The Inescapable Gravity Of Biotech’s Key Clusters: The Great Consolidation Of Talent, Capital, & Returns

Posted March 21st, 2017 in Bioentrepreneurship, Biotech financing, Boston Cluster, Talent

Two key geographic clusters dominate the biotech landscape today. These two areas, Boston and San Francisco, combine a unique blend of biomedical science, venture capital, entrepreneurial talent, risk-taking culture, and geographic density. Other regions have some or all of these elements, but not in the same magnitude or momentum that Boston and San Francisco have today – and the gap is just getting bigger.

Last year, GEN ranked Boston #1 and San Francisco #2 in their biotech clusters report (here). Others have covered these clusters and the rivalry between them (here), as the Economist did with “Clusterluck” earlier in 2016. But rather than draw distinctions between them, I’d like to focus on these key clusters relative to the rest of the biopharma ecosystem.

Context

Relative to the US biotech scene, Europe is often viewed as a laggard in the biopharma space from an entrepreneurial perspective. Of course, there are notable exceptions – like Actelion’s incredible success – but, by and large, there’s limited funding, limited R&D-veteran entrepreneurship and risk-taking, and limited prospects for scaling companies. While there is great science across many world-class research institutions in Europe, the commercialization of their science into local startups and emerging biopharma companies remains a challenge.

Two relevant analyses were captured in the data-rich report from HBM Partners on the M&A environment which highlight the essence of this challenge from a venture perspective: US-based biotechs drove faster exits (here) with higher investment return multiples (here) than their EU counterparts.

These data are striking.  But how much of this outperformance was driven by the two key clusters in Massachusetts and San Francisco? (I’ll refer to them as the “key clusters” from now on). In an attempt to answer this, I’ve worked with Pitchbook to assemble some data on these two key clusters relative to the rest of the US, as well as Europe.

The quick conclusion is that the rest of the US should likely use the Euro as its biotech currency; outside the key clusters, the rest of the US biotech sector performs and looks a lot like the European ecosystem.

As shown in the charts below, examining either M&A or IPO events between 2013-2016, biopharma startups from the key clusters were roughly two years faster at the median to get to that exit outcome (left chart): 7-7.5 years to M&A or IPO versus 9-9.5 years.  The quartile ranges are shown as well.  Similar timeline differentials are evident in prior time periods over the past decade as well.

In terms of value, biopharma startups in the key clusters have outperformed both on the median upfront M&A and the median IPO pre-money valuations during 2013-2016 (right chart). The average dramatically skews the distribution upwards in the key clusters (due to big outliers). Again, this differential in value also exists during other time windows of the past decade.

Holding periods and valuations at exit are reasonable but only directional proxies for investor returns. The actual returns depend on pricing of each of the venture rounds, as well as timing of stock sales, etc.  But it’s reasonable to assume based on these data that biotech returns in the two key clusters have outperformed other regions.

Why is differential in performance happening?

Biotech historians in the future might call it the “Great Consolidation of Talent and Capital.” While Silicon Valley quickly emerged in Tech a few decades ago as the nexus of all things IT and venture capital, in biotech it’s been far more geographically egalitarian in the past.  San Francisco and Boston were clearly important leaders in the early decades of the field, but so were other biotech clusters: Seattle, San Diego, Raleigh, Philly/NJ, Colorado, etc…  Most of these also had legacy Pharma or big Biotech footprints that were important for cultivation of talent.  And great firms grew out of places well beyond Boston and San Francisco: early winners like Immunex, IDEC, Centacor, Medimmune, and Celltech, just to name a few – and firms like Celgene (San Deigo, NJ) and Amgen (Thousand Oaks) – all born in other geographies.

In recent years, this has changed – Boston and San Francisco are now the preeminent biotech clusters.  And their gravity in the ecosystem is only getting stronger.

Beyond having great science and the right “pixie dust” in the local environment, two fundamentally important ingredients to the success of any cluster are capital and talent – and both are aggregating into the two key clusters.

Capital

Over the past decade, startups in the key clusters have been consuming ever-greater portions of the global biotech venture capital pie.

As shown in the chart below, since 2012, these two key clusters have increased their share by more than 50%, now securing nearly half of the global venture capital funding budget for biotech. In the US alone, depending on the data source, the two clusters are now receiving 60-70% of the country’s venture pie. Both the rest of the US and the EU have shrunk on a relative basis as a response.  The percent change in absolute dollars reflects this – nearly 130% increase in five years into the two key clusters, with the other regions relatively flat or down. Looking back to 2007, most of the change has occurred in the past five years – the distribution of capital across geographies were nearly the same between 2007-2012.

