Where Is Everyone? Biotech’s Dwindling Number of Venture Firms

Posted in Biotech financing

The past few weeks have been full of bad news about biotech venture: the numbers were abysmal as venture investments into biotech during the first half of 2012 were off some 40% from last year.  This drop can’t be a good thing for the ecosystem.

However, although concerning, it’s not the reduced capital flows into biotechs that I find so worrying – quarterly variations happen, these things are cyclic, etc…  It is certainly as hard as it’s ever been for bioentrepreneurs to raise money, but deals are getting done.  There was still $1.5B that flowed into ~200 venture-backed biotechs in the US in the first half of 2012; this volume represents more companies than any of the 16 other sectors tracked by the NVCA/PWC Moneytree venture capital survey outside of software (541), including media and entertainment (186) and IT services (165).  So we’re still a sizeable venture sector.  And assuming the economic and political uncertainties don’t create havoc, I expect venture-backed biotech’s numbers to rebound somewhat in the 2nd half with the typical lumpy variability of quarterly data.

But what I do find really disturbing is the longer term macro trend around the shrinking number of venture firms active in biotechand the number of partners in those firms.  Seems like every month there’s another diversified firm leaving healthcare (like Scale Ventures), or healthcare VC firms winding down altogether (like Prospect).  See recent tweets alluding to the subject here, here.

Even in a capital constrained world – and clearly the data suggest biotech venture is getting leaner – one of the biggest constraints on the ecosystem is the bandwidth of individual, active investors: what new startups are you working on forming, how helpful you are to the entrepreneurs you’re backing, what existing portfolio companies do you spend time on, how effectively are you leveraging your network for the portfolio, how many frogs (new opportunities) are you kissing, etc…  And as an active investor looking for syndicate partners in our portfolio, the dwindling “available bandwidth” of the biotech VC universe is a real concern.  Many are too busy working on their portfolios to do more than 1-2 deals a year (including me).  This bandwidth issue is as or more important of a constraint on the number of biotechs that get funded than the amount of capital itself.

To put some statistics around this concern, here are some data from the Dow Jones VentureSource database.  In the chart below, I’ve plotted the number of investment firms participating in at least one biotech financing by year since 1998, for both “first financings” (startups) and all venture financings (first and later rounds).

 

This reveals a 40% drop from 2007 in the number of participating investors overall, but also startup (“first financing”) investors.  For context, the number of “active” VC firms according to the NVCA only dropped from ~10% from 2007-2011.

These data help quantify the massive contraction in the number of firms investing in biotech that we all know and feel.

A surprisingly positive finding embedded in the data is that there are so many investment firms on the list to begin with.  Since 2008, 169 venture firms have invested in at least one “first financing” in biotech – I skimmed the list and it seems credible.  Hard to know exactly how many of these actually did more than a few investments, and undoubtedly a version of the Pareto principle is in effect: 60-80% of the deal volume is probably done by the most active 20%.  But with over 2000 rounds of funding in biotech since 2008, the ranks of the less active 80% are still doing a few rounds a year on average.

But even with those players, the data in the chart above would suggest we’ve lost nearly half of the investment firms willing and able to do deals in LS over the past five years.  A reasonable number of those are dead or are zombies unlike to ever raise another fund.  A good number are probably distracted by lengthy fundraisings, and praying for an exit to catalyze a close.  Whatever the reason, they are out of the picture today and possibly forever.

In line with this data, Luke Timmerman of Xconomy recently wrote a very good piece on who are the last remaining active early stage VCs in biotech, and shared a bit of data from Thomson Reuters.  Its clear that the shortlist of active biotech VCs is indeed shorter than its been since the mid-1990s.

Is this going to change anytime soon?  Not likely.  Jon Norris of SVB recently published a great pair of reports (here, here) worth reading.  Among many insights that I’ll bring up in the future, there were two great analyses with regard to venture investors:

  • Big Exits in the Life Sciences are up from 2005-2011 – but they are concentrated in the portfolios of relatively few firms.  Of the 170 Big Exits since 2005, the Top 10 venture funds (in terms of numbers of these hits) were involved with 52% of all the big exits.  The Top 20 expands that to 66%.   It’s a world of Haves and Have-nots.  For those funds without big exits, fundraising won’t likely happen.
  • Investing has outpaced Fundraising.  Since 2005, SVB estimates that there’s been 25% more money flowing out from VCs into biotech comapnies than into new VC funds earmarked for biotech.  This deficit in dry powder has to catch up to the sector, and it appears the numbers are beginning to reveal it.

The silver lining in the SVB data is that Life Science liquidity (distributions) in 2011 has outpaced both of investing and funding (as I also pointed out back in January) – and over time these improved returns would undoubtedly increase LP interest in Life Science investing, which should help to stem the tide of ever-shrinking biotech financings.  Looking forward to the day!

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  • http://twitter.com/sciencescanner David Grainger

    Contrarily, I see these numbers as wholly positive for biotech.

    You can trace the problems to the poor performance (by and large) of the funds with heavy exposure to life sciences.  Many of these guys have not returned enough to their LPs to justify continuing with the model.  And the cause of those poor returns have been large bets on late stage companies whose products were simply not good enough to achieve market penetration even if they were good enough to achieve regulatory approval (Dendreon would be a good example of this).

