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It pays to hire a strong general counsel sooner rather than later

Monday, 8-December-2014

Taking a quick look at recent headlines for Arrowhead Research (Nasdaq: ARWR) leads one down a progression of events that you will commonly see with small biotech companies.  Arrowhead presented disappointing data from its lead program for hepatitis B on October 8th, and since then I count no less than 43 press releases from class action lawyers announcing they are either investigating the company or already actively suing them.  The issue of contention here is that the data Arrowhead presented significantly fell short of what investors were expecting based on previous guidance from the company.  The misunderstanding was so big that they even took the rare step of releasing an apology the next day to clarify where things stand.


So after being bombarded with 43 press releases announcing that you are being sued, what is a company to do?  You might not be surprised to learn that Arrowhead, in their infinite wisdom, announced on Thursday that they finally hired a General Counsel.  Hmm, now let’s think about this.  Hiring an experienced GC when you are in the middle of such a legal tornado is an obvious move, but wouldn’t it have been so much better if they already had one in place before these troubles started?  Maybe some of it could have been avoided?  This is a mistake that so many young biotech companies make, and I think others can learn from it.


I am a big proponent of the idea that hiring an experienced and authoritative general counsel is one of the first moves any small public biotech company should try to make.  This is not about the lawsuits described above, because those are just part of a big game.  There is a cottage industry of law firms whose sole purpose is to pile on publicly-traded companies at any hint of bad news, knowing that these cases will ultimately be settled and net them big fees.  That part is almost unavoidable, and so not many people pay attention to it.  The bigger issue here is Arrowhead’s credibility and reputation, and its relationship with investors.  Those things are important to protect because they can genuinely affect a company’s future.


Credibility is something that you usually only get one shot at, so it should always be held paramount.  This is especially the case with biotech companies because ours is such a capital-intensive business.  In other words, even the most successful companies are constantly going back to investors and asking them for more funding.  The result is that there is a simple math equation at play when you mess things up like Arrowhead has done.  After you lose credibility, investors will for a very long time place a discount on you, which means your stock price will be lower than it should be, and your cost of capital higher.  In some cases the impact of this might only be incremental, but it is still nonetheless real, and in other cases it can hold companies back entirely.


I am guessing Arrowhead will argue that they did in fact have plenty of lawyers on staff before this problem arose, and probably supplemented it with the best outside legal help money can buy.  I am not implying they suddenly woke up and realized they needed a lawyer last week.  However, there is a world of difference between playing it standard like that, and having an experienced person on hand who can guide the company with authority from the start.  This is about much more than whether your contracts are up to date and your SEC documents are being filed on time.  A good general counsel will have a holistic effect that goes beyond basic blocking and tackling.  Let’s take a closer look at what is needed.


You need someone with a lot of biotech experience


The first thing you need in a general counsel is someone who has been there and done that in the biotechnology industry specifically.  Biotech is such a specialized and technical industry, so it takes someone who has been around for a while to understand the nuances of what it all means.  The Arrowhead situation is typical, where things have gone south because investors feel cheated by highly technical guidance.  Only an experienced GC who understands the science well and is following it at the company on a daily basis has any hope of helping management to shape the right message.  Furthermore, in such a highly regulated industry, it takes the experience of having lived through it to know what are realistic developmental and regulatory timelines, which is a big part of what is communicated to the public.


It also takes someone with the authority to keep management in check


Another key attribute of the ideal person is that he or she needs to be someone with authority, who can sway management during those times when they do get ahead of themselves.  Your average legal or communications staffer is not necessarily in a position to do that, no matter how smart and capable they might be.  You need someone with gray hair.  Especially when it comes to young companies, management teams are likely to be a) more optimistic than is realistic and b) more willing than they should be to sell that optimism to investors since these companies are so desperate for capital.  Those two things are how 90% of problems arise, and it takes a special type of presence to be able to recognize it and rein management in.  A lot of times only a veteran of the industry will garner enough respect to be able make the right impact.


Why don't more companies do this from the start?


Since all of these things basically sound like common sense, you might be wondering why all companies don’t hire people like that in the beginning?  One reason is because it costs a lot of money, so many feel like it is out of reach.  However, with your credibility (and future cost of capital) on the line, I personally think it is money well spent no matter what it costs.  You are much better off paying up now than suffering through the consequences later of having not done it.  A second stumbling block many executives cite is that it is difficult to convince experienced people to join a small biotech while its prospects are unknown.  That is understandable, but it should not stop a company from still trying.  I am a big believer in the theory that companies should be built with a foundation commensurate for what they will be one day, not what they are now.  Hiring the right people is a big part of that.  As the famous line from Wayne Gretzky says, skate to where the puck is going. 




The bottom line is that many biotech companies could save themselves a lot of trouble if they placed a higher importance on this position right from the start.  A company’s credibility is the most important thing it has, so you want an experienced legal professional around from day one whose job it is to protect that.  By their nature, biotech management teams are optimists.  That is a good thing too because optimism is one of the most important ingredients needed to get through such a difficult business as this one.  However, there also has to be someone around to keep things real.  While many smaller companies typically hire less-advanced people, and also use a lot of outside help, they would be so much better off by instead starting with someone who has the experience and authority needed to catch problems and correct them before they arise.  Take it from Arrowhead, cleaning up a mess after it has already happened is no fun.

Who Am I?
Brad Loncar

I'm an individual investor from Kansas City.  My focus is on biotech stocks, but I enjoy investing in all industries. I'm an old-school, buy and hold investor who believes the best way to outperform and grow capital is to own innovative companies with good management teams over the long-term. more>>

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