Between a Rock and a Hard Place—JP Morgan Afterthoughts

1/21/11

Yes, the mood has undoubtedly improved in comparison to last year’s gathering of the healthcare investment community around the “old clock” at Union Square in San Francisco. But given the overall depression of last year this was perhaps not all that difficult to achieve. I have mulled over all the conversations I had during the usual four day frenzy, trying to sort out reality from wishful thinking, and here are a few admittedly subjective conclusions:

—The industry is still facing fundamental problems and has not convincingly formulated breakthrough solutions when it comes to the exorbitant cost of drug development, high attrition in the clinic, predictable FDA decision-making, reimbursement, and disruptive innovation. Everybody has been forced to implement draconian cost-cutting measures and it is amazing to see how much can still be done with so much less resources and money. But, we are really stretching resources and dollars towards the breaking point.

—Skepticism around IPOs in the healthcare sector without solid near-term revenue streams remains very high. Very few VC investors expect a significant increase of IPOs in 2011, hence, this favorite exit route of the biotech boom years remains elusive, putting continued emphasis on M&A.

—The emerging mantra of last year’s conversation about pharma and biotech (as well as their investors) being all in one boat has taken root. The dialogue centers around collaboration and partnership, risk-sharing, and early-stage engagement. This trend provides important feedback to biotech and biopharma startups which hopefully translates into improved relevance of the work done and financed in the early stage.

—Creativity around biotech-pharma deals has definitely increased and no structure is off the table. Buzzwords around Union Square were “option deals with negotiated upside” and “structured acquisitions.” The trend clearly points towards earlier collaboration and cost-sharing, albeit with fairly modest technology access fees or upfront payments. As a consequence, investors see their exit options dragged out more and more; simple all-cash acquisitions remain rare and might only be achieved in competitive situations created by high strategic value of assets.

—The discussion continues around the strategies of bringing innovation into healthcare. The recent mergers in pharma—Merck and Schering-Plough, Pfizer and Wyeth—have resulted in very rich clinical pipelines and thus to a fairly radical reversal in the scouting efforts of pharma. “Clinical proof-of-concept,” typically a phase 2a compound—that was the going refrain biotech heard over the last 3 years or so. But now, with their clinical pipelines filled, pharma increasingly (and eerily univocally!) calls for innovative, disruptive preclinical assets and bona fide product platforms. No surprise that this is leaving an increasing number of biotech CEOs and investors who have followed the “clinical-proof-of-concept” call scratch their heads.

—On the positive side, the healthcare industry has shown nimbleness in building and running new ventures. The quality bar for real differentiation and overall innovation has risen, and luckily, deal flow has not shrunken in view of those higher standards. There’s a steady stream of great ideas and fascinating science. Startup teams are much more attuned to cost efficiency and early go/no-go milestones. They have learned to engage and manage external resources delivering good quality results. Virtual or semi-virtual setups are becoming the norm for early startups rather than wet labs and expensive infrastructures.

So, where does this new world leave venture investors like me? Between a rock and a hard place! I can see novel, potentially breakthrough science aplenty. I can find management teams who can stretch a dollar further than in the past. I have better and more open-minded access to therapeutic area leaders and decision makers in pharma. On the other hand, VC investors have large legacy portfolios of clinical-stage companies looking increasingly desperate for cash to continue development of their assets, or for M&A transactions which enable VCs to exit their investments. And that part has not become easier.

Jens Eckstein is a general partner in the life sciences practice of TVM Capital, a venture capital firm based in Boston and Munich. Follow @

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