    If these companies were not exciting enough to have been taken out by global pharma in their earlier stages, then why should we expect them to deliver blockbusters while independent?  It happens occasionally (Im thinking of Actelion) but its the exception rather than the rule.  And these “sliver medal companies” http://www.tcpinnovations.com/drugbaron/?p=152 consume the lion’s share of the life science venture capital flows.

    Reducing early stage plays would not move the needle on the total capital at work – so the reported “dwindling” in life science capital investment can only reflect a slowing in these “big” rounds.  If natural selection is killing the people who persist with this model (and it should – LPs don’t need to understand the problem, they only need to know that the returns they received were inadequate) then all to the good for the sector as a whole.

    As capital flows dwindle as the big rounds in silver medalists fade away, then the returns to the sector as a whole should sky-rocket.  We are seeing every increasing frequency and value of the early, private deals.  These exits are generating decent multiples for their investors (as we saw yesterday with BI’s acquisition of Funxional’s Ph2 programme).  If these successful, early stage private deals often involving lightweight (if not virtual) companies, are not bucketed with the capital-intensive silver medalists (and so the capital-at-work denominator for the sector comes right down just when the private exit returns are increasing) then the yield will soon turn positive.

    The challenge will be maintaining that happy state of affairs as we move into the next cycle.  When yields do turn markedly positive (albeit on a shrunken capital base in the sector), money will start to return.  Using that capital wisely – and not returning to the old bad habits – will be hard to achieve.  Perhaps thats why its also positive that many partners from funds with discredited investing models are leaving life science investing altogether…

  • LifeSciVC

    David,
    Agree there are some positives to the retooling of biotech venture, as I’ve noted before. But sadly lots of the firms still active appear to prefer big late stage spec Pharma like rounds, not the more innovative, early stage assets you and I both appreciate. At least in part, a misperception of risk (and time to exit) has been one of the drivers of the anti-early stage shift. Also, early stage venture creation is hard work – having syndicate partners to help build them is critical, and that’s a concern And I share your enthusiasm about returns from the newer experiments with the biotech venture model! B

  • http://twitter.com/EFZimmerman Eric Zimmerman

    To what extent do you think the dwindling number of venture firms is due to inefficiencies in the LS space?  It seems that every ECE/CS professional has an idea of what is commercializable and who to go to for funding, but most MDs and PhDs in LS I would argue aren’t thinking in those terms and/or aren’t familiar with the players (which may be the fault of VCs for lack of exposure).  It seems like there isn’t necessarily a lack of talent, aptitude or desire but more a lack of clarity around the process and a general disconnect between the lab and the clinic.  Both the information and people flow in the industry seem to be much slower than our IT counterparts which could create a barrier to entry.  The under-utilization of tech transfer offices is a good example of this; there is obviously a lot of innovation coming from all of the great medical academic institutions but there just doesn’t seem to be the same spin-out potential.

    There are obviously dollars to be made in LS but how do you get more healthcare people thinking in an entrepreneurial way?

  • M Poller

    Yet, @JohnCFierce says: “$175M new bio venture investments over 72 hrs. If we keep up pace we can beat the entire 2nd quarter by end of next week.”

  • Pheinecke

    Eric: I don’t think the issue is inefficiencies in the LS.  Certainly  some (but not all) MDs and PhDs don’t really grasp how build and fund a business, but there are plenty of experienced MBAs and lawyers who are available to work with them.  But these days, even experienced teams with strong technology have difficulty getting funding.  The VCs favorite excuse these days is that the technology is “too early” even if it is ready to start IND-enabling studies (which 5-6 years ago would have been considered a sweet spot by many VCs).
    Consistent with that, I don’t think tech transfer offices are “under-utilized”; most technologies available for license from those offices are 2 to 3 years (at least) away from the clinic.  Except in rare instances, VCs just are interested in funding that these days.

  • http://twitter.com/EFZimmerman Eric Zimmerman

    Doesn’t the lack of interest in funding early stage deals demonstrate the inherent inefficiencies in the field though?  The pendulum has overcorrected from center and has swung towards funding the later stage deals (not dissimilar to the FDA swinging towards safety instead of pushing through drugs/devices).  Although out of vogue, there needs to be capital to get companies across the valley of death between angels/bootstrapping and later-stage VCs.  There is definitely an opportunity for some players here and as more and more money is focused downstream, this should open up more opportunities upstream because the competition for these deals has thinned.  
    I would argue that now may be the time to start investing in some early deals because it’s an investors market – glut of ideas so you can cherry pick the best technology and cram down valuation.  The skill set required for this kind of investing is somewhat different than later stage investing…MBAs and lawyers don’t necessarily have the technical aptitude for identifying the most promising technologies at a bench-top level.  I know MBAs and lawyers can build businesses but identifying commercializable technology (especially early stage) requires serious scientific acumen.  How else will technologies get from tech transfer offices to the clinic unless there are smart investors willing to bet on sound science?  Despite the herding mentality in the VC world, I think there is an argument to be made that bucking the trend and doing some early stage could not only help diversify portfolios, but also allow venture firms to capitalize on the inevitable future re-adjustment back to center.