Corporate governance can be biotech's Achilles' heel

Some Australian biotechs are getting creative with company structure. But analysts prefer their companies to play it straight.

Look at the blueprints of a bunch of typical biotech companies -- particularly ASX-listed companies -- and you're unlikely to see much variety in structure. There is a board of directors, usually comprising some combination of independent directors (with no ties to the company or its shareholders) and non-independent directors (representatives of major shareholders, senior executives in the company and even founders of the company). Then there is the senior management team -- the CEO or managing director, chief financial officer, and, depending on the size and stage of the company, other executives such as the chief operating officer, chief scientist, chief medical officer, and a senior business development person.

While the board and the CEO work closely together, they have distinct roles to play -- the board answers to the shareholders and is responsible for setting the direction of the company and for issues of corporate governance, while the CEO is responsible for the vision and the strategy of the company, and holds the responsibility of making sure the company meets its goals in a financially appropriate manner. When investors, analysts or the media have questions, the CEO is the person who is answerable.

Simple, right? But what, then, does it mean when a company doesn't follow the standard blueprint for company structure? Recently, for example, we've witnessed a couple of companies list on the ASX with no CEO or managing director in place, and apparently no plans to hire an appropriate person to fill the role.

Melbourne-based Cryptome (ASX:CRP) floated without a CEO in 2003, but made it clear from the outset that one of its priorities was to hire a CEO soon after listing, which it did. But in the case of Mesoblast (ASX:MSB), which listed in December last year, chairman Michael Spooner told Australian Biotechnology News at the float that the company was in no hurry to hire a CEO, preferring to wait until the appropriate person came along. In the meantime, he said, CSO and founder Silviu Itescu would act as CEO for the company.

And Dia-B Tech (ASX:DIA), a spin-out from Cardia Technologies, has appointed a general manager, Ken Smith, who is also the company secretary, and has appointed management committees to oversee each of its four pre-clinical projects. The company's pre-float prospectus did not outline plans to hire a CEO or managing director, and the company had not responded to a request for comment by press time.

Such companies, while having had varying success on the market to date, have been unpopular with analysts in the sector.

"Quite frankly, I'm gobsmacked -- it beggars belief that people think they can list a company without having a clearly defined public face," says David Blake, biotech analyst and co-editor of investment newsletter Bioshares. "Imagine an Amrad or a Biota without a CEO!"

Alison Coutts, director of research at investment bank EG Capital, agrees. "I would argue that biotechs, even more than established industrial companies, need strong management -- more established companies at least have products," she says.

The major issue that appears to be at stake in these companies is that the company becomes a ship without a rudder -- there is no guiding hand behind the company to ensure that it stays on course and meets its milestones, and no one to be held accountable for failure to do so. At best, a CEO-less company may be considered as immature, undefined. At worst, says Blake, the listing of such a company on the market could be seen as a grab for cash.

And while a listed company could be seen as having a critical need for good company structure, it is something that should be put in place early on, according to the venture capitalists who often fund the early stages of a company's growth.

"In a very early-stage company the CEO or MD may be part-time, but you have to have someone who is responsible for how the money is being spent," says Brigitte Smith, a principal at GBS Venture Partners. "It's irresponsible to put funds in place unless there is someone running the company. We think those structures are pretty important."

Michael Panaccio, at Starfish Ventures, says that it is easier to put a formalised company structure in place early on in the life of the company, saving time when the company transitions into a listed company, and making the company more attractive for major transactions, such as mergers or acquisitions.

In these young companies, the board often plays a major role in management, too, helping to mentor the company as it navigates its growth strategy. "Often it is just a CEO at the start -- it comes down to the quality of the board," Panaccio says.

Risk managers Another good reason for a company to have an experienced team is that it minimises the chance of poorly-handled changes in board and management personnel. "The loss of key personnel in a short space of time, without an adequate explanation from the company is a problem," Blake says. But the problems can be circumvented early on, either by having good succession plans in place, or by preparing the company for upcoming changes such as a shift into intense commercialisation activity with a transition to a new management team.

"Quite often the needs of the company change. It's entirely consistent to say that it's time for a new CEO with a different skill set," says Smith. "We try to get that done prior to [the company] going public."

Board composition is also important and should be considered by a company regularly. While analysts differ in their views of the ideal board structure, executive chairmen -- who jointly rule the board and manage the company -- are not favoured. Other potential risks include retired politicians, too many scientists, or a lack of broad experience across the board members.

"You want to see a mix of skills and experience on the board -- so it is a sounding board for the CEO to call upon," Coutts says.

There are other red flags in company structure that may suggest that a company is a poor investment risk. Coutts says one of her issues is with companies that have unnecessarily complicated financial structures, perhaps as a result of listing through a shell, or from prior investment rounds.

"A warning bell would be when you look at the shares on issue and options tied to milestones -- you need to see if these unfairly dilute shares held by existing investors," she says. "Often what happens with these dilutive structures is that an inequitable amount goes to the promoters of the company that put the original structure in place. It happens all too regularly."

In fact, Coutts says, EG Capital had in the past declined to be involved in floats of companies with unnecessarily complicated financial structures.

Again, this can be avoided by setting up an appropriate financial structure from the start -- something that VCs consider is part of managing the risk involved with investing in early-stage ventures.

"We try to set up our companies to succeed -- the more complex the financial structure, the more difficult that can be," Smith says.

Ultimately, what it comes down to is a need for clear communication with the shareholders, whether a company is just launching itself on the stock exchange or is an established player.

"Investment will thrive on transparency," says Blake.

Two-for-one role outdated

The issue of the executive chairman -- a role combining both the chairman of the board and the chief executive officer -- is one that also worries some analysts. There's potential, they say, for the executive chairman to exert too much influence over the company. Under the recent changes to the ASX corporate governance guidelines, it is also not considered to be best practice. "By and large, the executive chairman has not been shown to be the best way of doing things," says Bioshares' David Blake.

But while it is not an ideal situation, sometimes it is a necessary bridge between the loss of one CEO and the appointment of a replacement. For example, Peptech's current executive chairman, the well-experienced Mel Bridges, chose to stay in the role while the company sorted out its legal challenges of the last 18 months. His decision has been popular with shareholders, keen for stability after witnessing the company's ongoing patent disputes, and board ructions.

In the company's AGM on Monday, Bridges said the issue of a CEO for Peptech would be revisited this year as he entered the last year of his current contract with the company. At the same AGM, one of the independent directors, Martin Kriewaldt, was identified as the lead independent director and spokesperson for the board in cases when it would be inappropriate for Bridges to comment due to his dual role.

Other companies, however, have specifically chosen to retain the executive chairman role. At last year's AGM, Norwood Abbey executive chairman Peter Hansen told shareholders that the board had considered the issue and decided to stick with the status quo for the foreseeable future.