Financing drug discovery via dynamic leverage

Abstract

We extend the megafund concept for funding drug discovery to enable dynamic leverage in which the portfolio of candidate therapeutic assets is predominantly financed initially by equity, and debt is introduced gradually as assets mature and begin generating cash flows. Leverage is adjusted so as to maintain an approximately constant level of default risk throughout the life of the fund. Numerical simulations show that applying dynamic leverage to a small portfolio of orphan drug candidates can boost the return on equity almost twofold compared with securitization with a static capital structure. Dynamic leverage can also add significant value to comparable all-equity-financed portfolios, enhancing the return on equity without jeopardizing debt performance or increasing risk to equity investors.