Investing in People, Not Products

It's a cliche that "VCs invest in people first and foremost." VCs will argue that the an experienced management team knows what it takes to commercialize a technology. But does it make sense to invest in entrepreneurs with out a technology or product? Apparently, VCs think so.

Clovis Oncology raised $145 million earlier this year without a single product to commercialize. Clovis' management team consists of former executives from Pharmion, which was acquired by Celgene in 2008 for $2.9 billion. Clovis plans to acquire or license and develop oncology products. Investors include Domain Associates, New Enterprise Associates (NEA), Versant Ventures, Aberdare Ventures, Abingworth, Frazier Healthcare Ventures, and ProQuest Investments. ProjeX Therapeutics, which is backed by Sofinova, Ascalon, and Kineta are also pursuing similar acquisition/licensing models.

Given the risks and costs of developing drugs, investing in companies pursuing acquisition/licensing makes sense. Why invest in five separate companies with five seperate products and five management teams, when you can get a portfolio of products all managed by one, experienced management team. Investors still get a say in what products/technologies to license/acquire as long as they have board representation. It's simply much more efficient and cost-effective.

I think we'll start to see more and more companies like Clovis get funded in the future. It will be interesting to see how successful these companies become. Unfortunately, if this trend continues, the individual entrepreneur will have an even harder time raising capital.

Next-Gen Genome Sequencing Attracting Investors

Despite the financial conditions, companies developing next-generation genome sequencing technology have been able to raise significant amounts of money. In August, Complete Genomics raised $45 million while Pacific Biosciences raised $68 million. Don't forget that Pacific Biosciences just raised $120 million in 2008. Both companies are pursuing the "holy grail" of genome sequencing, being able to sequence an entire human genome for less than $5,000. Keep in mind that the first human genome (Human Genome Project) took 13 years and $3 billion to sequence. See the recent article in Forbes for more on Pacific Biosciences.

While some people argue that sequencing the entire genome is not necessary, especially since 90% of the genome contains "junk" DNA, for less than $5,000, it doesn't really matter. The initial customers for genome sequencing technology will likely be drug companies for use in clinical trials, but as costs decrease, consumers will eventually become the customer. Look at the success of companies like 23andMe.

A number of next-next-generation companies, pursuing complete genome sequencing for less than $1,000, are chasing the tails of Complete Genomics and Pacific Bioscienses. They include Halcyon Molecular, Genovoxx, Lucigen, Sequenom, Oxford Nanopore Technologies, ZS Genetics, Anvantome, and VisiGen.

Highlights from California Bioscience Business Roundtable

A number of topics was discussed at the recent California Bioscience Business Roundtable including the venture financing environment, follow-on biologics (biosimilars), and health care reform.

Doug Kelly, MD from Alloy Ventures gave a pretty bleak outlook on venture financing; he even used the word "Armageddon" in describing the current environment. I was actually surprised to hear that he was not looking at any biopharmaceutical drug investments at the moment. Uncertainty surrounding biosimilars regulation and the FDA approval process were making it difficult to make any big bets. Adding to that is the financial crisis that is limiting the ability of VCs to make investments. Bill Gurley from Benchmark Capital has a great explanation of how the financial environment is impacting VC on his blog. I thought I was relatively pessimistic but Doug Kelly really depressed me!

Lori Reilly from PhRMA and Sam Youngman, White House correspondent from The Hill, discussed health care reform. The Democrats have not been doing a good job advocating health care reform apparently. Although, the recent passing of Senator Ted Kennedy might be a catalyst that galvanizes the Democrats. President Obama should start making an even bigger push for reform as a result. It's difficult to see whether any legislation will get passed by the end of the year given the amount of time Congress has left, but eventually, a compromised bill that doesn't make anyone happy will get signed. If the Democrats cannot get something signed soon though, the opportunity for health care reform will eventually die, similarly to what occurred during the Clinton administration.

Geoff Eich, Director of Regulatory Affairs at Amgen, highlighted the success of follow-on biologics regulation in the EU. For example, interferon biosimilars had different characteristics than branded interferon and caused relapses in patients. Ultimately, the EU rejected the interferon biosimilars. Human growth hormone (hGH) biosimilars suffered problems with side effects initially until it was discovered that there were problems with the purification process. Once the problem was solved, EU regulators approved hGH biosimilars. These examples clearly show that there will be a number of technical hurdles for biosimilar manufacturers to overcome. Just imagine how difficult it will be to manufacture antibodies if it's this difficult to do more simple proteins.

Top Life Science VCs

FierceBiotech just released a list of "top" life science VC firms. The article includes descriptions and different deals of each firm. It's a good resource to learn more about the life science VC firms listed, in particular what types of therapeutic areas and at what stage of development they are focused on. The definition of "top" here can be a bit misleading though. I believe that the term "top" used in the article really means most active. Nonetheless, all of the firms listed have a very good track record of making investments. There are many more VC firms that invest in life sciences, so entrepreneurs looking for financing shouldn't limit themselves to this list only.

