Not all initial public offerings are about smart money cashing out. Biotechnology firms exist in a topsy-turvy universe where early financial backers actually buy up large chunks of additional stock when their companies go public. That may sound like a refreshing alternative to the debuts of Facebook and other Internet hotties. But caution is advised.
At least three of the four biotech firms that have floated this year have relied on insiders doubling down. Verastem, for instance, raised $55 million, with about a quarter of that coming from existing venture capitalists - including a firm co-founded by the company's chief executive. Cempra raised $50 million, of which half came from existing investors. The industry's new listings last year exhibited a similar pattern.
Because biotech firms tend to run up losses for a decade before receiving approval to sell a drug, these semi-public offerings provide a few advantages. For venture capital firms struggling with too much capital and poor returns, buying stock in an IPO allows them to double down on their winners - or share risk with other investors. For companies going public, the calculus is simple: There may not be enough demand for their shares otherwise. It has become difficult for small firms to float, particularly as public markets have grown warier of the risk in biotech. Insider promises to buy stock can also act as a floor on pricing.
Finally, new investors get some reassurance. Prospects in biotech are hard for outsiders to evaluate. If early backers co-invest, it mitigates concerns they're trying to dump a dog on the public. It also increases the amount of stock covered by lock-up agreements. The results can please all parties. Clovis Oncology has nearly doubled since last year's IPO. But they're still risky. Small floats can create artificially high valuations and lead to more volatility. VC ownership creates bigger overhangs - they will presumably sell at some point. And it may make it easier for more speculative firms to go public that may be better off private. Horizon Pharma, for example, has fallen about 60 percent since going public due to patent concerns and a secondary offering at a fraction of the IPO price. In any case, the once bright line separating public and private companies is now fuzzier.