Biotech Is Raising More Cash, But Don’t Be Fooled: Startups are Hurting

1/23/12Follow @xconomy

Mark Twain used to toss around a saying about three kinds of lies. There are lies, damned lies, and statistics. This week in biotech, we saw some statistics that could lead some people to get a false impression that everything is just peachy in biotechland.

If you measure the state of life science innovation by the amount of money flowing in, things look swell. Venture capitalists poured $4.73 billion into 446 biotech companies last year, according to the MoneyTree report by the National Venture Capital Association and PricewaterhouseCoopers, based on data from Thomson Reuters. The venture industry association’s press release cheerily noted that overall venture funding jumped 22 percent last year. While software is still the No. 1 and faster-growing sector of the two, biotech held its own, with a solid 22 percent gain in dollars invested compared with a year earlier.

You have to dig deeper to see what’s really going on. There is still a good amount of money going toward late-stage development of drugs people started working on 10-15 years ago. But there is an alarming drop in support for today’s cutting-edge biotech startups. Last year, just 153 U.S. biotech and medical device startups got their first round of financing, the lowest amount of seed investment activity in 15 years, as reported by Ryan Flinn of Bloomberg News.

There’s something really wrong with this picture. Most any biologist will tell you we are living in a golden age of discovery, at a time when we will soon be sequencing entire human genomes for $1,000 in one day. We are able to ask questions about how life works that nobody could even imagine asking a few years ago. It ought to be the time to charge ahead with basic research, and early-stage R&D to test exciting new concepts in diseases like cancer, diabetes, Alzheimer’s, HIV, and more.

But everywhere you look, the story is about cuts, cuts, cuts. The National Institutes of Health, the primary government agency that supports basic biomedical research, used to write checks for one out of every three grant applications, but it’s now down to about one out of every six, NIH director Francis Collins said earlier this month at the JP Morgan Healthcare Conference. Pharma companies are cutting back on R&D, firing workers left and right, and leaning on cheaper outsourced vendors everywhere they can. As many as one-fourth to one-half of biotech venture capitalists are thought to be slowly going out of business, as they are unable to raise new investment funds. The same IPO investors that want to buy Facebook shares look at biotech stocks like a four-year-old looks at lima beans.

There are good reasons why we see all those things happening. Pharma companies have created enormous inefficiencies for themselves through mega-mergers, and now they need to spend years trying to get their houses in order. Biotech as an industry has overpromised and underdelivered, and many investors are tired of it. The FDA, stung by various drug safety scandals, has been cautious about approving new drugs (although there are signs that FDA leadership wants a more balanced approach). And of course, our society is still struggling to come to terms with healthcare reform, and the realization that it’s unsustainable to spend infinite amounts of money on healthcare.

John LaMattina

All that said, an entrepreneur or a bold Big Pharma executive is the kind of person who looks at that picture and believes he or she can overcome the hurdles, and form a plan to turn vision into reality. But there aren’t that many people out there with the can-do spirit, or guts, to put down real money behind really talented teams devoted to the discovery of new drugs. And because everybody’s talking about how to go from Phase I to Phase II with drugs people invented years ago, there’s a real possibility that once those projects run their course, we’ll all look around in 2020 and wonder where all the wonderful new drugs are going to come from.

“You can really get into a vicious cycle when you have to eat your own seed corn,” says John LaMattina, a senior partner with PureTech Ventures, and the former president of R&D at Pfizer.

There are exceptions, of course, with a few people trying creative new ways to plant seed corn. Third Rock Ventures and Atlas Venture are a couple of VC firms that have remained active, continuing to bet big on the edgiest stuff coming out of the labs. Most every Big Pharma company has set aside cash for corporate venture firms that are seeking to help fill the void being created by the shrinkage of traditional VC. Pfizer, Johnson & Johnson, Sanofi, Bayer, and deserve credit for working on creative new collaborations with top biomedical universities and research centers, which seek to minimize some of the problems with the fruitless alliances of the past. J&J made news this past week when it unveiled an incubator for 18-20 startups in San Diego which looks to fill up some lab space it had vacated through its own internal R&D cutbacks.

Right now, we are in an age of experimentation with new organizational structures for supporting biomedical R&D. The hope is that these new organizations can reduce the time, money, and high-risk profile that has made life sciences such a hit-or-miss investment over the years. Pharma companies know they don’t have all the answers, because they can’t develop everything in-house, no matter how many mega-mergers they do. Biotech companies generally realize they can’t raise a billion dollars, and wait 15 to 20 years for a payoff, in hopes of becoming the next Genentech. More and more R&D functions—chemistry, toxicology, formulation work—can easily be outsourced to contract research organizations who can do it faster and cheaper.

