A strange thing has happened during an otherwise bleak time for biotech venture capital. Life science venture capitalists are apparently hitting more of their investments out of the park.
There were 17 so-called “Big Exits” for investors in privately held biotech companies, and 18 in the medical device business in 2011, the most of any year since 2005 in a new set of data analyzed by Silicon Valley Bank. For this analysis, a “Big Exit” was counted each time a venture-backed life sciences company was acquired, and the up-front payment was worth at least $75 million. Although many of these “Big Exit” acquisitions are structured to include milestone payments that can make the deals more lucrative over time, those future payments often don’t materialize, and they weren’t factored in to the SVB analysis of investment returns.
Taken together, those 35 big deals in life sciences generated $8.8 billion in up-front returns to investors. That figure ballooned to $12.7 billion when counting the future milestone payments— in a year when just $7.7 billion of new venture capital flowed into new life sciences investments. The number of Big Exits, and their total value, has steadily increased for four straight years during the period when structured acquisitions became more common, according to SVB. (See the full report here.)
Ironically, the increase in “Big Exit” returns comes at a tough period for the industry, as tech investing in companies like Facebook, Groupon, and Zynga has overshadowed all things biotech. Many investors are clearly worried about how much time and money it takes to invest in new drugs, devices, and diagnostics, when regulatory barriers are high at the FDA and insurers are looking hard for ways to get health spending under control.
That perception has put a crimp into the biotech IPO market for years, and made it much more difficult for many venture firms to raise new funds to keep investing. Those forces have all helped thin out the ranks of active biotech VCs, especially among those who invest in companies in the early stages.
“The perception of returns in healthcare is bad, but the reality is far different,” says Bijan Salehizadeh, a San Francisco-based managing director with Navimed Capital. “The prevailing sentiment is that healthcare investing is tough, it takes so much money, and it’s hard. It is. But the returns are there if you are in the right companies.”
The analysis of returns certainly isn’t a comprehensive look at whether it really pays to invest in biotech overall. It focuses entirely on private companies getting acquired, and doesn’t include any data on returns VCs may get when their portfolio companies went public, or when public companies in their portfolio were acquired.
It’s also not the only analysis to buck the prevailing wisdom about the woes of biotech investing. Salehizadeh and Bruce Booth of Atlas Venture published an analysis of VC returns last July in Nature which showed that biotech generated mean realized returns of 15 percent during the decade of the 2000s, compared with 3 percent for information technology and 4 percent for software.
Quite a few examples of “Big Exits” were listed in the report, although not all were described by name. Some of the biggies in 2011 were reported widely here and elsewhere in the media—companies like Berkeley, CA-based Plexxikon, Seattle-based Calistoga Pharmaceuticals, Woburn, MA-based BioVex, and San Diego-based Intellikine were among the greatest hits.
Not everything turned up rosy in the report. VCs had to wait an average of about seven years for a biotech investment to yield a return, and eight years in medical devices. That’s difficult to sustain in an industry where venture funds are supposed to deliver returns in 10 years, Salehizadeh says. “If there’s one thing that gives me pause in this report is that average time to exit is trending up,” he says.
Jon Norris, a managing director with Silicon Valley Bank and the author of the report, says he saw a few surprising trends in the data, including the increased value acquirers are placing on biotech assets that haven’t yet advanced into clinical trials. Big Pharma companies have been competing for deals in that early-stage category partly as their own R&D pipelines have dried up, and many of the best biotech assets that are more validated, and further along in late-stage development, have already been snapped up.
“There are novel assets out there with big market potential, because of that you’re getting a lot of interest at the early stage,” Norris says. The investment math at that stage is also more attractive for VCs, he added, because they don’t have to foot the bills when drug development gets really expensive, in Phase II and III clinical trials.
All of these trends have altered the power dynamic between entrepreneurs and investors. As Norris notes, in technology, where there is more venture capital chasing fewer world-changing Facebook-like ideas, “the power is with the entrepreneur on the negotiation side.” The opposite is true in biotech, where a smaller group of active venture capitalists have more opportunity to pick the best companies they want to invest in, on favorable terms to them and their partners. “It’s a great time for investors with new capital, fresh capital, to invest in life sciences as a sector,” Norris says.
Salehizadeh, while saying he tries not to be a ‘rah-rah’ guy and seeks to maintain a healthy skepticism, agrees that now is a great time to be investing in life sciences. He points to two mega-trends working in favor of biotech investors—the relatively thin R&D pipelines at Big Pharma and public biotech companies, and a record sum of $350 billion in cash sitting on the balance sheets of S&P500 healthcare companies. That cash can be used for a number of things, but one obvious idea is to use it to keep buying biotech companies to fill up the R&D pipeline.
Still, betting on biotech is clearly not for everybody, and it’s pretty much impossible to put in a couple million and expect to get a $1 billion return in a couple years. But that doesn’t mean biotech can’t compete with tech as a sector for investment.
“Big companies buy little companies when their own R&D productivity slows down, and they have a lot of cash,” Salehizadeh says. “There are no Instagrams in biotech, and there probably never will be. That’s OK. But you can still make your partners happy in healthcare.”