25 Dec 2008

The Changing Face of Biotech Venture Capital

Last weekend I participated in a healthcare panel, as part of the MIT VC Conference in Cambridge. Sitting alongside me were VCs from Polaris Venture Partners, Bain Capital Ventures and Flybridge Capital Partners.

In response to a question about how metrics are changing for VCs investing in biotech, one panelist said that the combination of reimbursement challenges and capital costs are forcing VC-backed therapeutics (Tx) companies to look much farther down the road, and become more like medical device companies. For a long time, medical device company founders have made reimbursement analysis part of the work they did before even starting a company. They would frequently deliver a package to their startup VCs, including the specific CPT (reimbursement) codes. In fact, he said, sometimes the companies started from the goal, reimbursement, and worked their way backward to a product.

Tx companies, by contrast, have started with the molecule or platform and said: “Because your uncle or my dad died of cancer, it’s a good idea to fund this and there will be a big market.” That approach is no longer good enough. In fact, VC-backed companies are often asked to (or volunteer to) put together both a mock-up of their eventual product label and an analysis of what the reimbursement landscape will look like in ten to twelve years (when the product would be commercialized).

I detect a tiny little fallacy in that approach. Here’s Polaris, one of the most successful funders of early-stage startups in history, insisting on some absurd-sounding levels of analysis from their putative portfolio companies. Therefore, I predict that Polaris will not be doing too many molecule-driven startups for a while. And if others in the industry share this approach - which I am pretty sure they do - then companies with molecules more than 2-3 years away from market need not apply for venture capital. Those deals that do get done (e.g., Proteostasis, a $45M deal that closed in Boston just before the economic crisis hit) will be evolving milestone to milestone the way that biotech startups always have.

What will happen to VC-backed biotech companies that are farther away from commercial milestones? There seems to be a general refocusing of VC activity away from new deals and toward existing portfolio companies. There are already some tough discussions within VC partnerships about which companies to keep funding and which to sell or let wither. The VCs on the MIT panels all pledged to maintain a pace of something like 80% their previous pace investing in new deals.But given the politics inside VC partnerships, I cannot see the rate being anywhere near that. There will be too many turf wars that result in increased funding to existing companies and consequently far fewer new deals. But even that renewed focus on existing investments will not be enough to save more than 50-60% of existing companies, which will start to get sold at bargain prices in the next few months.


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