Developing the latest breakthrough drug just doesn’t pay these days as much as creating the hot new web app does.
Private life sciences companies in Silicon Valley that got financing in the fourth quarter of 2011 had an average per-share value that was about 10 percent higher than their previous round of financing, which typically was completed 12-18 months prior, according to an analysis by the law firm Fenwick & West.
That increase is sluggish when compared with fourth-quarter deal valuations from other sectors like hardware (43 percent), software (94 percent), and Internet/new media (129 percent). Given that venture capitalists and their backers typically want to see 20 percent internal rates of return on life science investments because of their risk, and the Fenwick analysis doesn’t capture data on companies that fail to fundraise, it considers a 30-40 percent increase in financing values to be considered ideal. While all sectors saw their valuations tumble in the downturn of 2008-2009, biotech still hasn’t returned to a healthy state even as other sectors have rebounded.
“If you compare life sciences to the hot sectors, like the Internet, things don’t look so good,” says Matthew Rossiter, a corporate finance partner at Fenwick & West in San Francisco.
He adds that while biotech is lagging behind, all sectors have their booms and busts, and there are some modest signs of improvement in the data. “People are risk averse, putting less money into life sciences venture capital, and it is having a fallout,” Rossiter says. “Things are challenging, but the sky isn’t falling.”
Still, the report offers the latest evidence for what’s been a troubling story for life sciences venture capital the past couple years. VCs invested $3.92 billion in biotech companies of all stages last year, compared with $6.17 billion in 2007, before the financial crisis, according to VentureSource data cited by the Wall Street Journal. As biotech VCs have struggled to show home-run returns to the pensions, endowments and institutions that support them, many limited partners have looked elsewhere to find high-risk/high-reward investments. Several notable VC firms have either decided to spin off their life sciences teams (Morgenthaler and ATV), stop raising new funds (Prospect Venture Partners), or stop life science investing altogether (Scale Venture Partners).
Many VCs, citing factors like FDA regulatory uncertainty and insurance reimbursement hassles around new life science products, acknowledge privately that they are having difficulty in raising new funds to keep investing in new companies.
Fenwick’s survey traditionally has looked only at valuations of Silicon Valley companies in their respective industries, but was expanded this year to include 338 life sciences companies that raised money nationwide in 2011. The analysis groups both biopharmaceutical companies and medical device makers under the banner of “life sciences.” Data on share prices is based on Fenwick’s analysis of third-party sources and public documents, Rossiter says. Here are the some of the key findings:
—Of the 338 life sciences financings in 2011, about 47 percent were characterized as so-called “up” rounds, meaning the per share price was higher than the prior round. Another 25 percent were “down” rounds, and 28 percent were flat. While Fenwick doesn’t have national data to compare that breakdown to previous years, the percentage of “up” and “down” rounds was almost identical to the Silicon Valley data on up-versus-down valuations in 2010. A healthy environment in non-recession years should produce about 60 percent or more “up” rounds, Rossiter says.
—On the plus side, the survey showed improvement in valuations from the beginning of the year to the end of the year. The average life sciences deal price saw a 4 percent increase in the first quarter of 2011, compared with a 29 percent increase in the fourth quarter.
—Many life science investors look to be working extra hard to ensure they can get returns from their existing portfolio companies. Life sciences deals are now significantly more likely than those from other industries to use participating liquidation preferences—in which preferred stockholders are entitled to get their returns before common stockholders and founders. Participating liquidation preferences now appear in 64 percent of nationwide life sciences deals, according to the Fenwick report.
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