VC Career Advice

I've been talking recently to a number of people interested in pursuing a career in VC. It's really difficult to offer any good advice as to the best way to become a VC because there are a number of different paths to choose from. VCs can come from investment banking, management consulting, start-ups, big corporations, etc. There is no "typical" career track to follow to break into VC.

With a very limited number of openings each year and many qualified applicants, VC firms can be very picky in their hiring; most VCs working in life sciences have either an M.D. or Ph.D., and several have an M.B.A. in addition to the other degrees. As the VC industry contracts (see figure below, source: WSJ), there will be even fewer positions available.


While there's no guarantee of landing a job, I believe the Kauffman Fellows Program is a good way to get your foot in the door. Search firms, such as Glocap, Pinnacle Group, and Polachi, might also be helpful.

I'd like clarify a misconception that some people might have about being a VC. I absolutely love my job, and I'm very fortunate to work with very smart, stimulating people. It's a lot of fun meeting entrepreneurs with really interesting ideas about solving the world's problems. There is no such thing as a perfect job though, as every job has its pros and cons, and being a VC is no different. Let me know if there are any jobs out there that will pay you to sleep with models (j/k). While it may appear that being a VC can be somewhat glamorous and lucrative, it is definitely not always the case; especially if you're not a partner. I rent a one-bedroom apartment and lease my car. I have about $35K remaining of almost $100K in student loans to pay off. I am by no means poor, but my life is not very extravagant either. I believe most VCs who aren't partners live relatively modest lifestyles.

Even if you overcome the odds and land a position, the probability of becoming a partner is relatively low. With fewer firms remaining, there are even fewer partner positions available. Ultimately, "you eat what you kill" in this business, and if my investment decisions result in poor returns, I won't survive in this business for too long.

Check out John Gannon's VC Career Resource page for more information.

Dow Jones VentureSource 2Q09 Results

Dow Jones VentureSource released results for U.S. VC Financing for Q2. VC financing during Q2 rebounded 32% from a dismal Q1 but was down 37% compared to the same quarter last year. For the first time, more capital flowed into health care than IT companies. While biopharmaceutical and medical device investments decreased, the health care services sector had a great quarter, improving nearly three-fold.

“Health care investment was the only sector to spring back to levels seen before the economic meltdown that began in the third quarter of 2008."

The following figure summarizes the proportion of dollars invested into the different industries (click on figure for larger view).

This rotation to health care is pretty amazing considering the capital requirements and risks associated with health care startups relative to IT companies. I believe that investors recognize that there are still healthy exit opportunities in health care compared to other industries. In my opinion, there is still a lot of downward pressure on the VC industry. Hopefully, health care can remain a silver lining moving forward.

Signs of Life in Life Sciences VC

After a rough 1st quarter, the recently released OnBioVC 2Q09 Trends Analysis shows that life sciences VC funding increased year-over-year by 31%, totaling about $1.71B for 2Q09 vs. $1.18B for 2Q08. Funding for the quarter increased about 20% relative to Q1, which was approximately $1.43B. Not surprisingly, most of the money (almost $1B) went to later-stage companies (Series C and beyond).

It will be interesting to see what the NVCA/VentureSource Q2 results will be. I'm wondering if VC firms are rotating into life sciences deals or whether other industries will see a healthy increase in VC funding. I can see why VCs are interested in life sciences investments at the moment given the exit opportunities. I am a bit surprised, though, by the magnitude of the increase in life sciences funding compared to last year. Maybe LPs are loosening up faster than I expected, which is great for start-ups seeking capital.

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.

Asset Bubbles

Easy credit, in addition to other factors, contributed to the real estate bubble. I believe that venture capital also benefited from cheap money. I looked at the amount of venture capital invested in biotechnology and medical devices (from Thomson Reuters, NVCA Yearbook 2009) and compared it to the Case-Shiller Home Price Index (from Standard & Poor's). As the chart below shows, VC investments in biotechnology and medical devices (bars) have followed a similar path to that of home prices (line). While there shouldn't necessarily be any correlation between the two, the abundance of cheap money seems to have helped over inflate a number of assets. If you believe that real estate is overpriced and that the correlation to hold, VC investments still has a ways to fall.

The Coming Contraction

As I mentioned in a previous post, I believe the VC industry will contract mainly because some funds will have a difficult time raising new money from LPs in this new financial environment. Fred Wilson has a very good post on the "Math Problem" that the VC industry has and why the asset class will likely shrink because of it. One could argue that the Math Problem doesn't apply as much to the life sciences sector since M&A activity remains relatively robust, but we'll leave that discussion for another day. While less capital is good for LPs, it does make things harder for entrepreneurs trying to raise. As the industry emerges from the current financial crisis, I believe that capital efficiency will be the focus of most VCs, both in technology and life sciences. It's not like capital efficiency wasn't important before, but it will definitely be more now. For the entrepreneur, that means doing more with less. It likely means that fewer primary care drugs and more specialty drugs get funded. Unfortunately, it also means that fewer startups in total will likely get funded.