On top of the flow of venture capital, other funding sources are also consolidating into these geographies. Take NIH funding, for instance: California and Massachusetts rank first and second in terms of total NIH funding to its institutions.  And Massachusetts ranks a far-and-away first with regards to NIH funding per capita, nearly 3x higher than most other strong states (like CA, NY, PA, NJ, etc). Five of the top six NIH-funded independent research hospitals are in the Boston area (here).  Fund flows like these further contribute to the consolidation of biomedical activity into the key clusters.

However, it’s important to call attention to the disconnect between where scientific discoveries are made and where startups are formed. Many of the new companies that get created or launched in the two key clusters do not have scientific roots in those regions. As an example from our own portfolio here at Atlas Venture, despite nearly all of our startups being located/formed in Cambridge MA, the founding science is sourced from all over the globe: Unum came from Singapore, AvroBio from Toronto, Padlock from Florida, Quartet from EPFL in Switzerland, Delinia from San Francisco, etc… About a third of our new startups have roots or connections into Boston’s research institutions, a third with institutions across the rest of the country, and a third outside of the US. So the concentration of capital doesn’t mean scientific sources have shrunk; in fact, it’s increasingly clear to us that science competes on a global stage and we need to access the best substrate wherever it may be – but put the startup where it can take advantage of the benefits of a key biotech cluster.

Talent

It’s much harder to quantify the talent metrics, but one only has to see all the cranes in Cambridge MA to know that big things are happening here. Nearly every major biopharma company has a research footprint in the region.  Same goes for the Bay Area, though much more spread out around the region.

To get a sense for the consolidation of talent, here’s a chart that attempts to capture the change in biopharma R&D employment in the three geographic groupings.  The key clusters have seen R&D employment grow by 30% in past decade, versus shrinking in the other major biopharma states (like PA/NJ). Europe, according to their pharma trade group, is flat – though I suspect the metric is actually down in Pharma R&D organizations and up in the CRO R&D world.  As a macro point, these data reflect the intuitive sense we have of recruiting talent from other regions into Boston: with regards to R&D teams, prior Pharma hubs are shrinking rapidly while Boston is growing. We’ve even recruited a few sun-loving San Diego biopharma vets to move to the Boston market recently.

As this implies, for startup biotechs, larger biopharma companies are the lifeblood of the talent flows (prior blog on topic is here). Most of our early stage startups are led by teams with experiences inside of larger R&D organizations. The serial cycle of biotech entrepreneurship – starting companies, recruiting talent, discovering new medicines, and getting acquired (or going public) – is accelerated in high density clusters. The entrepreneurial diaspora enabled by biotech M&A is just much larger and more vibrant in these clusters (here). As shown by the data above, faster timelines, more acquisitions, and more R&D talent flows just add more and more water to the millrace, powering the wheel of the biotech mill churning out startups in these key clusters.

As these data suggest, the great consolidation of talent and capital into the two key clusters has clearly been happening in the past decade – and shows no signs of abating any time soon. While the prior return metrics of time and value are clearly lagging indicators of an ecosystem, as they reflect the value creation pace and trajectory in the past few years, metrics around talent and capital flows into startups will most definitely shape the future of these ecosystems.

So what are the implications of this consolidation for different stakeholders in the ecosystem?  Here are a few thoughts.

If you are a sector or civic leader in one of the key clusters, some simple advice: don’t get complacent. Make sure the local infrastructure doesn’t fail you at the most critical moment. Congestion, commutes, and chaos can only lead to an exodus over time of those interested in a better quality of life. Further, building capacity to grow will be important; scarce lab space has already driven rents in Cambridge to outlandish levels. We’re seeing startups begin to move back out to the Rt 128 corridor. While still part of the greater Boston ecosystem, those locations are less hyper-connected to the benefits of the density and proximity of the Kendall biotech scene. Lastly, make sure you keep importing ideas and talent into the cluster from around the world or you risk becoming insular; ideas are global, talent is mobile – so keep focusing on bringing them into the region.

