The phrase “the VC model is broken” has become cliché over the past few years. Many theories on why this is the case have been posed, including Sequoia Capital’s Douglas Leone, who told a VC conference at MIT last month, “Big is completely the enemy of great.” I agree with Leone; in fact, I have been employing what I call a “small ball” style of investing at City Hill Ventures, a fund I started in San Diego in 2010 to invest in biotechnology, molecular diagnostics, medical devices, and health IT. City Hill is a small, focused fund making a limited number of investments, chiefly because I’m deeply involved, taking a hands-on, operational, or advisory role with each portfolio company.
Recall that in baseball, the goal of the “small ball” offensive strategy is to maximize your team’s on base percentage and advance the runners to score more runs, instead of relying on home runs to win the game. Small ball investing in life sciences means employing capital efficiency (bunt) to drive focused value (advance the runners) that can be creatively monetized (score) to generate attractive returns (win the game) with a higher probability of success for investors.
We are blessed to operate in an industry in which winning is ultimately measured by the impact of our innovative products on patients’ lives. But making money for our shareholders is also a critical part of winning. Eclipse Therapeutics, a Biogen Idec (NASDAQ: BIIB) cancer stem cell spinout that I co-founded with Peter Chu and Chris Reyes in 2011, serves as an interesting example of a small ball investment win for City Hill. Here’s how I scored it:
Bunt: Employ Capital Efficiency
City Hill led a $2 million investment round with a group of individual investors to acquire a late discovery/preclinical cancer stem cell program from Biogen Idec when it closed its San Diego facility, and to start Eclipse Therapeutics. This seed funding was the company’s only financing round. We kept things lean, and closely managed the burn to hit our value inflection points as efficiently as possible.
Advance the Runners: Drive Focused Value
We acquired the oncology assets from Biogen Idec by structuring a back-end loaded deal; recruited a team of renowned advisors and scientific talent; generated additional preclinical data that validated our lead program; selected a lead monoclonal antibody candidate to take into cell line development and early manufacturing; and signed manufacturing and antibody engineering deals.
Score: Creatively Monetize
Taking nothing for granted, we dual-tracked our financing and M&A discussions with VCs and biopharmaceutical companies, respectively. We did not have a preference a priori for the VC versus acquisition path. In the end, we selected the option with the best prospects for creating value for our investors, which also turned out to be the most creative: We sold Eclipse to Adelaide, Australia-based Bionomics (ADR: BMICY), a publicly traded company listed on the Australian Stock Exchange, for a stock-based $10 million up-front, and up to $65 million in cash earn-outs based on achieving late-stage development success or partnering outcomes based on Eclipse assets, plus royalties on product sales.
Win the Game: Generate Attractive Returns
Eclipse was successfully acquired less than 18 months after we founded it, generating attractive internal rates of return for all investors. The math is simple: $2 million in, and between $10 to $75 million out, creating a win-win deal for every stakeholder, on both sides of the table. More importantly, the potential benefits for patients and shareholders are amplified by Bionomics’ and Eclipse’s shared vision of building a leading oncology franchise. As entrepreneurs, we are driven by passion to build great companies – fortunately, the original Eclipse team continues to play an active role with Bionomics in shaping the destiny of the cancer stem cell assets.
Developing late discovery/early preclinical biotech assets is capital intensive and highly risky. The small ball strategy of seeking creative options with less capital invested helped maximize our range of options and probability of success, mitigating the risk and generating attractive shareholder returns for early stage assets in a challenging biotech financing environment.
We are only two years into the small ball investing strategy experiment, and it is still too early to tell whether this can be a winning strategy across an entire portfolio. However, it is an interesting alternative, or complementary, strategy for life science investors and entrepreneurs to consider, especially in an environment in which traditional financing sources are scaling back. The small ball investing principles also may be applicable to larger venture funds, and to venture funds in other industries.
Small ball investing is a potential strategy for racking up the wins because the probability of success for each investment is higher than a “swing for the fences” approach, thereby maximizing the overall win:loss ratio for all stakeholders.
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