Like many other biotechs, Nyxis Neurotherapeutics found itself in need of cash, but after seven years in business, it had a complicated investment structure preventing it from finding new investors that could help fund the preclinical research it was hoping to conduct.

After spending $15 million in grants and another $2 million from angel investors, executives at Nyxis decided in 2007 the best way to get their fast-acting antidepressant from preclinical research into Phase I was to recapitalize the company and start over.

So in 2007, Nyxis was rechristened Naurex Inc. and wiped clean its capital structure. Led by Edward Chandler, its largest individual investor and chairman, Naurex put together a $2 million seed investment. "There were a lot of loose ends," Derek Small, current CEO of what is now Naurex, said. "To bring in new investors, a new financial structure was needed."

Small said the company made the right decision when it decided to recapitalize. Now, its depression therapy for treatment-resistant patients is in Phase II and the company has enough money to move its second compound through preclinical development. It expects to file an IND in 2012.

The lead drug candidate, originally deemed NT-13 and now called GLYX-13, is a peptide comprised of four amino acid sequences: threonine-proline-proline-threonine. NT-13 was being developed an enhancer of learning and memory, but when the company decided to recapitalize in 2007, it also decided to forge a new path for GLYX-13, re-envisioning it as a potential treatment for depression and other central nervous system disorders (Also see "Naurex Inc." - Scrip, 1 March, 2011.).

Since it recapitalized, Naurex has conducted a Series A, which raised $18 million in May 2011, led by new investors Adams Street Partners and Latterell Venture Partners. Other backers included Druid BioVentures, Genesys Capital, PathoCapital, H. Lundbeck AS, Takeda Ventures and Shire PLC ([See Deal]). All of the investors are new, since the company had relied on money from grants and angels in its previous iteration. Small said Naurex has enough capital to take it through 2012, but he expects the firm will have to look for further financing late next year, when it expects to be ready to advance to later stages of development.

Recaps Happen

Naurex's story isn't unique; plenty of biotechs choose to recapitalize when investors become hard to find or their development plan hasn't worked out as initially intended. That said, metrics are hard to come by, in part because companies describe recaps using a variety of terms.

Sofinnova Ventures partner Garheng Kong said it isn't the biotechs that are doing well, or even those that are ready to shut down that decide to recapitalize. Rather, it is usually companies that are somewhere in the middle and have made progress, but have hit a snag, he said.

Atlas Venture partner Bruce Booth agrees. "A recap is often catalyzed by setbacks to the lead program. This could include cases where a drug didn't meet its endpoints in a clinical trial or a big delay in reaching a key milestone such as IND," said Booth. "It could also be triggered by heightened financing risk, say the drop out of important syndicate members, which diminishes the financial support that company can draw on from its insiders."

When companies are at this point, as Nyxis was in 2007, the capital structure is usually a complicated one that involves layers of financing from different parties with different stakes in the company. When a company and its investors decide to take the recapitalization route, the old capital structure of the company is wiped out and often that includes the stake of previous investors, giving the company a clean financial slate.

Usually, existing investors face significant dilution or have their investment written off altogether when a recap happens. Kong said he has found that original investors often cannot reinvest, even if they want to. Most funds have a specified allotment of resources to devote to a company to get it to certain milestones; if those milestones are not reached and the cash has been used up, the fund cannot participate in any financings going forward, he explained. The only way that investors can protect that original investment is by participating in the new investment rounds.

"As an existing investor, we have companies that need to recap - it's part of reality," said Kong. "Sometimes the only way to get your existing portfolio financed is to recap. The alternative is to give up and go home."

How Much Can You Earn A Second Time Around?

Recapitalized companies often earn as much in a new financing as they did during an average financing in their previous iteration. Yet, that is not always the case and many factors play into how much a newly structured biotech can bring in from investors.

"If it's an externally led recap, these are driven by the market. A new investor sets a price that is significantly below the price of the last round, and this leads to a negotiation around the terms of the recap," Booth said of how companies raise new funds after a recap. "Less often, it can be driven by the insiders and involves testing the market at different price points."

A recent example is Zelos Therapeutics, which raised $4.5 million through a Series A recapitalization in early October under its new name, Azelon Pharmaceuticals. The Series A recap round was nowhere near as successful as Zelos' previous financings, which included a Series A of $16 million, a Series B of $42.5 million and $12.5 million extension of the Series B. Prospect Venture Partners, which announced in early October that it would stop efforts to raise a $250 million fund, was one of the original investors in Zelos and led the recap round. Covington Capital Corp. and Lighthouse Capital Partners, which previously provided debt to Zelos, also participated in the restructuring.

Azelon has shifted its focus from its former lead compound, ZT-031, an injectable next-generation parathyroid hormone (PTH) analogue meant to treat osteoporosis, to ZT-034, a nasal spray version of the PTH analogue. Azelon's investors may have just been testing the waters before making a major commitment.

In an interview, new CEO Joan Lau said the company is waiting on Phase IIa data that are expected in the third quarter of 2012 before Azelon decides what the next steps for the product may be - the company could even shelve the product if data aren't as good as expected (Also see "Zelos Becoms Azelon; Restructures To Close A Series A" - Pink Sheet, 11 October, 2011.).

Success After Recap

Recapitalization isn't a predictor of how successful a company will be going forward. Kong said he often finds that recapitalized companies tend to perform better than newly formed biotechs because the management has learned from its previous mistakes or stumbles.

"I would argue that recap companies have a higher probability of success than a brand new company," said Kong. "The new companies haven't done anything yet, while the recap has scars and experience. Investors are also looking at a recap much more closely; there is a tighter filter."

While plenty of recaps have gone on to success, that isn't the case for all of them. Yet, in the current economic climate where the financial markets have not been as kind to the biotechnology sector, finding funding through new investors and recapitalization is quickly becoming a reality that many companies may have to face if they are going to bring a drug through clinical development.

- Lisa LaMotta (l.lamotta@elsevier.com)

Recapitalization Becomes A Better Alternative In A Weak Economy

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