Third Rock’s Bet on Lotus Tissue Repair Generates Big Return

2/27/13Follow @xconomy

Third Rock Ventures has seen its biotech startup companies achieve some impressive things since it got going in 2007. But now the firm can point to the first venture-style return on one of its home-grown startups.

Dublin, Ireland-based Shire (NASDAQ: SHPG) shed some light on Third Rock’s biggest return in a regulatory filing this week.

Shire said last month that it agreed to acquire Cambridge, MA-based Lotus Tissue Repair, and Monday it disclosed the amount of the deal—$49.3 million up front plus another $275 million later if Lotus can hit certain safety and development milestones. The disclosure came in a footnote of Shire’s annual report filed with the Securities and Exchange Commission.

The dollar amounts aren’t huge by biotech standards, but the deal is still important to Third Rock. That’s because the firm was the sole venture investor in Lotus, and doesn’t have to split the winnings with any other VC firm. Third Rock committed $26.5 million in a Series A venture round in June 2011, but only pumped $2.8 million into Lotus at that time, according to an SEC filing.

Shire swooped in to buy the company after just 18 months in business, when Lotus had only done one financing round. Third Rock still held a 73 percent ownership stake, with the rest held by founders and employees, a Third Rock spokesman says. If Lotus can hit all the milestones in the Shire agreement, it could end up delivering a 20-fold return on investment to Third Rock, the spokesman says.

If my math is correct, it means that Third Rock generated a three-fold return on investment from Shire’s up-front payment, at a minimum.

“Not bad at all,” says Bruce Booth, a partner at Atlas Venture in Cambridge, MA, and an active life science investor. Third Rock declined to make a partner available for comment about the deal.

If Third Rock can secure a few more paydays like that in the years to come, it will earn the right to continue as one of the few venture firms still active in early stage biotech investing. Third Rock, which has offices in Boston and San Francisco, raised an initial $378 million fund in 2007 and a second fund worth $426 million in 2010. Unburdened by the need to prop up older portfolio companies that had to limp through the Great Recession, Third Rock charged ahead with a high-risk/high-reward strategy based on building startups from scratch in areas where it perceived big scientific opportunity.

Just as many other venture investors have turned conservative in hopes of eking out some short-term returns, Third Rock has bet on long-term fields of science, like tumor metabolism, gene therapy, and epigenetics. Sometimes, like in the case of Lotus, it decided to take the risky route of being the sole investor, rather than build a broader syndicate of venture investors that could help mitigate the downside.

Although some of these early portfolio companies have shown signs of promise, like Agios Pharmaceuticals, Foundation Medicine, and Constellation Pharmaceuticals, many of Third Rock’s investments, by their nature, will take years to achieve the scientific validation they need to generate liquid returns.

Only one member of Third Rock’s original portfolio of more than 30 companies had delivered a liquid return before Lotus. That was Cambridge, MA-based Alnara Pharmaceuticals, which was acquired by Eli Lilly for $180 million up front in July 2010. That return, however, wasn’t as meaningful to Third Rock, because it was one of five venture firms in the deal, and it didn’t start the company.

Lotus, which we profiled at its start back in June 2011, was founded by Third Rock to treat a rare genetic disease called dystrophic epidermolysis bullosa (DEB).

Only about 300 people in the U.S. are thought to have this condition, which causes painful skin blisters that can result in fingers and toes getting fused together. Sometimes the blisters migrate internally, to the esophagus, the mouth, the gastrointestinal tract and the upper airways, causing all kinds of pain and suffering. Victims are also at high risk of developing squamous cell carcinoma, a deadly skin cancer. There is currently no FDA-approved treatment for the disease.

The technology for the startup came from Mei Chen and David Woodley, a pair of dermatology professors at the University of Southern California. They performed animal studies with a protein replacement treatment that is supposed to migrate to the wounded skin, and heal it. Mark de Souza, formerly of Dyax, was the founding CEO, and served as a co-founder with Philip Reilly, a venture partner at Third Rock.

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