Perspectives on VC-Backed Biotech: Looking Backward & Forward

Posted in Biotech financing, Biotech investment themes, Exits IPOs M&As, General Venture Capital, Pharma industry, VC-backed Biotech Returns

Tis the season for reflecting and predicting, so I figured I’d follow the custom and share some of my thoughts about the state of biotech in 2013 and the year to come.

Reflections on 2013.

The Biotech IPO Returns.  This is clearly a (the) major biotech market story of the year, and the positive sentiment around it rippled through the sector.  Depending on how you count “biotech”, at least 46 U.S. biotech firms had their IPOs price in 2013 – the best in 13 years.  Many of these were venture-backed biotechs, but not all of them (NVCA counts 32 biotech companies as VC-backed IPOs).  Burrill & Co reported today that US Life Science IPOs went up an average of 48% since their offerings in 2013, and 80% of the offerings were above their IPO prices at year-end (here).  There are a number of reasons behind this booming IPO market (check out here from September), but a big part of it has been generalist interest in biotech’s wide outperformance – both at the sector level, and in recent 2011-2012 IPO vintages (here).  Along with lots of potentially high impact, development-stage companies, the positive euphoria has surely let some laggards get public that would never have made it out in more “normal” times, and only the long-term markets will tell us if those companies deserved it (or are destroyed by it).  It has also biased sentiments of those firms earlier in their biotech lifecycle: discussions about preclinical exit scenarios involving IPOs are now deemed “realistic” during Series A pitches for drug discovery stage startups, and comparisons to pre-money valuations of high flying IPOs are used to justify pre-money expectations of brand new startups.  I’d argue that the latter sentiments are not going survive intact in 2014. A nuance around this key 2013 reflection is worth noting: while biotech’s outperformance has of course been due to some surprisingly good clinical data and drug launches, it’s also that the Fed’s near-zero risk free rate is driving fund flows into higher risk equities as they seek better returns over the past 4+ years.  When this accommodative stance changes, lets hope the sector’s fundamentals are strong enough to withstand the pressure.

A number of Biotech VCs reloaded with new dry powder.  We saw several high profile funds get raised this year, including 5AM, Frazier, OrbiMed, Third Rock, and Atlas.  Extrapolating from other data sources, it seems likely that ~$3.5B was raised into VC funds for Life Science investing last year (here).  Several other high profile life science funds are ramping up for 2014 fundraises that are likely to be over-subscribed given the rumors of their returns.  Fundraising is never easy but I think returns for the “survivor” funds are solidifying and LP’s are taking notice. Cambridge Associate’s 2Q 2013 quarterly newsletter (here) has healthcare, along with software, as the two top performing VC subsectors, besting IT and media – similar (barely) to the 2012 numbers (here).  And these are metrics that don’t include the significant post-market performance since June 2013 of this year’s healthcare IPOs.  In summary, I think the support from LP’s for these biotech VC allocations in 2013 is recognition that you can make good returns in biotech venture – LP’s aren’t pushovers during fundraising and they expect good returns.  While clearly in the minority, some LP’s are even more bold about their interest in biotech: earlier in 2013, a large LP and advisory firm manager emailed me that “Life science VC is our only private equity overweight right now” (a position they’ve held since well before the IPO boom) and ran a panel on the topic for his clients – I suspect he will look very prescient for that allocation emphasis over the next few years.

Corporate Pharma R&D continued its move toward an external innovation hub model.  J&J announced their Innovation Center approach in the spring of 2013 and have been incredibly active; since that time, they’ve already become a major coinvestor for Atlas’ seed program.  Sanofi’s Sunrise hit its stride in 2013, focusing on external innovation and the new SGBC (rebranded corporate venture arm).  Pfizer’s CTI effort continues to gain steam.  Merck just announced its major R&D reorg, focusing on a few innovation hubs.  Amidst all this external focus, and internal reshuffling, the big R&D mega-site appears to be the big loser, with those types of entities shedding jobs all over the place (e.g., Novartis’ Horsham site announced in 2013, Roche’s Nutley actual closure was early 2013, etc…).  The big winner appears to be Boston, reinforcing its place as the epicenter of biotech.  Another winner is the biotech ecosystem as a whole: an abundance of talented R&D veterans are eager to move to smaller companies, and big companies that are increasingly interested in externalizing innovation.  Talent and demand are great additives to our ecosystem.  2013 was in many ways just an accelerated “more of the same” on this theme vs 2010-2011.

