To paraphrase Winston Churchill, starting up tomorrow’s biotech firms is a bit of “a riddle wrapped in a mystery inside an enigma.” The riddle is that cutting-edge biotechnology may both increase and decrease risk.
The mystery for biotech start-ups is how to obtain capital when so many investors have been burned before, and may now prefer less impressive but more predictable returns in later-stage investments.
The enigma is how venture capital (VC) firms will raise the funds to invest in biotech or any other technology when so many limited partners, whose portfolios were hit hard by the 2008 financial crisis, have fewer funds to invest in VC firms and, by becoming more risk averse, may prefer to avoid such investments. We’re definitely entering a game-changing era.
First, let’s consider the riddle. Biotech investments have always been high-risk investments due to the high costs of R&D, long lead times for R&D successes to be commercialized, and high R&D failure rates. R&D spending per new biopharmaceutical launched can readily exceed $1 billion. Yet, over the past 30 years, an escalation of discoveries in molecular and cellular biology and a proliferation of concomitant technology platforms have dramatically increased the odds of solving big problems regarding health, agriculture, energy, and the environment.
For example, advances in functional genomics will eventually impact healthcare to an unprecedented extent, not only by helping to enable the widespread practice of personalized medicine, but also by leading the way toward the treatment of learning and memory disorders, the cure of hereditary diseases, and the retardation of aging.
This example of cutting-edge technology will both increase and decrease risk. The increase is obvious. A gigantic opportunity, such as the retardation of aging, will entail many years of research, costly false leads, and huge outlays of capital.
The decrease in risk is due to the coming of age of personalized medicine.
Customized therapeutics are likely to provide greater efficacy with fewer side effects if targeted to population subsets. Clinical trials should require lower enrollments and shorter periods of time to complete and result in reduced failure rates and fewer product recalls following FDA approval. The costs of R&D should drop considerably and lead to high rates of return from such niche market-directed therapeutics.
On to the mystery. A recent PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report (Q1 1995–Q3 2009) has revealed some surprising data in light of the financial crisis that exploded at the beginning of the fourth quarter of 2008. Comparing total U.S. VC investments and number of deals closed in fourth quarter 2008 vs. fourth quarter 2007, first quarter 2009 vs. first quarter 2008, second quarter 2009 vs. second quarter 2008, and third quarter 2009 vs. third quarter 2008, in all cases significant deceases were noted in the quarters occurring one year later than the comparison quarters. For the most recent four quarters, compared to their corresponding prior quarters, the total dollars invested and the number of deals closed averaged 41% and 32% lower, respectively. However, for just biotech investments, the total dollars invested and the number of deals closed averaged only 21% and 22% lower, respectively.
For all U.S. VC investments representing first-sequence investments, i.e., the first investment made in a company from external sources, the total dollars invested, and the number of deals closed averaged 54% and 46% lower, respectively. With respect to first-sequence biotech investments, the total dollars invested and the number of deals closed averaged only 33% and 39% lower, respectively. In other words, the falloff of VC investments from the fourth quarter of 2008 through the third quarter of 2009 was less severe for the biotech industry than for all industries combined, even regarding riskier first-sequence investments.
The relative competitiveness of the biotech sector in securing VC funds during the current economic downturn reflects a similar pattern observed during the prior 13 years, a growth period for both the economy and VC investing. As I reported in the October 15, 2008, issue of GEN, and subsequently documented in the October 2009 issue of the Journal of Commercial Biotechnology, from 1995 through 2007, VC funding of U.S. biotech companies grew at a faster rate percentagewise than total VC funding of U.S. companies (except during the dot-com bubble from 1999 to 2001).
Now for the enigma. Thomson Reuters and the National Venture Capital Association released a report on October 12, 2009, showing extensive declines in the ability of VC firms to raise funds from the fourth quarter of 2008 through the third quarter of 2009. Comparing total capital raised and number of funds closed in fourth quarter 2008 vs. fourth quarter 2007, first quarter 2009 vs. first quarter 2008, second quarter 2009 vs. second quarter 2008, and third quarter 2009 vs. third quarter 2008, in all cases significant deceases were noted in the quarters occurring one year later than the comparison quarters.
For the most recent four quarters, compared to their corresponding prior quarters, the total capital raised and number of funds closed averaged 66% and 54% lower, respectively. Moreover, the declines were most severe in the second and third quarters of 2009, compared to the second and third quarters of 2008, when the total capital raised and number of funds closed averaged 80% and 70% lower, respectively.