If you aren’t in a cluster today, different stakeholders might think about this challenge differently. A few themes:

  • Can’t beat ‘em, join ‘em. One school of thought would suggest that rather than fighting the consolidation, work to benefit from it.  If you are an academic investigator interested in founding a new company, and you want to maximize its chances of success, you might consider putting the startup in a key cluster and create virtual links back to your lab elsewhere in the US or Europe (we’ve done this successfully many times). You’ll need connections into those clusters, but some creative use of email and social media can usually get you that. If you are a tech transfer executive, you might also work to build connectivity with venture creation firms in the key clusters.
  • Give them an offer they can’t refuse. The alternative for economic development minded folks in other regions is to enable your local startups with “extra” advantages. Provide R&D credits or funding, like Texas did with CPRIT grants – these significant funding infusions lower the cost-of-capital for young startups and let them progress with less equity investment (since its less available outside of clusters). Unclear whether these are sustainable in the long run, but they could help prime the pump. It’s also important to cultivate more anchor tenants to remain or build in the region; easier said than done, but the revolving door of talent from larger biopharma into smaller companies is a crucial component to a successful cluster. Along those lines, facilitating the return of your regions biopharma diaspora could help; many exec’s in the key clusters hail from other parts of the country or world, and some wouldn’t mind returning “home” like former California investor JD Vance recently did with Ohio. I’m sure tax deductions to successful returnees would spur lots of interest. At the end of the day, in the face of this ongoing consolidation, regions need to figure out how to give their startups a leg up to compete without a major disadvantage.
  • Be the big fish in the small pond. This is a riff off the age-old contrarian investor thesis. Much like biotech has been a recent contrarian bet in venture capital amongst many LP’s, creating or investing in startups outside the key clusters could offer some advantages – fewer competitors for the regions talent and capital, even if scarce, means that you could attract more of them. And there’s less threat of losing talent if there’s few other places for them to go. Further, operating costs are lower – both people (salaries) and fixed costs (rents, etc) are often far less expensive outside the clusters. Most of these other regions remain under-appreciated, and a local champion might get a reasonable cut of the “best” ideas in the smaller pond.  But you’ll need to figure out how to evolve these businesses into global competitors over time – and one idea is to have a satellite office inside one of the major clusters to access the talent and capital advantages of those markets (which we’ve done with numerous startups in the recent past, like here).

The current trends around capital and talent flows strongly suggest that Boston and the Bay Area will be the preeminent biotech clusters for the foreseeable future – and the global biotech startup scene needs to figure out how to adapt to that reality.

 

 

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  • Leslie Molony

    This clustering in two cities is not a great thing for innovation or for talent. Some of us do not wish to live in those areas, or cannot. Some of our regional faculty have great ideas and discoveries that don’t get money. This geographic segmentation sets unnecessary limits to industry innovation.

  • jim hoch

    People who have the drive to be successful will move. It’s no different than film, finance, or country music, if you want to be a player you go to where the action is.

  • LifeSciVC

    Leslie, thanks for the comment. We back ideas and discoveries from all over the globe, so happy to connect with your regional faculty on great science. Building successful companies requires more than just great science though – talent, capital, culture, environment all play into the mix.

  • Stephen Provost

    Having recruited biotech management teams in both the clusters and the non-clusters (our proudest was the Arkansas search), this is a daily convo I have.
    My thoughts:
    – CPRIT companies are islands right now. Texas hasn’t built a critical mass to start a tight community yet and since the cities are spread out, it adds to that challenge.
    – Shaving 2 years off an exit could do with that fact that it’s easier to meet quickly in person at Le Meridien or the Weston than getting on a flight to Denver/Seattle/Austin. Those smaller, accessibility reasons, can add up over time.
    – MA will pull away with the lead soon from Bay Area based on cost of living. I have senior management members tell me daily that they’ll move anywhere BUT Bay Area. You’ll pay $3.2m for 3/4 BR in Palo Alto. South Bay and North Bay aren’t too much better.
    – Non-cluster areas can work. We’ve completed searches in 15 states in biotech. Like most things in this industry, if the science is sound, things always find a way of falling into place.

  • Tim Gallagher

    Boston & SF surely are the top biotech clusters in the world, but I’m wondering if this is an inevitable win for BOS/SF simply through numbers or are the companies in the “key clusters” better? (E.g. if a given technology or start-up or person has a higher ceiling or greater probability of success in Boston or SF.)