Smaller companies were behind the discoveries of lots of the most compelling new drugs.  Many of the most exciting NMEs that were being launched, or highlighted in late development, in 2013 were discovered outside of Big Biotech/Big Pharma: Pharmacyclics/J&J’s Ibrutinib (here) was discovered by Celera/Axys scientists as a tool compound; Gilead’s Idelalisib was developed initially by venture-backed Calistoga after being discovered at ICOS; and, BMS’ anti-PD1 mAb Nivolumab was discovered at Medarex.  Biogen’s Tecfidera (BG12) was discovered and developed in Germany by Fumaderm, among others, decades ago for psoriasis before Biogen repurposed it in MS.  And Gilead’s sofosbuvir was discovered at Pharmasset.  These soon-to-be blockbuster drugs were all smartly acquired, and subsequently developed, by Big Biotech/Big Pharma.  2013’s ‘big drug news’ was largely a great reminder of how important BD strategy is for successful R&D.

Consumerization of Genomics got slammed.  The Direct-to-Consumer genetic testing play, 23andMe, suffered a massive blow from the FDA, probably setting the adoption of broadly applied personalized genetic information sharing back years in its wake.  Many would suggest, upon reading the letters and interactions with the agency, that a more engaged and solicitous strategy from 23andMe might have avoided such a negative confrontation.  But the field is where it is now.  Hate to say it, but I never bought my kit – so I won’t be able to adjust my diet of anti-oxidants to prevent my pending Alzheimer’s.

There are obviously a bunch of other interesting themes in 2013 that others have commented on, or I’ve touched on in prior posts: the JOBS Act, dawn of Crowdfunding, the euphoria in immuno-oncology and the arrival of engineered T-cells to the mainstage in cancer care (and to the main stage of venture funding with Juno!), and many others.

Crystal Ball Gazing for 2014

Always a risk, considering that predictions are seldom right, but I’ll toss out six highly probable ones:

Biotech IPO buyers will suffer from indigestion early in the year, but their appetite for good offerings will persist throughout 2014.  The IPO ‘window’ took a pause following Thanksgiving, with buysiders locking in their 2013 returns, with nearly a dozen offerings postponing until 1Q 2014.  I suspect between now and end of January some two dozen companies will try to get public, swarming the buyside at the JPM Healthcare meeting and over-working their investment bankers to jump the queue.  Some subset of these ~25 or so will price in late January and early February, but it won’t be pretty.  The markets – in particular the thought leader buyside accounts – won’t be able to absorb the supply, and a bunch of offerings will price at painfully low levels or be delayed indefinitely.  But after this mad rush, when discipline affirms itself, great companies that deserve to be public will still price attractive IPOs.  The shrinkage in the inventory of interesting small/mid-cap biotech stocks over the past 5-10 years will continue to drive the scarcity/recycling thesis supporting IPO interest.  The biotech laggards on the other hand, and those old tired companies whose broken syndicates can’t support them anymore, won’t get out or will get slammed in their debuts.  I suspect we’ll see 12-15 offerings in 1Q 2014 price, and only half-a-dozen or so a quarter for the remainder of 2014: in short, while we won’t have 46+ offerings like this year, I’d guess it will be 30+ by year end.  Worth noting this is still 2x more activity than in 2010-2012, so very much a “healthy” overall market.  Now if the Fed surprises the market with some unexpected rate changes, all bets are off – but a gradual, predictable change in Fed policy should be manageable by biotech and other higher beta equity sectors.

Pharma M&A will return, more aggressively, and earlier stage.  Despite Burrill & Co’s reported M&A volume being up for 2013 ($79B worth of US-based Life Science companies were acquired, up 8%), the venture-backed private M&A market appeared to cool off in 2013.  Although there were some great exits, like Aragon, there seemed to be fewer of these “big exits” in biotech than in 2010-2012 – or they got lost in the euphoria about the IPO window.  Irrespective, I speculate that 2014 will see a return to aggressive levels of M&A, and deals occurring earlier in biotech R&D life cycle.  We are already seeing a shift in the dialogues with Pharma in our own early stage portfolio and suspect it’s a real trend: Pharma wants innovative assets, there aren’t many unencumbered in Phase 2 or beyond and so many companies are seeking creative partnerships/acquisitions earlier in drug development.

The first crop of structured “build-to-buy” deals will come to fruition.  Over the past few years, lots of companies have been formed at inception with creative structured buyout rights pre-defined for their Pharma partners (e.g., Arteaus and Annovation in our portfolio, several of the Inception clones in Versant’s portfolio, Warp Drive Bio from TRV, Quanticel and PharmAkea with Celgene, etc…).  Many pundits have been skeptical of these structures as they possess “capped upside”; but well put together, they offer a lean and capital efficient path to high top decile venture returns.  To date, I don’t know of any of this type of deal that have exited successfully, but there are several of these across the industry that will reach their trigger milestones in 2014.  With success, I would expect to see lots more of these structured project-financing-like deals emerge across the biotech sector.