Since we’re talking about experiments, some will pan out, some won’t. But ultimately, these ideas need to be tested in startups if we’re going to make real progress. I’m reminded of the time biotech pioneer Leroy Hood told me that “new ideas need new organizations.” He brought this up while telling the story about how nobody in industry wanted his technology in the 1980s for an automated gene sequencing machine. Big companies just had too many other projects going on, and didn’t believe it would work. Somebody needed to come along and take the risk to finance Foster, City, CA-based Applied Biosystems, now part of Life Technologies. And we’re lucky that somebody did, because that company made the workhorse machines that made the Human Genome Project possible in the 1990s and early 2000s.

We’re at a point now where there are lots of good ideas, perhaps some even as good as high-speed gene sequencing was in the early 1980s. The question is whether we as a society will recognize the challenge we are facing with early-stage biomedical R&D, and step up to solve it. If we don’t, we’ll never know which of today’s ideas will turn out to be great advances for medicine.

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  • Nessan Bermingham

    Luke – you hit on a very important issue our industry is facing today. Our biggest challenges revolve around R&D risk and capital requirement. When compared to alternate asset classes the IRR for early stage venture investing has been disappointing. Liquidity today requires human PoC with a clear FDA pathway to approval, & reimbursement. Acquisitions are milestone based with the true upside for investors coming much later after acquisition – with a 10 year lifecycle for a fund this is an issue. With the dwindling number of venture investors in an environment of smaller funds we face unprecedented challenges. As an industry we need to work with academics, regulators and industry to start to design models that are viable long term – the Atlas and Third Rock approach are certainly steps in the right direction but they are not the complete answer. One shouldn’t forget that the markets are cyclical, our industry will survive however, for it to prosper we need to accept the new world we live and work in, developing appropriate ways to address it and truly developing innovative, game changing therapeutics.

  • Nessan Bermingham

    Our biggest challenges revolve around R&D risk and capital requirement. When compared to alternate asset classes the IRR for early stage venture investing has been disappointing. Liquidity today requires human PoC with a clear FDA pathway to approval, & reimbursement. Acquisitions are milestone based with the true upside for investors coming much later after acquisition – with a 10 year lifecycle for a fund this is an issue. With the dwindling number of venture investors in an environment of smaller funds we face unprecedented challenges. As an industry we need to work with academics, regulators and industry to start to design models that are viable long term – the Atlas and Third Rock approach are certainly steps in the right direction but they are not the complete answer. One shouldn’t forget that the markets are cyclical, our industry will survive however, for it to prosper we need to accept the new world we live and work in, developing appropriate ways to address it and truly developing innovative, game changing therapeutics.

  • http://www.xconomy.com/author/sfriend/ Stephen Friend

    Exceptionally cogent description of the reality provide yet again by Luke. Until we question how we work together, how we construct a better social value chain, and until we foster new public private partnerships- 2012 for biotech’s will look like a bad year compared to 2002– but be ready for even harsher times to move in within the next decade as overall US prosperity erodes further. Seems like a crime when so many of the new biotechnologies to drive innovation are beginning to blossom.

  • Adam Michael

    Interesting article. In response I don’t have a Mark Twain quote on three types of lies, but I do have quotes from three biotech Venture Capitalists I’ve been talking with recently – and they’re mostly the same:

    “If you think it’s hard to raise capital for a start-up right now…try raising capital for a new venture fund!”

    And herein lies the issue. For sure the venture funds can see new opportunities…but they have to complete what they have already begun. Existing portfolio companies must be prioritised and be taken through to fruition, to maintain credibility with the LPs behind each venture fund.

    Not following this path, and failing to deliver on existing investments, is a guarantee of never having another fund.

    Nessan’s comments point to a collective solution, that could bring in more parties to back our latest biological discoveries. No single group will, or can be expected, to do this alone.

    =A=

  • http://www.xconomy.com/author/ltimmerman/ Luke Timmerman

    Here’s a new blog post from Atlas Venture’s Bruce Booth, who did his own analysis of the MoneyTree data, which he says led him to a more positive conclusion about the state of early-stage financing. I’m still concerned about the state of the early-stage biotech community, but Bruce is a keen observer of this part of the ecosystem, and an insider, so I’d encourage you to check out his take.

    http://lifescivc.com/2012/01/startup-biotech-paradox-data-positive-press-negative-huh/

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