Can crowdfunding cure cancer?
Despite remarkable scientific progress in recent decades, current funding models for projects in early-stage drug development and climate change have failed. These projects tend to be expensive, risky, and lengthy. Andrew Lo and his colleagues at MIT suggest that crowdfunding and financial engineering can provide the solution to this funding problem.
In 2012, Fernandez, Stein, and Lo (MIT Operations Research Center and Laboratory for Financial Engineering) proposed a new cure to cancer: financial engineering. The puzzle they identified was simple: remarkable scientific breakthroughs in biopharma on one hand; and mediocre financial performance and a flight of investment capital from on the other hand. Pre-clinical, early-stage drug development projects are risky, capital-intensive, and have a long pay-off timeline (10+ years). Public companies face pressure to manage quarterly earnings and are often deterred from such projects. The investment horizon of private equity projects is too short, and the projects are too expensive for venture capital funds to diversify. Andrew Lo and his colleagues advocate that the creation of a megafund can address the risks that come with single-project drug development. A megafund would use sufficient capital ($3 to $15bn) to securitize assets (equity, royalties) associated with multiple drug development projects (e.g. 150 trials). Diversification would allow this megafund to provide the high pay-offs of drug development investments but with much lower risk. Given its size, it would give the option to institutional and retail investors to invest in liquid instruments with equity and bond-like investment profiles.
Crowdfunding in biopharma has potential for huge value creation. To start with, crowdfunding can give capital access to an industry where funding is currently scare. The megafund Lo proposes uses a mix of debt and equity. The use of debt in an industry traditionally funded by equity will create value by lowering the cost of capital. By issuing “research-backed obligations”, institutional (e.g. pensions, endowments) and retail investors will be able to invest in a new asset class with a potential for double-digit returns. The performance of the underlying assets has a very low correlation to economic cycles, and the bond-like performance would be very attractive in today’s low interest rate environment. Economic and social value creation is also huge. Millions are affected by cancer and the total economic impact of premature death and disability from cancer worldwide in 2008 was $895bn, or 1.5% of GDP. The crowdsourcing model can also be applied to other areas, such as orphan diseases. In the U.S., 25mn people are affected by a total of 7,000 orphan diseases. Despite attractive financial returns associated with drug development, funding to cure orphan diseases has been scarce due to single-project risk.
Crowdfunding in biopharma can capture value by acquiring financial interest in a number of drug development projects. The megafund would invest in startups, public pharmaceuticals, private companies, royalty streams, intellectual property, and other assets. Royalties and the sale of assets to the secondary market would capture value. Investors would then realize this value through financial returns. Sample simulations indicate that megafunds could offer: a) 10-yr zero-coupon bonds with a yield of 3.8% and 0.4% default probability; b) equity with an expected return of 17.8% and standard deviation of 78.9%; c) multiple risk-return profiles in between (a) and (b) through the use of tranches.
Naturally a number of conditions need to be met for the model to succeed. Project results need to be independent to achieve diversification. Although this seems to be the case, regulation of intellectual property and healthcare reimbursement costs could impact all projects simultaneously. The sheer size of this megafund makes implementation difficult and the process of capital allocation would have to be carefully executed. Lastly, investors would need to become comfortable with the complexity of the model and liquidity terms would need to ensure a steady supply of capital.
Healthcare drug development and climate change are examples of failure of the capitalist system as it stands today. Government action and funding have not really addressed these problems. Capital markets do not reward investors sufficiently in these areas and as a result scientific research does not reach its potential. Lastly, investors are not compensated for the externalities associated with these big problems. There is no doubt that implementing the crowdfunding model Lo and his colleagues created will be difficult. But there is also no doubt that their approach is very noble and that there is huge value to be created and captured by investors and society.
Student comments on Can crowdfunding cure cancer?
Very interesting post. I believe that in today’s world sometimes the incentives to find a cure to a disease like this one or others are not aligned. I think there is a lot of potential for crowdfunded developed drugs and treatments, specially on the field of long treatment illnesses like depression.I wonder what kind push back will the pharmaceutical companies do to avoid this. When a change is imminent maybe joining it is the best option.
Thanks for the comments. Gonzalo, my first reaction is that pharmaceutical companies would not oppose this effort, since it would provide access to more and cheaper capital. On the other hand, I realize they may start losing control over the R&D process, which is vital for their success. One thing you could see under this model is the role of pharma becoming mostly distribution and marketing of drugs. Startups would focus on R&D and rely on pharmas to commercialize the drugs. I can see how the balance is delicate and pharmas could feel threatened.
This is such a compelling use for crowdsourcing and I am surprised it hasn’t gotten a lot of attention yet. Especially for rare diseases that are only known to those directly affected by them, this could be an extremely effective way to drive research and development. I can see huge potential for building a platform where researchers can post their projects or ideas and raise funds directly on the site from people all around the world who want to invest in the medical field but do not yet know how. The digital revolution has the potential to democratize crucial research that could lead to new life-saving drugs and discoveries.
Thanks for the post Yannis! Do you have a view on why pharma companies have been unable to sufficiently diversify their research project portfolios in-house? If the new model is feasible it would appear that a company could internalize the benefits of diversification by raising sufficient capital to use multiple research funnels.
Do you think it will be feasible to raise such a large amount of money for what is essentially a new venture? I wonder whether investors if they are not able to assess the likelihood of success of different projects within the portfolio.
For individual investors, do you think there is any way crowdfunding could be used to make investors feel good about their investment in drug development and thereby reduce the returns they require? It would be awesome if this could get us closer to socially optimal level of investment (incl. the positive externalities)!
Vlad, from what I know pharmas have gone through consolidation and acquisitions to diversify and reduce project risk. Even then, however, I do not think they have the scale to truly reduce the risks of drug development. In addition, since they are public, they face pressure to manage earnings quarterly. While their growth engine still depends on blockbuster drugs and R&D, the incentives to invest in long-term, capital-intensive, and uncertain projects (especially in cases such orphan diseases) are not always there.
Your observations on implementation are spot on. I do see an opportunity to attract capital from philanthropy and mission-driven individuals. In theory, once you reach a certain scale there should be no need to have lower return expectations. The returns are high (double-digit), but the challenge is raising enough money to diversify and bring down the risk. As you point out, raising this money (~$15bn) for a new venture is tricky. By comparison, the total size of the VC industry is $150bn and the size of the U.S. bond market is $30trn. To succeed you would need to come up with a test market for proof of concept. Early support from mission-related investments could really help. I remain optimistic since new asset classes have surfaced in the past to adapt to needs of society. Private equity, venture capital, hedge funds all arose in the second half of the 20th century so I see room for new methods of financing.