What Is a Biotech Milestone Payment?

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A milestone payment is a pre-determined fee smaller biotechnology companies receive from larger partners, after their collaboration project passes a specific goal. The goals, and milestone payments, typically begin small at the early clinical stages of a new drug candidate's development. Milestone payments tend to increase substantially if a candidate earns regulatory approval, and end with some percent of future sales to be paid in the form of royalties.

While that all seems fairly straightforward, milestone payments can provide several important insights for savvy biotech investors.

Milestone payments vs. upfront cash

The probability of a new drug candidate earning an FDA approval is a dismal 9.6%, after success in a phase 1 clinical trial. This is why industry slang for potential milestone payments, "biobucks" is a fairly derisive term.

When a deep-pocketed drugmaker is willing to pay upfront for rights to co-develop early stage drugs, it speaks volumes about the larger company's confidence in its partner's candidate, management, or both. For example, Celgene's upfront payment of $150 million and an equity stake inJuno Therapeuticsfor an initial payment of roughly $1 billion screamed confidence in Juno's ability to succeed.

Discover or develop?

Sometimes bigger drugmakers enter "discovery deals" that generally entail paying another company to discover potential candidates for clinical testing. It's easy for these types of deals to catch your eye with billions in biobucks, but the devil's in the details.

For example, last summer AstraZeneca gave Ionis Pharmaceuticals$65 million upfront to discover and develop an unspecified number oftherapies for treating cardiovascular and metabolic diseases. Although there isn't a specific drug in clinical development, the number of potential candidates leaves Ioniseligible to receive milestone payments, and other fees, of more than $4 billion from AstraZeneca.

Before you lose your head, it's important to understand Astra must accept each candidate. It might select just one, or two, or possibly none. To collect all $4 billion would require Astra to select and develop multiple candidates and advance them all from phase 1 through commercial success.

Collecting all $4 billion in potential milestone payments from Astra under the terms of the deal isn't impossible for Ionis.Considering the overall failure rates associated with new drug development, it's pretty close.

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The Motley Fool owns shares of and recommends Celgene and Ionis Pharmaceuticals. The Motley Fool has the following options: short October 2016 $95 puts on Celgene. The Motley Fool recommends Juno Therapeutics. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.