Corporate venture capital’s rise to prominence in biotech over the past few years is now a well worn subject. It was yet again debated this week at the Windhover PSA meeting, in part triggered by the recent widely-covered launch of the Merck Research Venture Fund. Like much in biotech, there are lots of (mis)perceptions about corporate venture capital (CVC) and thought I’d toss in my two cents.
From our vantage point at Atlas, CVC investing has without question been a good thing for early stage life science innovation. During a period where many of our venture brethren have focused on later stage deals, CVC involvement has brought smart coinvestors to our syndicates, deep pockets of capital, abundant advice & guidance from their R&D organizations, and market “validation” of downstream Pharma interest. As evidence of this, we’ve partnered with corporate VCs on most if not all of our recent early stage deals, including Nimbus, Bicycle, Protaffin, F-star, Miragen, and Avila. Just among those six we’ve syndicated with SROne (4), Novartis (2), Amgen (1), Lilly (1), MerckSerono (1), and Mitsubishi (1). So its clear we like them.
There are a number of common criticisms of corporate venture worth challenging.
- “Here today, Gone tomorrow”: Critics complain that Pharma changes its venture strategy every few years and so these funds aren’t reliable partners. Strategies may indeed change, but that criticism holds for all VC firms too: many independent VCs fail to raise their next fund, become zombie funds, or, even worse in an existing syndicate, decide not to support any more early stage deals. And its worth noting that GSK’s SROne (1985) and J&J’s JJDC (1973) have been around longer as consistent investors than most independent venture firms. So this worry, often used to disparage CVC, is in general unwarranted.
- “Only fair weather friends”: A number of critics say that the rise of corporate VC is just a temporary phenom or stop-gap measure in today’s tough environment, and that when the capital markets return they will be once again shunned from the best syndicates. This strikes me as highly unlikely and feels like using yesterday’s faulty frameworks to opine on the future. I think a strong presence of corporate VCs is here to stay. Our ecosystem is getting tighter and more connected, and “open source” models will further support this. In addition, venture is about personal relationships: its not the firm you work with on a deal, it’s the partner. There are some great partners at these corporate funds that I like to work with and will continue to seek out on new deals: Debbie Harland and Kent Gossett at SR One, Janis Naeve at Amgen, Henry Skinner and Anja Konig at Novartis, Steve Hall at Lilly, and many others.
- “Dumb money”: This criticism (I think) wasn’t ever a reflection on IQ, but more a perception that CVCs don’t care about price (financial returns) and only ever follow or “top-up” a round. This may have frequently been the case 5+ years ago. But the world is different today. While all CVCs have a strategic element to them (as they should), the one’s we know well have explicit financial return expectations just like our funds. And they frequently lead or co-lead deals, set the price of rounds they participate in, jump on Boards, and are personally incentivized for making returns. One CVC partner just told me they may pass on a deal because it didn’t have 5x return potential at this price. I like to hear that market discipline: it helps prevent “dumb money” pricing that leads to inflation in the market and depresses returns across the board.
So it’s clear that we (all early stage life science VCs) have benefited greatly from the rise of strong corporate venture funds, especially in the scarce capital world of early stage financings. And that’s likely to continue.
But the big question is why are corporate venturing efforts good for Pharma?
The two most commonly cited are an improved visibility into emerging biotech and enhanced access to innovation. I think these two arguments in favor of corporate venturing are frankly very weak and stem from the faulty assumption that CVC is just another form of Business Development. Its not.
- Biotech Visibility: The reality is that most Big Pharma with any semblance of a Business Development function have plenty of visibility into and awareness of the innovative companies in their disease areas. This is further cemented through their dedicated venture outreach programs (e.g., “VC Days”, face-to-face meetings to review a VC firm’s portfolio, etc…), and so I think most Pharma could (and do) have a front row seat on the biotech stage that doesn’t require venture fund activities.
- Access to innovative assets. With regard to using CVC to secure access to new products, there’s little if any evidence that Pharma’s venturing activity leads to the sourcing of new programs or the acquisition of new companies out of their “portfolio” of investments. I can think of a few examples of deal-making linked to venture activities (e.g., Amgen Ventures’ Avidia investment was later bought by Amgen; MerckSerono Ventures invested in F-star and its parent did a BD deal one-year later), but these are anecdotes and don’t reflect any trends in the broader dataset. Its pretty clear that in general CVC doesn’t drive products or deals back to the CVC’s parent. There may be some evidence, however, that involvement of a corporate VC may signal quality and lead to a favorable bias in returns (StartUp June 2011), but there’s no real evidence for it materially improving a Pharma’s BD activities.