    I think this article ably demonstrates the greater scale in the “key clusters” (total NIH funding, greater valuation at exit, etc.), and wants to deliver the ceiling/probability of success, but I don’t see evidence of that (yet). Yes, key cluster companies are 2 years quicker to the public markets, but I’m not sure that represents better companies rather than more financial engineering or more hype. As an example, consider the 2 Boston CRISPR companies (EDIT & NTLA.) They’re super-quick to the public markets, which only could have happened in BOS/SF, but they are still fundamentally preclinical companies. Only in the “key clusters” do 2 pre-clinical companies have a collective $1.3B in market cap, but 40% of this is cash on the balance sheet, with very little news flow to come for years. suggesting a lower true/future valuation, along with the inevitable trimming from platform company to a product company with 1-5 programs nearing IND. Might these companies have had a higher ceiling had they started as cash-starved start-ups in the hinterlands?

    I also see that the mega-biotechs were (generally) created outside the “key clusters,” suggesting that what the Hinterlands lacks in quantity, it makes up for in quality. Working down the top holdings of IBB, which list represents greater long term success?

    Boston/SF: Biogen, Vertex, Gilead, Incyte, Biomarin, Exelixis, Alnylam, Bluebird

    Hinterlands: Amgen, Celgene, Regeneron, Alexion, Illumina, Shire (CT), Qiagen, Seattle Genetics, Jazz Pharma, Tesoro, United Tx, Ionis, Acadia, Kite, Bio-Techne, Cellectis, Juno, Genmab, Morphosys, Galapagos

    Up for debate: Alkermes (half-BOS, half IRL.)

    (I recognize that this is a trailing indicator of key cluster growth.)

    It seems that the “key clusters” lead in numbers of companies and dealflow, but not necessarily long term success, Another area to explore (in another post) is where the economic impact is generated, as many well-funded companies in the “key clusters” are 2-10 person virtual companies, with operations contracted out to hinterlands CROs like Biocon (India), PPD, INC, PRA, Quintiles (all NC) and Covance (various), with manufacturing ultimately outsourced as well to Patheon/Dr. Reddy’s/DSM in the hinterlands.

    (full disclosure: I work in biotech economic development in a hinterland location.)

  • Alex

    Whilst it is true that Boston and San Francisco are undeniably the homes of Biotech, I feel I should make an effort to stand up for Europe and, in particular, London. As a young scientist looking to work for a start-up biotech I was spoilt for choice in many areas of research. The company I am with now is one of the first on a large new site being developed for Biotech Research and Translation. The number and quality of nearby universities with a desire to foster new talent and feed innovation is ever growing (4 out the top 5 European universities plus The Francis Crick institute, The Wellcome Trust etc). Proximity to both large pharma and the financial industry of London encourages collaboration and access to funding.
    London has also been a talent draw in a similar way to the North American key clusters with a strong influx of great people from Europe. I can only hope that this remains so throughout and after Brexit. In the meantime I will continue to count cranes out of my lab window…..I’ve got to 23.

  • Nathan W

    Thanks for a wonderful blog. I am a technology and patent analyst for an investment bank in Dallas, TX. I have to agree with Leslie on this one. Not everyone can afford to live in SF, especially talented scientists coming from places like UT Southwestern, UT Austin and WashU. The Bay Area doesn’t have a monopoly on talented scientists (nor Boston).This trend sends a chilling effect on great scientists living outside of these hubs; often forcing them to leave the profession. I have been asked to do some advocacy work to promote biotech in Dallas. The goal with my presentation is to encourage local entrepreneurs and financiers to invest in Texas start-ups that are spun-off from Texas medical school and universities. There have been over 16 biotech start-ups launched in the last 15 years in the Dallas metroplex that have failed, been bought-out, or relocated to biotech hub cities, like San Francisco. Further, we have some start-ups here with a bare bones headquarters in Dallas but their main R&D operations are located elsewhere. Why? Most of the companies from this list were spin-offs from local Universities whose basic research was supported with local alumni and taxpayer money. Two of these companies were asked to relocate to hub cities at the request of an out of state VC(s). Even though it would have been cheaper to have them here in Dallas than SF ($29 sq ft vs $75 sq ft office space; plus salaries are higher due to the increase in the cost of living, mostly housing). These relocations of start-ups just the cost the VC and angel investors (and their backing accredited investors) more money and will result in a decrease ROI. Even some CPRIT executives are encouraging the out of state relocation of spin-offs; using TX tax dollars to create jobs in CA. Of note, if one looks at migration patterns between TX and CA. Most people are leaving CA to move to TX due to lower taxes and a substantial decrease in housing costs. So what are these VC investors thinking?

  • Nicholas Phillips

    Great article! But unless I missed it in the above text, you did not mention infrastructure. Biotech requires hazardous waste removal, special water, companies that expertise building ISO certified rooms, etc. Since CA and MA both have this infrastructure, they are more attractive for start-ups.