Biotech VC Funding Faces Tough Market

You don’t hear much about funding of young biotech companies these days. No wonder, given the state of the economy.

The situation for venture capital is uncertain but so far sound, says David Collier, a medical doctor and managing director of CMEA Ventures who focuses on life sciences.

Today, caution is the watchword among VCs, he says.

Collier spoke with IBD.

IBD: How’s the economy affecting your company and other VCs?

Collier: The big question is, are the investors VCs rely on still good for the money?

There’s been a lot of speculation as to whether investors will default on capital calls. To date that has not happened.

When a venture fund is raised, it’s a contract with commitments from the investors to provide the capital on an as-needed basis to invest in companies.

So, as you find companies to invest in, you issue capital calls to those investors in the fund who are limited partners.

Every time you issue a capital call, they have around two weeks to come up with the money.

Funds have default provisions in their partnership agreements. They’re typically draconian.

On a first default, a limited partner’s position in a fund might be cut by 50%.

On a second default, he might be wiped out entirely.

Most investors are reassuring their venture firms that they are good for the capital calls.

IBD: What strategies are VCs following in this economic tumult?

Collier: There’s an attitude of caution — that we need to reserve additional capital in our funds to support our companies, to make sure they will have the money they’ll need to weather the storm.

To some extent that will translate into fewer new investments for new companies because we can’t exit from the ones we’re already in.

We have to save the cash that we have to protect the companies we’re already in.

There’s been a general slowdown in biotech investing over the past year.

I can’t quantify the slowdown, but I’d say it’s a very difficult time to be raising money and there are very few deals getting done.

IBD: How have life science VC exit strategies changed?

Collier: There have always been two types of exits for life science companies.

One is an initial public offering, where they go public, raise a substantial amount of money to advance the progress of the company, achieve some significant milestones and get a higher stock price. Then the investors are able to sell or distribute the shares they own.

The other exit is a sale to a Big Pharma company.

We’re seeing two trends. One is that the IPO exit has not been very attractive since the bursting of the previous bubble in 2001. It’s been a very difficult IPO market for biotech companies.

On the positive side, we’ve seen an increase in the number of acquisitions by pharmaceutical companies. We’ve also seen pharmaceutical companies paying higher prices for biotech companies and seen them willing to buy biotechs at an earlier stage.

The reason is the pharma companies are in desperate need of new growth to fill their pipelines because they’re all facing imminent expiration of patents of their big revenue generators.

IBD: Are VCs competing with pharma for investment opportunities?

Collier: It’s possible. In fact, many of the pharma companies have their own venture capital arms. They’re frequently both competitors and collaborators with us.

If you’re competing with a pharma company that wants to acquire a drug program from an innovator or university, whoever owns the asset has two choices.

One is hand it over to a pharma company for a royalty stream if the drug is developed. The other is to hand it over to VCs to form a company in exchange for equity in that company.

If the drug is a success, it’s usually the case that the equity will pay off more than the royalty deal they would have got from the pharma company.

IBD: Is your firm lowering expectations of return on investment?

Collier: Everybody has to lower their expectations of ROI in the current environment.

I see the venture capital industry is likely to contract over the next few years.

IBD: What changes is your firm making in its biotech investment plans?

Collier: We are looking at public market biotech companies that are essentially facing bankruptcy.

We look to see if there are assets that might be attractive with a recapitalization, or a PIPE (private investment in public equity) deal, or a deal that could take a company public, or an acquisition of assets to bring them into a private biotech company we already own.

We don’t have a strategy to take a therapeutic area and roll up several companies.

But we are looking for synergistic situations to add to a company we’re already invested in.

Source: Investor’s Business Daily