[[Correction: 11:20 am ET]] It’s never been easy to make a buck in biotech venture capital, but there used to be more predictability and logic to it, according to Clarus Ventures’ Nick Galakatos.
You’d invest a few million, or tens of millions, and push a new drug or device toward some scientific validation in a few years. The world would recognize the value, you’d cash out, and repeat the process.
But in the strange way the market has worked for biotech since the financial crisis of 2008, that’s not always how it is anymore.
“For any VC firm to be in business, you have to raise another fund, and to raise another fund, you have to have exits,” says Galakatos, the co-founder and managing director of Clarus. “When you think about exits, there are traditional ones, like IPOs and M&A. But the IPO market is not a healthy market, and the M&A market is idiosyncratic. And idiosyncratic is really the right word. You can’t predict the M&A market very well, you can’t probabilize that. Five years ago, you could say ‘I’ll create a company, and do X, and there will be five buyers.’ You can’t say that anymore.”
Galakatos, a 20-year veteran of biotech ventures, spoke philosophically at times about the state of biotech venture capital during an interview last week at the JP Morgan Healthcare Conference. Clarus, a firm with $1.2 billion under management in biopharmaceutical and medical technology companies, is feeling the same heat others have in this industry. Biotech VCs have all been pushed to show returns to their investors that justify their high-risk endeavors, especially when investors have plenty of other ways to put capital to work.
This will be an important year for Clarus, which will go a long way toward determining what its future looks like for the next five. The firm raised its last fund, worth a reported $660 million, in February 2008 just before the financial collapse. Clarus was “exceptionally fortunate” to raise the fund (now worth $700 million, Galakatos says) when it did. But now that four years have gone by, it will probably be just a few more months before Clarus hits the fundraising trail again, Galakatos says. “Probably in the latter part of this year, we’ll go out and raise a new fund,” he says.
[[Correction: the returns cited below are for current partners at Clarus, but their investments were made previously at MPM Capital, not Clarus.]] The partners at Clarus have had a strong run of returns. Before the financial crisis struck in 2008, the partners at Clarus were able to claim success when Rinat Neuroscience was bought by Pfizer for $500 million, Syrrx was acquired by Takeda Pharmaceuticals for $270 million, Tercica was bought by Ipsen for $373 million, and CoTherix was snapped up by Actelion for $420 million.
In the post-financial crisis era, Clarus has pulled out a few wins, but not as many. ESBAtech was sold to Alcon for $589 million, and Taligen Therapeutics was taken over by Alexion Pharmaceuticals for $111 million. Clarus was also the largest shareholder in Aliso Viejo, CA-based Avanir (NASDAQ: AVNR) when that company won FDA approval of its first product, and it held a 13 percent ownership stake in San Diego-based Zogenix (NASDAQ: ZGNX) when it went public last year.
But those last couple deals aren’t screaming home runs—Avanir was worth a little more than $360 million at yesterday’s close, and Zogenix’s value was about $164 million as of yesterday. And one of Clarus’s portfolio companies, Virdante, sold for the bargain price of $4.5 million up front to Momenta Pharmaceuticals a couple of years after it raised $30 million in venture capital.
Still, there are reasons to be optimistic about the year ahead, Galakatos says. Clarus is waiting on pins and needles to see what will happen with New Haven, CT-based Achillion Pharmaceuticals (NASDAQ: ACHN). Clarus owns about 20 percent of Achillion’s shares, according to the most recent proxy statement. That stake could be worth a fortune, because Achillion is one of the few independent hepatitis C drug developers left standing after a Big Pharma bidding frenzy led to the takeovers of Pharmasset ($11 billion) and Inhibitex ($2.5 billion) in the past few months. There’s much scuttlebutt on Wall Street about how Achillion could be the next takeover candidate.
“We currently own a material percentage of Achillion, and it’s a good time to own a material percentage of Achillion,” Galakatos says with a smile.
Beyond that, there are a number of portfolio investments from the past couple of years that are showing promise, but haven’t yet generated liquid returns. Galakatos singled out Seattle-based NanoString Technologies as a company that is developing what could be a serious new technology for cancer diagnosis; Princeton, NJ-based Ophthotech‘s promising drug candidate for macular degeneration; and Mountain View, CA-based Restoration Robotics, which is developing hair transplant technology. “I look forward to maybe benefiting from that one,” Galakatos says.
The overall strategy hasn’t changed much at Clarus in the past few years, although it does try to remain diversified within healthcare to deal with cyclical ups and downs. About three-fourths of the firm’s money gets allocated toward biopharmaceutical R&D, and spread among early, mid, and late-stage development, Galakatos says. The remaining one-fourth goes into medical technologies like devices and diagnostics, he says. Clarus looks to put between $20 million and $70 million into each company, depending on what stage it’s at.
Much of Clarus’ future depends on the behavior of Big Pharma. While pharma has been extremely aggressive in hunting for hepatitis C compounds, it has been gun-shy about other areas like Alzheimer’s, or certain cardiovascular conditions. Even a great drug in a field that’s out of favor could struggle to stir up interest among acquirers, if the clinical development takes too much time and money, Galakatos says.
“Pharma companies are supposed to be long-term focused, but they have to be near-term focused as well,” Galakatos says. “They have huge, very strong balance sheets, but they are P&L (profit/loss) constrained in the near-term.”
For biotech VCs and their startups, it puts more pressure on them to find clever ways to get to a key milestone on a modest amount of capital. And that milestone had better be one that produces a fundamental, not just an incremental, advance for the standard of care. At least if you want someone to buy it. “That is the challenge we face. How do we build not only exciting innovative companies but ones that have a relatively predictable probability of achieving an exit?” Galakatos says.
Do that repeatedly as a biotech VC, and the reward is you get to stay in business. If you don’t, Galakatos says, “investors have other places to put their capital, whether it’s IT, real estate, or something else.”
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