In the wake of an increasingly improved economy and a strengthening stock market, many private biotech companies have either initiated the process of going public or are at least contemplating it. Millions of dollars are being raised, sometimes at nose-bleeding valuations that defy gravity.

It is in this climate that private companies looking to go public should be very wary. If they want to go public, they should be aware of very significant pitfalls that lie in wait, regardless of how they approach the offering. As a result, we have seen in our practice the gamut of biotech companies raising tens of millions of dollars becoming publicly traded, while others have crashed and burned as a result of bad advice, poor handling, or choosing the wrong methodology to enter the public markets.

Below are some important steps to take as any company, whether in the biotech space or not, as they initiate the process:

Assemble an Experienced Team

A team of insiders, board members, and outside accountants and attorneys that are seasoned in the process of going public can be invaluable resources for biotech companies looking to make the move from private to public. IPO experience is important in every position, but particularly with the CEO, Chairman of the Board of Directors, and outside advisors. If they do not have the people with the necessary experience in place, companies will want to start looking for how they can build their team. This team should be well versed not only in financial details of the company, but what the market looks like, where the trends are leaning, and how investors have been responding to comparable stories.

It is extremely helpful if their leadership has already been through the process, whether it is the entire management team, or certain members, as well as relying on Board members who are also familiar with the terrain, specifically folks that are known on Wall Street. Experience and connections with Wall Street are also extremely important for an attorney and a CPA firm. Firms that are known on Wall Street can help make connections to bankers. 

Choose the IPO Route That Aligns with the Company's Goals

Historically in the biotech space, there have been three different ways of going public:

  1. Traditional IPO (Initial Public Offering)
  2. Reverse Merger into a public shell, and
  3. Form-10

Each has its own advantages and disadvantages, and biotech companies will want to consider each as it relates to the company's end goals and objectives.

1. Traditional IPO

If the biotech company is a well-funded, venture capital (VC) backed company, with a drug that is far along in the approval process, going public is a good exit strategy. The risk is low that the IPO will fail. However, we have seen dozens of companies that are either too early in their development, or unfamiliar with the process who sign up with Wall Street bankers, spend hundreds of thousands of dollars on attorneys and CPAs, only to be told at the end of the process that “the climate has changed” and that they need to come up with between 30 to 50 percent of the money to be raised themselves in order to complete the IPO.

Here is where a seasoned management team and/or Board come into play. Those familiar with the process will have performed their due diligence of the bankers they have signed up to take them public. In addition, their consultants should also have warned them of the potential risk of an IPO in which some of the funding must be raised independently. In most cases, early-stage companies don’t have immediate access to this type of money, and their friends and family shareholders’ pockets are not deep enough.  

Further, depending upon the stage of development of the company's technology, the chance of an unsuccessful IPO significantly increases, making an IPO, especially for an early stage company, something to very carefully consider.

2. Reverse Merger

There have been quite a few successful reverse mergers, and this seems to be the path that many biotech companies at earlier stages of development seem to be taking in order to enter the public markets. We have seen many that work out extremely well, but this too comes with risks.

A reverse merger is, in essence, a private company that reverses itself into a publicly traded "shell" company, or a company that owns a ticker symbol and has some history of filing with the SEC, but is no longer in operation, despite the company having some shares to be traded on the open market. Some public shells are "clean" brand new companies, with no history, just with some money in them and no liabilities. Some are failed companies with some money in them and virtually no liabilities. Some, however, are old shells with a lot of undisclosed liabilities and very little money in them. The challenge in the latter scenario is what are the undisclosed and contingent liabilities? We have seen instances where company management says that they have "scrubbed" the shell and have found all the liabilities; only later to find out that there are liabilities that they did not know existed. This can and will hurt the new company that reverses itself into the shell.

Another important aspect to realize is that, in many cases, these shells are behind on their filings, and are not traded on one of the major exchanges (e.g., NYSE, Nasdaq). Companies that complete these reverse mergers must be also prepared to meet the requirements in order to uplist to the major exchanges, which requires additional commitments of time and resources. Finally, the reverse merge approach often requires additional time to elapse before shares can even be traded on the open market, and not all OTC-traded companies can be traded with all brokerages and online trading venues. 

Therefore, while this is the most common manner of going public, it also has inherent risks that can keep the stock down and thinly traded for a time.

3. Form-10

This is where a company converts itself from a private to a public company.

The challenge with either a reverse merger or a Form-10 is that the company needs commitments from capital sources that money will come in simultaneously when the company becomes public. In our practice, we have witnessed promises being made and then broken, with the newly public entity having no operational capital, and difficulty in raising additional funds.

For this reason, choosing a strong team that can anticipate a biotech company's short, mid- and long-term capital needs is essential to avoid this pitfall.

Evaluate Before Taking Action

The decision to go public is not one to be taken lightly. Private biotech companies need to be thorough in their planning process to mitigate their risk of a failed IPO or that they would run out of funding before being able to make the change. A seasoned management team and experienced advisors can help companies avoid the pitfalls. For more information, please contact David Diamond at or 858.795.2014.

Published on February 27, 2018