VentureSource Q1 Numbers Not Very Pretty

Dow Jones VentureSource just released Q1 results for VC activity in the US. Not surprisingly, the numbers weren't very pretty. Total dollars invested decreased by 50% from the same quarter last year. The one bright spot - if you can really call it that - was health care, which only declined 34%. M&A activity in health care has kept VCs interested in the space. VC investments in all the other sectors declined 50% or more. So have we hit the bottom? Are VCs going to jump back in and start deploying cash? Will companies finally be able to raise capital? Unfortunately, I think it's too early to tell. Even if we have bottomed out, I don't expect too many VCs will rush back in right away. It's probably going to be a drawn out process as investors slowly test the waters.

Laying Down Some PIPE

A PIPE (private investment in public entity) occurs when a private investor (e.g. a VC/PE fund) purchases shares of a publicly traded company. Recently, VCs have been showing a lot of interest in PIPEs. Sunesis just announced that the company secured $43.5M in a private placement led by Bay City Capital. Other recent PIPEs include Xenoport, ATS Medical, and Stereotaxis. The main reason VC funds are doing PIPEs is because valuations of public companies have been indiscriminately slaughtered; a number of companies are trading for less than cash. Another advantage of PIPEs is that of liquidity (theoretically), especially with the IPO window closed. VCs normally don't do many PIPE transactions. Public companies are generally left to mutual funds and hedge funds to invest in. PIPEs don't always result in a board seat for the VC; thus no active management or much control over the investment. Another reason PIPEs aren't too common is that a portion of the financing is spent on adhering to SEC regulations for public companies rather than improving the business; Sarbanes-Oxley is a common complaint. Liquidity is not always guaranteed; even though the companies are public, there might not be enough float to sell the shares. In the current financial crisis, some PIPEs make sense though. Unfortunately, PIPEs only make it more difficult for private startups looking to raise money.

Corporate Venture Capital

Merck KGaA recently launched a corporate venture capital fund called Merck Serono Ventures. The fund intends to invest $54 million in biotechnology startups over the next five years. Even Google's new venture arm plans to invest in biotechnology companies. It's a bit of a surprising move; most life sciences corporate venture groups have not fared well. Merck Capital Ventures, for example, was shut down last year. Fred Wilson has some great comments on the inherent conflicts of corporate venture capital arms on his blog, A VC. Nonetheless, this is good news for startups trying to raise capital in a very challenging environment.

With Adversity Comes Opportunity

As mentioned in a previous post, the financing environment for pre-revenue life science companies is challenging. The IPO window is closed, and venture capitalists have become more stingy about deploying capital. Unfortunately, some start-ups will be unable to find financing and will fold. According to BIO, ten biotech companies have already gone bankrupt since November of last year. About a third of publicly traded biotech firms have less than 6 months of cash on their balance sheets. I hate to encourage taking advantage of others misfortune, but for those who survive and have cash, opportunities to pick up valuable assets for very little may abound. Keep an eye on bankruptcy filings. Unfortunately, the DowJones Bankruptcy Review requires a subscription, but the WSJ Bankruptcy Beat might be viable a free alternative.

VC Financing in the New World

It should be no surprise that the current financial crisis is negatively impacting VC financing. Limited partners are having problems making capital calls, and IPOs are no longer an option for an exit. Cooley Godward Kronish LLP recently released its report on venture capital financing terms for 2008. As expected, valuations significantly deteriorated in Q4. How does the new financing environment impact life sciences investments? According to VentureSource, investment in U.S. health care companies decreased by 42% in Q4 compared to the same quarter in 2007. An article in the February edition of Nature Biotechnology summarizes some of the negative consequences, especially for early-stage health care startups. As VCs become more risk-averse and as valuations come down, later-stage investments will probably be more favored, and terms will be more onerous for the entrepreneurs.

The Venture Capitalist Is Dead! Long Live the Venture Capitalist!

I recently attended the Medical Device Growth Conference in San Francisco. Not surprisingly, the mood was pretty grim given the current financial environment. One of the discussion topics was whether the VC business model was dead. Alan Patricof from Greycroft Partners recently wrote an article in the NY Times about the subject. With fewer exit opportunities and less funding, the VC industry will likely contract. I doubt many people will argue that a number of VC funds will not survive the current financial crisis, but is the entire industry dead? Phil Young, from U.S. Venture Partners, was a member of a panel and reminded everyone that he's been hearing that the model was dead ever since he started working in venture capital over 20 year ago. As the financial landscape evolves, the VC industry will likely adjust with the changing environment as it always has.