neighboring skin cells as to what kind of skin they are supposed to be, and then voila: you have fully functional skin. The patient’s body won’t reject it because it’s the patient’s own (autologous) cells that generated the skin. So there is little risk. Using the patient as the most advanced bioreactor in existence, the construct can regenerate skin in the exact form that is present everywhere else on the body. What is truly remarkable, is that the technology has demonstrated it can be carried over to all the tissues in the body, including bone (OsteTETM), muscle (MyoTETM), blood vessels (AngioTETM), cartilage (CartTETM), and so on. As if the $30 billion wound care market wasn’t large enough, spreading into each additional market containing their pipeline of products allows PolarityTETM to target a variety of interdependent markets such as wound care, regenerative medicine, organ transplantation and cancer research. Growing new skin, bone, and muscle, is truly revolutionary — and deserves the “disruptive” label.
Of course, the big question is: can they pull it off? Time will tell. Placing the innovators at the helm of a new company isn’t a new concept, and is commonplace in tech companies. Research by Jeff Dyer, Hal Gregersen, and Clayton Christensen (authors of The Innovator’s DNA and creators of the innovation premium metric Forbes uses to rank the world’s most innovative companies) shows that companies are 3X more likely to make Forbes list of 100 most innovative companies when they are led by an innovative founder. This is especially true among high tech companies like Amazon (Bezos), Facebook (Zuckerberg), Salesforce (Benioff) and Tesla (Musk). Not surprisingly, innovative companies are led by people who get innovation. But the question remains, why is this model so rare in biotech?
As previously suggested, the main reason that medical innovators and inventors don’t leave their medical institutions to start companies is that it is too risky. But wasn’t it risky for tech pioneers like Steve Jobs, Paige and Brin, and Zuckerberg to start their businesses? The answer, actually, is “not really.” Jobs was a drop-out from Reed College when he launched Apple. Paige and Brin were Ph.D students at Stanford; Zuckerberg was an undergraduate at Harvard. What did they forego (in terms of financial opportunity cost) in order to launch their ventures? Not much. In contrast, Lough was two years from finishing his plastic residency. He already had requests for his services upon graduation, at lucrative salaries, as an academic plastic and reconstructive surgeon. His 17 years of investment in specialized education that was about to pay off. By leaving to launch PolarityTE he chose to voluntarily walk away from that.
It is interesting that the culture of academic medicine, and especially academic surgery, has rooted itself in a culture that contains elements that more closely mirrors the military hierarchical and seniority system rather than the free-thinking, patient-centered atmosphere that is sometimes portrayed to outsiders or in the media. Walking away from medicine prior to completing specialty training (residency), as Lough and Swanson did, results in a form of ex-communication. Therefore, the threshold to leave medicine and pursue a different venture is extremely high for most because they’ve invested so much time (e.g., at least a decade) and money (e.g., hundreds of thousands of dollars in student loan debt) in their education and training to become a doctor. This creates an innovation problem for the biotech industry (indeed the entire medical field) and here’s why. Research by Riita Katilla and colleagues at Stanford shows that medical product companies are more innovative and successful when leadership has deep medical expertise (balanced with management expertise). Similarly, Stanford’s Nicholas Bloom and Harvard’s Rafaella Sadun find that even healthcare organizations perform better when leaders have strong clinical expertise. So while medical expertise is critical for innovation and start-up leadership, the system is rigged against it. The fact that PolarityTE’s leaders are the inventors of the original technologies that have launched the company should increase the odds of success. Lough and Swanson talk about having the same kind of impact on the biotech industry that Amazon has had on retailing or Tesla is having on automobiles.
Despite the promise of PolarityTE’s technology, Lough and Swanson would likely never have resigned from Hopkins to pursue the venture without an innovative financing model. Indeed, Lough met with numerous VCs, and received term sheet offers, but in every case the VC’s wanted control and the majority of equity. (Roughly 86% of life science ventures are VC backed and, on average, the VCs own 46% of the equity at IPO). And the VC’s didn’t want to put up the financing required to build the team that Lough knew would be necessary to successfully launch the venture (see Sidebar: “Why PolarityTE Can Recruit an All-Star Team”). Enter billionaire investor Philip Frost and his investment team. In the biotech sector, and especially in small cap ventures, there is no bigger name than Dr. Philip Frost. Across a career spanning over 40 years, Frost has built a net worth over 4 billion dollars, the vast majority of which derives from founding, buying, selling and investing in biotechnology companies. Frost and his team are well known for using a “reverse-merger” approach where they use a dying public company (in this case Majesco, a game publisher) as a public shell company to offer a promising private entity (in this case PolarityTE) a route to the public markets and — by proxy — access to cheap public capital. His very own, OPKO Health (Ticker: OPK), was formed in 2007 by merging Acuity Pharmaceuticals and Froptix, both privately owned pharmaceutical companies developing treatments for eye diseases into eXegenics, a shell company with $16 million in cash. As part of the merger, The Frost Group provided an additional $12 million line of credit. Today, OPKO is a multibillion dollar multi-national pharmaceutical and diagnostics company built up through acquisitions. Dr. Frost has been the CEO and Chairman of the Company since March 2007.