Ignoring Chicken Little, the sky will remain where it is regarding overall biotech venture funding levels.  Betting behind a 10-year trend line, I expect overall biotech venture funding to be in the $4-5B range again next year, and as usual it will be the 2nd most active venture capital subsector behind software.  But I’m sure we’ll still hear about how biotech VC is collapsing every time there’s a bad quarter of statistics.  More on the substance, I think we’ll continue to see a barbell: a bunch of seed or modest financings (hopefully increasing the first-financing numbers), as well as some really large biotech financings (>$50M).  The latter will either be the large “go-big or go-home” style Series A fundraises (Juno’s $120M being the most recent example), or will be big later-stage, pre-IPO rounds coming together around high quality stories.  Many core biotech buysiders were frustrated with their small IPO allocations last summer, and being an active crossover investor helps to lock in the required capital at work to make even a quality deal meaningful.  In short, there’ll be an active and significant venture capital segment in biotech in 2014 – expect about $1-1.25B per quarter.

Corporate VC will begin to swing back to being more strategic than financial.  For much of the last decade, most corporate venture funds fought to establish themselves as savvy, financially-focused lead investors who were truly arms-length and independent from their parent R&D groups (to prevent contamination of confidential information).  They have successfully overcome many of the prior criticisms of corporate VC (described here).  In fact, they’ve been so successful that they are now largely indistinguishable from other large VCs in the ecosystem – many bring big funds (e.g., half-a-dozen have $300M+ equivalent funds) and play lead roles in syndicates.  But they don’t typically bring deep connections with their R&D or BD organizations to the table.  This is starting to change.  Many CVC teams are seeing their mandates morph back into more strategic elements where some ‘rights’ may be important.  Some CVCs are being disbanded in favor of more direct deal-making. Further, others are stepping up their LP involvement; we had Amgen and Novartis join as new LP’s in Fund IX and their R&D teams actively engage in dialogues on projects with us.  I suspect that 2014 will see the continued evolution of the Pharma VC model toward a less financially-driven, more strategic one.  Hopefully, though their mandates may evolve, their wallet size won’t shrink: corporate VC has been a big percentage of early stage biotech venture funding for the past few years.  Without them, I might have to modify my prediction above about the sky not falling.

Big Science will continue to be big in every way.  My last prediction is that within the early stage venture universe we’ll see a continued push into high risk, high return spaces with “gosh-and-golly” blockbuster-type technologies (credit to Stan Fleming): more gene therapy, angles on genome editing, cutting-edge neuroscience, engineered cell therapies, stem cell agents, novel disease targets, new agonist modalities, etc…  These new hyper-innovative startups will attract the most interest from Pharma, and early stage VCs depend on Pharma for building these types of companies.  They are also fun to be a part of, and can generate great returns when they work.  Expect more of this kind of excitement out of the emerging portfolios of Atlas, Third Rock, Polaris, Flagship, 5AM, MPM, etc.  But this Big Science can of course lead to big disappointment and even bigger losses. Figuring out how to balance the “bigness” of an early stage financing with the realities of the risk profile is critical – many of these Big Science projects don’t offer easy inflections for a fail-fast “kill the losers” type strategy. Along with the launches of some great new startups, I also suspect we’ll see some very high profile flame-outs in 2014.

So, with that, and the pending blizzard bearing down on the Northeast, I’m going to go sharpen my skis.  My last prediction – this weekend will be great out on the slopes.

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  • Stan Fleming

    Bruce, Your last prediction about the return of big-science
    early stage investing is particularly interesting.
    Having lived through the “-omics” era of mega start-ups, I can’t recall a
    single case of a science-based large platform deal since Genentech/Amgen that achieved
    financial success on the basis of its foundation technology. You are right; they were and are a lot of
    fun, but I am not sure they are sustainable.
    It is great to have genuine interest from pharma in partnering the
    pursuit of breakthrough technologies.
    However, venture has to be careful that pharma doesn’t put them on the
    front lines of the innovation battle while the corporations, like staff
    officers of old, sit safely at HQ and take credit for the victories, if they happen.

  • Jay Caplan

    Hi Bruce,

    Thanks. I share your optimism about VC funding for biotech. Interested readers can find a list of “Biotech VCs … with new dry powder” on my blog at

    - Jay

  • Nick Seaver

    Interesting and insightful, thank you. Looking at the correlation between a variety of public market metrics and lagged VC investing figures, I’d wager that VC dollar invested will actually break out above the $5BB mark. Will be interesting to see in a year’s time.