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size of early-stage funds is not likely to grow substantially in the near term, despite attractive returns: Life sciences venture does not scale.
Fund size is restricted by exit valuations for portfolio companies; Lalande estimates that, given the high attrition rate of drug development projects, a life-sciences fund should be no larger than 1.0 to 1.5X the average exit value. In bio-pharma, exit valuations are limited by the stage of development. No matter how good the phase II data, a product-candidate is not going to command Facebook returns. So successful early-stage venture firms are not likely to greatly expand the size of their funds or portfolios.
In his blog, Booth pointed out, “There are only a handful of firms that do early stage biotech.” Yet in the era of precision medicine, pharma needs vastly more drugs. Pharma has not been able to profitably expand their own R&D—in fact, many have cut back budgets—and venture has limited capacity or incentive to scale its R&D. Hence the blockbuster problem.
Pharma understands it must expand its early pipeline of prospective drug candidates, as reflected in the growth of incubators like JLabs and Lab-Central and pre-competitive research consortiums (here, here, and here). But large corporations must do more than simply sow seeds. While products will emerge from incubators, expanding the number of startups without increasing the supply of capital and drug developers needed to shepherd them through phase II will leave a lot of good technology short of clinical proof-of-concept needed to qualify for commercial development.
To have a meaningful impact on the supply of new drugs, pharma needs more outside managers, funds, proof-of-concept companies, and products in the industry pipeline—in short, a more robust entrepreneurial community. Pharma has to work with external developers in ways that preserve their independence, initiative, creativity, and energy, while substantially expanding the scale and scope of the sector.
Incubators like J&J’s JLabs do this for research teams that can operate on a shoestring. However, early clinical costs are an order-of-magnitude greater than pre-clinical studies and don’t lend themselves to bootstrapping. Start-ups require infrastructure (i.e. labs); proof-of-concept companies require capital and management.
Large corporations have to find ways to fill gaps in the external development pipeline. Programs like JLabs encourage startup teams to take risks, and to explore new territory with the opportunity, but not the obligation, to partner with the sponsor. Pharma needs similar business models to help entrepreneurs attract more resources, and to complete proof-of-concept opportunities.
As explained earlier, new venture managers are unlikely to attract institutional backing on their own. By sponsoring new early-stage funds and partnering with portfolio companies, pharma can provide access to the experience and resources of a large corporation—intellectual infrastructure, if you will. Arrangements like buyout options can enable start-ups to forge close working ties with a potential acquirer over time as products and technologies progress in the clinic. The support of a large partner enhances the prospect of timely exits and strengthens a team’s ability to attract capital and resources. Like with incubators, the goal should be to enhance creative energy without co-opting the independence or initiative of the entrepreneurs.
Though organic growth through innovation is not likely to improve the next quarter’s earnings (or executive bonuses), it must become a first-tier priority if pharma as we know it is to survive. The entire organization has to focus on sustainable development. More than simply “working closely” with entrepreneurs, large corporations have to integrate R&D seamlessly with the external community over the entire spectrum of development. To expand the industry pipeline on sufficient scale, pharma has to embrace the entrepreneurial business community as a partner in innovation.