A Case for Preclinical Biopharma Companies

Despite the talk about how later-stage companies are being more favored, Jeff Himawan from Essex Woodlands Health Ventures made a very good case for preclinical stage biopharmaceutical investments at the recent LARTA Life Sciences Venture Forum. Concert Pharmaceuticals recently announced a partnership with GSK for three preclinical programs potentially worth over $1 billion in milestone and option payments. The lead compound, CTP-518, is a novel HIV protease inhibitor expected to enter Phase I trials the second half of 2009. Chroma Therapeutics also entered into a partnership with GSK for four discovery and development programs to identify small molecule therapeutics, including a macrophage-targeted HDAC inhibitor program for inflammatory disorders such as rheumatoid arthritis. The partnership is also potentially worth more than $1 billion. Last year, Daiichi Sankyo acquired U3 Pharma AG for $235 million. U3's lead program, which is partnered with Amgen, is a fully-human HER-3 monoclonal antibody that will start clinical trials by the end of the year. Obviously, investing in preclinical programs are risky, but with most investors focusing on later-stage opportunities, there might be some good bargains at the early-stage.

Global Trends in VC 2009

The Deloitte 2009 Global Venture Capital Survey results suggest that, not surprisingly, the majority of firms plan to maintain or decrease their level of investment in the future. The pie chart below shows the proportion of U.S. firms that intend to change their level of investments in terms of capital and number of companies. There's also a shift towards later-stage companies (figure not shown).
There is a silver lining though. The medical device group appears to be favored by global VC firms compared to other sectors.The following pie charts show the proportion of U.S. venture firms' anticipated change in the level of investment for biopharmaceutical and medical device companies.

Right-sizing VC

Paul Kedrowsky of the Kauffman Foundation recently published a not-so flattering article about venture capital, Right-Sizing the U.S. Venture Capital Industry. He outlines why the VC industry will likely shrink over the next few years. His argument is simple: VCs must offer investors competitive returns for the industry to be viable. Unfortunately, VC performance has been relatively poor since the dot-com bubble burst. The amount of capital committed needs to return to levels when the VC industry generated competitive returns. So how much should the industry contract by?

"...we should expect it to fall by half to a $12 billion per year investing pace from it current $25 billion (and higher) rate."

The thesis is similar to Fred Wilson's Math Problem. I also believe that the VC industry will contract simply because many LPs will not have as much capital to invest. It will be interesting to see how quickly this right-sizing plays out. Unfortunately for entrepreneurs, obtaining capital from VCs will get more difficult as a result of right-sizing. Hopefully, other avenues (e.g. government grants, angel funds, friends and family, etc.) will be able to fill in some of the gap.

IPO Window Possibly Reopening

At the recent Wilson Sonsini Goodrich & Rosati Medical Device Conference in San Jose, Piper Jaffray investment bankers, Richard Gustafson and Neil Riley, presented data suggesting that the IPO market was possibly reopening.

As the stock markets recovered in 2003, the number of IPOs increased (see table below). The 2009 market recovery is showing a similar trend. Average revenue for IPO companies in 2003 was $165M. Similarly, average revenue for IPO companies in 2009 $149M. So far, the IPOs in 2009 have performed well, up about 35%. Due to increased volatility, a lot of money is currently on the sidelines. As volatility returns to normal, the bankers believe that some of that capital will go into IPOs.
The bankers admitted that unemployment is now much higher than it was in 2003, 9.4% vs. 6.5%, respectively. Unemployment is a lagging indicator though, so it should have less an impact on the markets' recovery. They did expect the recovery to be gradual and protracted.

Before everyone gets too excited, keep in mind that the companies that have done an IPO this year were profitable and growing at 20%. While some medical device companies can make that claim, most biopharmaceutical companies can't. For what it's worth, I remain a bit skeptical about a near-term recovery for a number of reasons - too many to discuss now. But, I am hopeful that the IPO market will eventually recover.

Financing for Med Device Startups in an Uncertain Economy

I attended the SVASE (Silicon Valley Assoc. of Startup Entrepreneurs) sponsored event entitled "Financing Strategies for Medical Device Startups in an Uncertain Economy" the other week. The panel consisted of Frank Rahmani from Cooley Godward Kronish, Ted Driscoll of Claremont Creek Ventures, Albert Cha of Vivo Ventures, and Michael Bates of Life Science Angels and Band of Angels. There were a lot of interesting conversations, but the discussion on different financing opportunities is important to highlight. I've listed some of them below:

• Government - SBIR grants are a great way to finance a startup without diluting equity, but the grant process can be time consuming and competitive.
• Incubators - For a stake in your startup, incubators provide lab space, administrative assistance, strategic guidance, etc. Although incubators usually don't provide direct capital, they will assist in finding angels and VCs to invest. Attending the meeting was Mike Partsch, entrepreneur and former VC, who has successfully launched a few medical device companies from his incubator. The Foundry is another medical device incubator with a number of companies that have been financed.
• Angels - Angels typically provide seed-stage financing to startups that are "too early" for most VCs. Raising money from Angel groups is like "herding cats" to paraphrase Michael Bates, but the members are usually seasoned entrepreneurs, who can provide very valuable advice to early-stage startups. Angel networks commonly work closely with VCs and can also assist in obtaining VC financing.
• Venture capital - In addition to providing cash, VCs offer strategic guidance, help recruit management, etc. When trying to raise money, "VCs are not all the same," as one panelists stated. Some firms focus on early-stage companies, while others invest in only health care IT startups. It's important to identify the right match. Also, make sure that there are no conflicts in the VC's current portfolio, i.e. companies with competitive technologies.
• Corporate investors - Corporate investors usually wait until most of the risk is removed from a startup before investing. Depending on the deal terms, a corporate investment may limit the number of potential acquirers in the future.

Other financing options not listed above might be available. For example, private equity might be an option depending on the stage of the company. Keep in mind that this was not meant to be a comprehensive summary of the event. I just wanted to highlight some of the important topics discussed.