So these outreach and access arguments for corporate venture are at the margin, and probably without much quantitative merit. But I still think Pharma is wise to support some element of corporate venture activity and the reason is simple: it is essential to the health of the early stage ecosystem that the industry relies on for future innovation.
If the sector wants a vibrant environment for building an innovative pool of technologies that could eventually become a part of Pharma’s future pipeline, then we need both the capital and expertise that corporate venture efforts can bring. Surprising as it may sound, the involvement of a corporate venture partner is often the catalyst for getting an early stage financing round together. The other ecosystem benefit is that as Pharma absorbs the challenges facing their own venture efforts, they have and will appreciate the broader challenges to venture investing that we all face. Hopefully this leads to more win-win thinking.
Unfortunately, having a corporate venture effort is not necessarily a no-brainer investment for any individual Pharma company: if there’s not a specific tangible strategic advantage like access or deal flow by having a venture effort, then why bother making the investment?
It’s comes down to a game theory question about the sector. It would be easy to free-ride and cheery pick out of the ecosystem while not investing in it. But if every big Pharma bailed out of venturing today there’d be a meltdown in the early stage life science venture arena. Then we’d really have a gap in venture funding (more so than the perceived gap in place today).
I think Pharma companies that are evaluating or refining their corporate venturing efforts should think about it in two distinct buckets. Venture fund activities for supporting the ecosystem (that can be strategically aligned with long term priorities), and separate BD-directed efforts around securing specific assets.
On the venture fund side, there are at least two flavors:
- Plain vanilla corporate venture funds. These are the lifeblood of what I describe above. They tend to be “arms-length funds”, separated from their parent R&D organizations by (semi-porous) Chinese walls so as to prevent issues of IP contamination and the leaking of confidential information. From my perspective, these are really no different than other venture funds – and are often run by partners with similar backgrounds to those in independent venture firms (e.g., recovering scientists, R&D folks, former biotech executives).
- Strategic Limited Partner relationships. A number of Pharma’s support early stage innovation by making investments directly into venture capital firms. Biogen and Amgen have both been LPs in funds I know well. These arrangements enable a broader exposure to venture without having to build an internal team. As an important LP (and a rare one with lots of cash to put to work), a Pharma can also influence the nature of the deals done by the fund, and can shape the macro venture fundraising environment by only investing in funds that will do early stage innovation vs later stage incremental assets. Being an LP could also be a great way to leverage some of that corporate balance sheet cash, especially if venture returns to its historically attractive rates of return.
The BD-directed “venturing” efforts are really quite different than traditional venture, although often have fund-like attributes: the Novartis Option Fund exemplifies this model, as do side-car funds like the MPM-Novartis/J&J option funds, and even the new Mirror Funds at Lilly. There are lots of experiments around these models right now supported by both buy-side and sell-side drivers. On the buy-side, Pharma is trying to secure a portfolio of external bets for its future pipeline. And the on the sell-side, many VCs are now open to “defined liquidity path” deal constructs at the inception of a new investment to help mitigate exit risk. These can involve put-call structures. If the drug program hits its milestones, the shareholders can “put” it to Pharma for $X, or Pharma can “call” it for $Y (where $X<<$Y). If it fails, well, that’s one of the 50% that lose money. I think that in order for these types of option-based venture efforts to be successful they need to have (a) direct buy-in from the therapeutic area leadership teams that will be considering the option; (b) a more collaborative team structure where the Pharma can provide ‘advice & guidance’ to make sure the optioned program or company is matured in a favorable or attractive way. This engagement clearly means confidentiality and patent contamination issues will need to be embraced. Pooling programs may be one way to solve this. I think the lack of perceived “success” by a number of the current existing option fund deals to generate new programs may be in part due to the lack of buy-in and collaboration at the outset.
My big caution about corporate venture efforts is when Pharma attempts to do both things – business development and venture capital investing – with the same fund concepts and organizations. Its a challenge. And this is where I wonder about Merck’s new effort. Is it for BD or venture? Is it taking options, or not? Maybe I just don’t have the details well understood. But as Jeremy Levin of BMS often says, partnering and investing are different and require different mindsets. I tend to agree with that. But even more critically, the practical goals of each are very different for the corporate sponsor: one supports an ecosystem, and the other a specific pipeline.