Sidebar: Why Polarity Can Recruit An All-Star Team
Why will someone leave a secure job in the medical field to join a start-up? One reason, of course, is because the work and opportunity is perceived to be intrinsically interesting. But for most, it comes down to simple math: what is the probability that the venture will successfully create value X (times) what is my share of that value? Put simply, PolarityTE can offer more equity to induce talent to join the team because the founders have more to give. Compared to VC-backed biotech firms, Lough has 5-10 times the equity to share with talent— which explains, in part, why he’s been able to quickly recruit a half dozen key individuals with MDs or Ph.Ds from Johns Hopkins and other top medical institutions. Indeed, the most shocking hire was Dr. Stephen Milner, one of Lough and Swanson’s superiors at Hopkins and the former Director of the John Hopkins Burn Center. Milner left a lucrative position to become Chief Clinical Officer at PolarityTE. This simply doesn’t happen. Indeed, based on interviews with over a dozen current or former Hopkins clinicians, none can recall the director of an important Center at Hopkins leaving for a start-up. This is only possible because PolarityTE can offer attractive equity options — and because it is led by inventor founders who Milner and others know personally and believe in. Innovators like to work with innovators — not VCs.
Since 2014 Frost, along with co-investor Barry Honig, have used the reverse merger process multiple times with life science companies including SciVac now VBI Vaccines, Inc. (NASDAQ:VBIV) and CoCrystal Pharma Inc. (OTCBB:COCP).
As it turns out, this financing model can be very attractive for both biotech founders and investors. For starters, it gives the founders control of the company and they don’t have to report to VCs — folks who have a reputation for focusing on short term financial gains and early exit strategies to the exclusion of long term innovation. As a public company with patient major shareholders like Frost and Honig, the company can go after home runs in the field of regenerative medicine. Instead of focusing on an exit strategy for the VC’s investment and Limited Partners, PolarityTE has essentially already achieved that goal as a public company, with every new investor enjoying the benefits of liquid capital, but at the same time having the enormous upside of a brand-new biotech company with numerous value inflection points ahead of them (e.g., human proof of concept, market entry, and revenue growth). Given the company’s upside, it’s not surprising that PolarityTE’s stock has increased by a factor of seven — from $3 to over $20 in the first six months.
Beyond control, launching a new biotech company through a public merger immediately gives the company access to a whole new breed of investors who move quickly and spread the story.
As Lough recalls, “Frost and Honig dropped a term sheet on us 24 hours after initiating discussions — a welcomed pace after enduring multiple rounds of VC due diligence that takes 4-5 months before anyone puts numbers in writing. Because of their vast experience in biotech, they quickly understood the potential value of our technology.”
Aside from the equity and control benefits that the deal structure provided, when you ask the founders what was so attractive about this structure, you hear a calculated confidence that is sure to make any investor feel even more comfortable. “This deal immediately allowed us to put our money where our mouth was,” said Swanson. “After pursuing multiple deal structures with private investors, debating our valuation became tiring, which in the private markets in a pre-revenue pre-clinical biotech company is almost entirely imaginary. Taking our company public out of the gates gives us the opportunity to tangibly prove to the world what we’re worth because the capital markets will give us that answer daily.” Lough and Swanson claim that the cost of capital (in terms of equity they had to give up) through this process was less than half of what it would have been using VCs. Of course, many startup companies with no prior funding would shy away from a public launch because of the pressure and responsibility it demands. “We know we have the goods and we jumped at the opportunity to demonstrate it,” claims Swanson. “Perhaps this model of funding startups can weed out the weak investments faster than VCs are able to, which can explain the drastically different timetables between the two types of investors.”Lough and Swanson’s willingness to leave their residencies and go public was an important signal to Frost and Honig that PolarityTE was worth the investment. “Reverse mergers provide a seamless process for getting a company public,” says Frost. “If done properly, it is faster and cheaper than an IPO. As a Dermatologist and an investor for over 50 years, I have seen countless regenerative medicine technologies that have failed. The technology and initial results seen by Polarity has the potential to transform the regenerative medicine landscape. This structure has allowed Polarity to launch their trials and get into commercialization much quicker than a traditional IPO.”
Lough and Swanson’s willingness to leave their residencies and go public was an important signal to Frost and Honig that PolarityTE was worth the investment. “Reverse mergers provide a seamless process for getting a company public,” says Frost. “If done properly, it is faster and cheaper than an IPO. As a Dermatologist and an investor for over 50 years, I have seen countless regenerative medicine technologies that have failed. The technology and initial results seen by Polarity has the potential to transform the regenerative medicine landscape. This structure has allowed Polarity to launch their trials and get into commercialization much quicker than a traditional IPO.”
While the public merger model lowers the cost of capital for biotech founders and inventors, it is also a boon to early investors like Frost and Honig. Based upon our analysis of five public reverse merger deals they’ve done in the biotech space since 2014 (including PolarityTE), their average annual return on these deals is more than 175%.
Any VC would be thrilled with these returns. But this type of investing is not for the faint of heart as not all deals have been successful. Betting on new life science technologies is risky—and requires a portfolio approach. The bottom line is that the public reverse-merger structure can work extremely well for both smart portfolio investors and biotech inventors. It gives founders the financial incentive (i.e., equity) to walk away from their careers and lead new ventures; and it gives smart investors great returns. And while the jury is still out, PolarityTE represents an interesting test case as a pioneering new model for biotech innovations, inventors, and investors.
Jeff Dyer (Ph.D UCLA) is co-founder of Innovator’s DNA LLC, a fast growing innovation consultancy and on the board of PolarityTE, a revolutionary life-science company.
Barry Honig is an entrepreneur and CEO of GRQ Consultants, Inc. Renowned for innovative investment strategies, Mr. Honig continually seeks out tech and other investment opportunities. Barry Honig also founded the Barry & Renee Honig Charitable Foundation which supports youth after-school programs. For more information, go to BRHCharitableFoundation.com or contact Mr. Honig at Barry@BarryHonig.com.