Can’t Get No Respect? Bio-venture Issues Are Deeper Than Paper Gains
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returns to investors sufficient to compensate them for the risk and illiquidity. If bio-venture is to prosper, it must meet that challenge before it worries about its public relations image.
The argument that in the future things will be different may turn out to be true, though no one, including Bruce, has provided convincing evidence why “different” should be better. In fact, I can think of a number of reasons why life for bio-venture is more difficult now than it was ten years ago.
Pharma is the industry’s principal customer and source of liquidity for venture fund investors. A fundamental change in the biotech-phama relationship occurred as a result of the melt-down. Prior to 2008, for example, pharma’s average up-front payment was roughly 80 percent of a buyout, based on data I pulled from the HBM Pharma/Biotech M&A Report 2012. Since 2009, the proportions have reversed such that up-front payments now account for less than half the purchase price.
The gold-standard measure of performance in the venture world is cash-on-cash returns; paper profits in private companies and BioWorld-dollar deals mean nothing to an institutional investor. The shift to back-end loaded payouts delays payment and shifts risk to biotech, in some cases tying the bulk of the purchase price to approval of the drug. According to Bruce’s data, the average time to buyout is roughly 7-8 years, similar for both IT and pharma ventures. However, the bio investors may have to wait another 3-5 years or more for their money. Add to that the usual late-stage failure rates, and venture funds would be lucky to collect half the promised BioWorld dollars. Milestone payouts threaten to make the current venture model untenable.
Bio-venture capital’s challenges are pharma’s as well. Neither can survive without profitable innovation. Venture and pharma have to work together to find new, more efficient business models to develop drugs. Atlas and other venture groups have been active in that area, but pharma must take a leadership role in exploring new approaches. They are the customer, and they have the resources to change the landscape in a major way.
Pharma has been an active sponsor of incubators and research collaborations. If they are to realize the value of those investments, they need to encourage the development of an early stage venture community that can bridge the gap to commercialization. Incremental steps investing with established venture funds are a first step, but the industry needs real change, and that does not come from groups that are prospering under the status quo. Pharma needs to substantially increase the scale of their efforts and pursue a broader range of options in this space.
Our entrepreneurial community is remarkably resourceful and responsive. More than research grants, biotech innovators need a clear path to the rewards that a successful new molecule can provide. Pharma can communicate their strategic needs, provide access to developmental resources and complete the bridge from research to commercialization by working through allied venture fund managers. The concept goes beyond pharma-as-VC in captive corporate funds or pharma-as-LP sharing in deal flow and providing advice to a general partner. Those models have their places, but I am talking about a working partnership of equals—pharma and VC, integrated with the internal R&D, as we have outlined in recent Xconomy discussions of a pharma supply-chain model.
With proper incentives and adequate resources, the life-sciences ecosystem can generate the new medicines that both industry and patients need. If pharma and venture managers focus on cosmetic enhancements to the status quo, neither will fare well.
Bruce is a leader in the next generation of venture capitalists, among the brightest and the best the industry has to offer. His analysis reflects a triumph of reason over experience, the eternal tension between young and old. If this industry is to survive and prosper, we need more than a rationalization for the status quo.