Kinsella Redux: Charting a Way Back for Life Sciences Startups
As a man of many talents, Avalon Ventures’ Kevin Kinsella has a tendency to apply a term from one of his fields of interests in a conversation about another.
Kinsella’s career as a biotech venture investor has spanned nearly 30 years and more than 100 financings. These include early stage bets on San Francisco-based Onyx Pharmaceuticals and Aurora Biosciences (now Cambridge, MA-based Vertex Pharmaceuticals) that produced the billion-dollar drugs sorafenib (Nexavar) for treating kidney cancer and telaprevir (Incivek) for hepatitis C.
He’s also had a lifelong love for Broadway theater and is now a Broadway League member (and Tony Awards voter). Kinsella and his wife Tamara were the biggest individual investors in the hit Broadway musical Jersey Boys. They also are among the Jesus Christ Superstar producers who were nominated in May for a 2012 Tony for Best Revival of a Musical.
I’m pleased to note that on October 4, a week from today at the Apella event space at Alexandria Center, the San Diego Xconomist will be taking a star turn at Xconomy’s next big event in New York: Reinventing Biotech’s Business Model for the Big Apple. So when I checked in recently for an update of Kinsella’s showstopper critique of Big Pharma business practices, I was half-expecting him to take a metaphorical detour through Manhattan’s theater district.
Instead, he asked me if I knew what véraison means.
It’s a French viticulture term, and refers to the changing color of grapes as they begin to ripen. As the proud owner of a 12-acre winery in Sonoma County (a purchase made possible by the Kinsellas’ successful investment in Jersey Boys), Kinsella said véraison came to mind because the ideas he expounded last year on overcoming the difficult climate for building biotech companies are now ripening. What that means, he says, is that Big Pharma is finally listening.
“The pharma companies have in unison realized that their actions have jointly and severally done a lot to destroy the VC ecosystem where they’ve lived for the past 20 to 30 years,” Kinsella says.
The VC laid out the specifics of his grievances with Big Pharma for me in early 2011—provoking an industry debate that continues today. He has argued that pharmaceutical companies are driving life sciences VCs to the brink of extinction by their buyout tactics, which in his opinion include bad-faith negotiations, lowball buyout offers, and partnership deals that load all the risk on the startup and its VC backers.
Now Kinsella says the effects of what he calls Big Pharma’s “predatory business practices” can be seen on a variety of fronts, as venture firms decide against raising new funds, turn away from further investing in the life sciences, or simply go out of business.
Some examples from the public record include Palo Alto, CA-based Prospect Venture Partners, a life sciences firm that is now tending to its existing portfolio companies after it was unable to raise enough cash to execute its strategy for a fourth fund. Menlo Park, CA-based Versant Ventures significantly downsized its operations and is expected to raise a fifth fund that will be half the size of its previous $500-million fund. Foster City, CA-based Scale Venture Partners decided last year to make no more healthcare investments from its third fund, and as Luke has reported, the Column Group is in a holding pattern on new life sciences investments until the San Francisco-based firm can demonstrate what partner Peter Svennilson called “a couple of spectacular exits.”
Kinsella contends there are many more examples of life sciences venture firms that are in denial—meaning they won’t admit they have ceased making new life sciences or biomedical investments. “They might pretend they’re still in the business, but in effect they’ve retired from the playing field,” Kinsella says. “My gut sense is that two-thirds, at least, of the healthcare venture funds have gone out of business.”
With the flow of venture capital drying up and the overall ecosystem for drug development dramatically downsizing, Kinsella says pharmaceutical companies are beginning to realize, “Hey, there aren’t any decent Phase 2 drugs to look at.” So now, he says, the pharmas are “running around, trying to find ersatz solutions” to the dearth of new drug candidates. Kinsella says that’s why Big Pharmas are now organizing new corporate venture funds, creating incubator spaces for biotech startups, and trying to strike new types of partnership deals with venture firms.
To Kinsella, such moves are signs that Big Pharma recognizes there is now a problem in developing new drug candidates and in creating new biotech startups—and is trying to do something about it. Still, he says he’s skeptical about such initiatives. “I consider these all to be artificial solutions, with one exception—and that is backing a venture fund that has an established track record of success.”
Kinsella considers Avalon’s fifth fund, which flourished from 1991 to 1997, as the epitome of success—with an 11x return on venture investments in 13 startups, including Neurocrine Biosciences and Aurora Biosciences. Sandoz, led by CEO Max Link, provided the entire $18 million for that fund—and as Kinsella puts it, “We all got rich.” Three of the companies funded through Avalon V were acquired, and eight went public through IPOs. In addition to its management fees, Avalon got 50 percent of the carry—the fund’s overall investment return.
But Sandoz merged with Ceba-Geigy in 1996 to form Novartis, and Kinsella says he never learned why the combined company never sought to repeat the success of Avalon V. Instead, when Novartis CEO Daniel Vasella created the Novartis BioVenture Fund a few years later, he named former licensing and technology acquisition manager Peter Bissinger to lead the corporate venture fund.
Kinsella concedes that the ‘90s were part of a golden era for biotech investors. As he told an MIT alumni group in the Bay Area earlier this year, “You could take a company public or sell it within three years and you could make 10 to 100 times your money when your molecule, if you even had one, had never even seen the inside of a rodent.”
Now, following a wave of industry consolidations, big biotech and drug companies have been making some dramatic cuts in their own in-house R&D. As they look to resupply their drug development pipelines, Kinsella says they are faced with a limited pool of startups to partner with—and they are running out of options. “I doubt there’s a Phase 2 [drug] asset out there that hasn’t already been committed to a [corporate] partner,” Kinsella says.
The San Diego investor has drawn widespread attention by singling out “Big Pharma’s bad behavior” as the target for his ire. Still, there are surely larger economic forces at work, as there is plenty of evidence that the life sciences venture industry as a whole has not fared well lately.
For example, at an annual “State of Biomedical Innovation” Conference in June, Jonathan Leff of Warburg Pincus painted a dismal picture of the returns generated by life sciences investors in the previous decade. (A pdf file of all the conference slides is here.) For 24 life sciences funds (including Essex Woodlands, TPG Biotech, Sofinnova, and Frazier), Leff says the average return was 1.4 percent from 2000 through 2008—and the average return on investment multiple was 1x, or, in other words, just breaking even.
What’s more, the latest MoneyTree report for the quarter that ended in June shows that venture investing in the life sciences (biotechnology and medical devices) continued to decline for the second consecutive quarter, with nearly $1.4 billion invested in a total of 174 startups. That was also a nearly 40 percent drop in dollars and a 22 percent slide in deals from the $2.3 billion that VCs invested in 223 deals during the same quarter of 2011.
In the biotech sector alone, the $697 million invested in 90 deals during the second quarter was the lowest total the biotech industry has seen in more than nine years.
As Intersouth Partners general partner Jimmy Rosen recently put it, “As economic uncertainty continues and fewer venture investors remain, VCs are less willing to commit to companies in which capital requirements continue to increase, timelines extend, and regulatory guidance is unclear.”
So what now, in Kinsella’s view?
“The pharmaceutical companies need to go back to the old days, where the companies that get the most benefit from billion-dollar drugs shoulder the most risk,” he says. To get out of their straits, Kinsella says the pharmaceutical companies need to strike deals with the surviving biotech venture funds—“the clever VCs who know how to organize a biotech startup, and how to hire a discovery team, and how to staff it for drug development.”
Ideally, he adds, such deals would be structured like the one that Avalon cut with Sandoz/Novartis for Avalon V.