The Risks of Small Biotech

DepoMed got crushed yesterday, losing almost 60% of its market share after the company announced its Phase III trial for Gabapentin GR, a extended release tablet for neuropathic pain, did not meet its end goal. Evidence, yet again, that the risks of investing in small biotechs are very significant. For as many home runs in small biotechs, there are many more strikeouts and determining which companies will hit a home run is not easy.
So is investing in small biotechs just bona fide gambling? It sure can be if we just put all of our eggs in the proverbial one basket.
Investors are so often reminded to keep a diversified portfolio and this should be the case again when investing in biotech. Here are some steps that I would do when investing in small biotech.

1. Spread your money into more than two different firms -- this reduces risk by giving you a better chance of being in a company to will succeed
2. Invest in companies with drugs in late-stage trials -- this reduces some of the risk involved, as Phase III drugs have much better chances of making it to market
3. Invest in companies with drugs that are not faced with significant competition -- there is always going to be competition, but drugs that could gain a 30% or more market share because of a lack of competition is great for investors.
4. Value the drugs -- intrinsic values can be arbitrary, but it can give you an idea of what the drug could be worth -- try my rNPV method spreadsheet for starters.
5. Collaborations are key -- many of these small firms do not have the capability of selling a drug on their own, and collaborations are necessary. So, look for firms that already have collaborations in place. Large firms have more resources and would give a drug a better chance to succeed.
6. Get out if necessary -- save some money and sell before its too late if it starting to look like the firm is not going to be successful after all.
7. Use options too -- options can give you other opportunities to make money without contributing as much capital up front.

These are just some things to keep in mind. Leave a comment if you would like to contribute any further advice to investors.