Avalon Stakes Claim as Survivor Among San Diego Biotech VCs
Nobody will ever confuse San Diego’s Sorrento Valley for Sand Hill Road. And that’s not a bad thing if you’re one of the guys at Avalon Ventures.
“The story is really that Avalon is now one of just two really active life sciences venture funds in San Diego, which is the third largest biotech hub in the world,” says Jay Lichter, a managing director with Avalon.
I sat down with Lichter, one of four managing members at Avalon, to talk about this phenomenon during my visit to San Diego in December, and followed up with him again a couple weeks ago. A lot was being written then, and still is, about the decline of the entire venture capital industry, and its impact in particular on San Diego’s longtime stalwarts of the life sciences community.
San Diego’s Forward Ventures, which has shed several partners, has shifted its strategy to an ultra-lean model, as Bruce recently reported. Enterprise Partners Venture Capital hasn’t said for sure what it plans to do when it is time to raise a new fund. While other national firms have individuals who are well-connected on the ground in the local life sciences scene—Venrock Associates’ Bill Rastetter and Sofinnova Ventures’ David Kabakoff come to mind—the only two firms left with sizable operations in San Diego and do a lot of local investing are Avalon and Domain Associates, Lichter says.
(Drew Senyei, a managing director for Enterprise Partners, challenged the assertion that his firm has gone quiet. “We have made small investments in seed companies this year. We have two companies in registration for an IPO and four companies in active M&A process at venture multiples. Yes, we are busy.”)
Still, new venture funds have been hard to come by. Domain, spearheaded by partners Eckard Weber and Jim Blair, is one of the rare VC success stories of the past year, having raised a new $500 million life sciences fund back in August. It has flexed its muscle through a string of sizable investments, including VentiRx Pharmaceuticals, Meritage Pharma, and Sequel Pharmaceuticals.
While Domain often seeks out specialty pharma companies moving through the middle stages of clinical trials, Avalon has carved out its niche in the really early-stage, startup phase. It has placed smaller bets on companies like Zacharon, Otonomy, and aFraxis. Back in December, Lichter told the story about how Avalon flew in some top biologists for a retreat at The Lodge at Torrey Pines, just to talk about some of the big problems in biology, and some elegant experiments to test new concepts.
Lichter is fully aware this runs against the current in venture capital, where funds are scrambling to gin up some quick returns in late-stage companies to spruce up their balance sheets just in time to hit up pension funds and endowments for another round of fundraising. This isn’t a trend that Avalon is seeking to follow, Lichter says.
“We get involved at the cocktail napkin stage,” Lichter says. “It’s pure venture investing. Early stage. High-risk. High-reward. Most people don’t want to do it anymore.”
A poster child for the popular style of venture funding is Cambridge, MA-based Gloucester Pharmaceuticals, which was a story I covered last fall. I recounted for Lichter how Gloucester raised $29 million in August, just a week before it was scheduled to go before an FDA advisory committee hearing with pivotal clinical trial data for a new cancer drug. The panel vote was a slam dunk in favor, the FDA approved the drug as expected a couple months later, and Gloucester was acquired for $340 million in December by Summit, NJ-based Celgene (NASDAQ: CELG).
Presto, it was a return on investment inside of six months for biotech VCs, who ordinarily would have to wait a decade or more for an early investment to bear fruit.
It’s almost like venture capitalists woke up one day and decided they wanted to become fast-money hedge funds, I said. Lichter didn’t disagree. “Good for them. But what they’re doing isn’t really venture investing,” he says.
That late-stage deal isn’t as innovative, and it isn’t as much fun, Lichter says. Rather, he describes it as largely a numbers game. A venture fund needs to put so much capital into a late-stage deal that it’s impossible to get home-run returns of 50-fold on investment, which can be possible with seed investments of just a few million dollars, Lichter says. Over the years, San Diego’s life sciences community has done particularly well with its seed and early stage startups. But if everyone flocks to safer bets, and hardly anyone is willing to gamble on early-stage investment, then how can a region like San Diego create companies?
Avalon is just one firm, so it can’t really be the answer all by itself. Still, I had to press Lichter on how viable the approach really is, and how well the firm has performed, because that will determine whether it can continue.
Avalon was founded 25 years ago by Kevin Kinsella, and is now working on its eighth fund, which provided $150 million to invest in August 2007. The firm splits its bets 50-50 between life sciences and high tech, Lichter says. The last fund is now almost completely invested. One of Avalon’s tech investments, Zynga, the developer of “FarmVille,” secured an investment from a Russian group that put in $180 million. “We did extremely well on that one,” Lichter says, without providing specifics. One other winner Kinsella pointed to was Sytera, a maker of drugs for eye diseases, that was acquired by Sirion Therapeutics in August 2006. Avalon is also bullish about a couple of other portfolio companies in the Boston area—BioVex and Acceleron Pharma—although they haven’t generated returns yet, Kinsella said.
Avalon is having discussions about raising another fund, although it hasn’t put together a prospectus yet, Lichter says. A lot will depend on how pension funds or other institutions view Avalon’s track record. Lichter noted that Avalon’s sixth fund ranks in the top 5 percent of venture funds raised in 2001 according to data from Cambridge Associates; the seventh fund is still a little “too early” to judge; and of course, the eighth fund is still just a couple years old, although it has already returned half of its invested capital, Kinsella says. But at least as of now, Avalon insists it has a future in bucking the trend, and doing venture capital in the old-school, early-stage way.
“We invest in companies that we thought up, or with entrepreneurs we’ve known a while and trust,” Lichter says. “We always take Series A deals. And we only invest in disruptive technology.”
This may sound like an uncomfortable place to be in a cautious economic climate, but Avalon insists it’s perfectly happy digging through the scientific literature and venturing out on the edges of biology. “We don’t need to feel the brush of the furry skin of our fellow sheep in venture capital to feel good about our investment decisions,” Kinsella says. He wouldn’t say for sure whether Avalon plans to raise another fund, but Kinsella did make a clear statement that Avalon has a future. “None of us are getting ready to retire,” Kinsella says.