Many sectors have been hit by the virtual disappearance of initial public offerings to fund their operations, but biotech, which is generally in a pre-revenue stage as it develops and tests a new drug, is particularly vulnerable. We explain why below:

“Biotech has been significantly disadvantaged,” says Robert Freedman, a partner at law firm Fenwick & West, who focuses on biotech M&A. “They need cash in the door.”

As a result, many of Freedman’s clients are discussing a reverse merger with public companies that have cash on hand but are trading below value. A reverse merger is when a private company goes public usually by acquiring a majority stake in a public company.

“Reverse mergers are complicated, they take longer,” says Freedman. “But they’re popular.”

Freedman and his Fenwick co-authors describe a range of alternatives to IPO financing in a recent report called “Navigating Uncertain Times: IPO Insights for Late-Stage Technology and Life Sciences Companies.” These include cost-cutting and a down round of investor finance, where companies get new funds at a lower valuation than the previous one.

Some tech companies can wait it out, cutting costs were possible and relying on revenue from existing products. Biotech companies in the pre-revenue stage don’t have this luxury.

These biotech firms can cut costs, Freedman notes, by focusing on one promising drug and abandoning other development projects. This strategy can entail layoffs, but also saves costs by reducing the number of clinical trials involved. It is risky because a new drug may not pan out, no matter how promising.

A reverse merger can help. “A lot of them aren’t as successful as an IPO,” Freedman cautions. “It’s a splashier thing to do an IPO.”

But the days when a pre-revenue biotech can raise a lot of money through a public listing are gone for now and the Fenwick survey indicates most companies and investors are pessimistic that the market will revive this year.

What may happen is that some private companies will start the process in the second half of the year. “It can take five months from kickoff to pricing,” Freedman says, so these companies would be ready by the end of 2023 or early 2024.

The recent turmoil in the banking sector hasn’t changed those expectations, and may have even improved them if it leads to a reversal in monetary policy. “The Fed easing ironically helps,” Freedman explains.

In the meantime, reverse mergers are filling the gap for biotechs. For example, the combination of Graybug Vision and CalciMedica, completed earlier in March, left the new firm, CALC on Nasdaq, with $34 million in cash to develop its therapies for inflammatory diseases.

Public companies considering a reverse merger are choosy about which private biotech firms they pick, because they often give up control of their company in the transaction.

One decisive factor can be well-established management in the biotech firm. “It’s an industry where players repeat,” says Freedman. A CEO can go through multiple companies, moving into another one once the previous one has succeeded.

“Investors have more faith in management with a track record,” Freedman says. It helps, too, to have a board with seasoned investors.

The IPO drought will come to an end, Freedman predicts. As a 29-year veteran at Fenwick, he has been through many cycles. It gives him some perspective on the current situation. “There are many people,” he says, “who have not seen this before.”

Darrell Delamaide