The stock market rout that has engulfed the biotech industry is beginning to work its way down to privately held startups and the venture investors who back them.
Already, the pace of biotech initial public offerings, which accelerated in recent years, has slowed significantly. That's left emerging drugmakers with a less certain path to new funding, and tough decisions to make while the downturn continues. Many are preparing to save cash while staying private for longer.
But there are other ripple effects, according to a panel of venture capitalists who spoke at the BIO CEO & Investor conference Monday. While life sciences venture capital firms are flush with cash, funding rounds may not be as easy to close as they have been, for instance. So-called crossover investors, which specialize in helping biotechs get to an IPO, are pivoting. And young drug startups may be forced to change development plans as investors tighten scrutiny and adjust their expectations.
Investment rounds are taking longer to complete
When the market for biotech companies peaked in early 2021, drug startups were able to go from creation to the public markets faster than ever. Nearly two-thirds of the roughly 150 biotechs that raised at least $50 million in an IPO during 2020 and 2021 were in either preclinical or Phase 1 testing when they went public, according to data compiled by BioPharma Dive. That share was notably higher than previous years, too.
"Up until recently, the reflex for management teams, and perhaps the other existing investors was 'let's do this financing and then we'll go public in six months,'" Otello Stampacchia, founder of the investment firm Omega Funds, said in a recent interview.
The parade of early stage biotechs going public occurred because the market rewarded them with large valuations, earning their backers sizable returns. And that made it easier for biotechs to quickly amass syndicates of venture firms and crossover investors who invest in public and private startups.
Some of these factors remain in place. Several venture firms reloaded over the last few years and therefore have plenty of cash to invest in new startups.
"There is money for everything from seed through to late-stage," said Asish Xavier, the vice president of venture investments at Johnson & Johnson Development Corp., the healthcare conglomerate’s startup financing arm. JJDC approved its first couple deals this week and they should close in May, he added, speaking at the BIO conference.
But the poor stock market performance of biotechs that went public last year, combined with the sector’s overall downturn, has forced investors to reset expectations. Companies seeking 2021-esque valuations now need "a lot longer" to raise funding, said Sara Nayeem, a partner at Avoro Capital, on Monday.
"In many cases those rounds are getting done," she said, but "they’re having to go to more and more investors."
As a result, companies may need to be more frugal with their money and stretch their funding until they achieve "demonstrable milestones," like data from a trial, Stampacchia said Monday. Biotechs may also "top up" existing rounds by bringing new investors in on the same terms, which he described as an insurance policy against a bleak IPO market.
Crossovers are less willing to wait it out
Several venture capitalists who spoke with BioPharma Dive over the past month indicated biotechs are now likely to stay private longer than they previously might have. Though still early in the year, that view is reflected in the sharp slowdown of biotech IPOs. Only four biotechs have raised at least $50 million via an IPO in 2022, compared to 14 by this time last year, according to BioPharma Dive data. Many investors expect the trend to continue.
In a tough market, a fast return on an IPO is no longer a sure bet for crossover investors, which played a large role in the surge in biotech offerings over the past decade. As a result, funding for biotech startups "likely to IPO" has slowed, according to Silicon Valley Bank Managing Director Jonathan Norris.
To get a sense of the biotech IPO pipeline, Norris has been tracking private financing rounds of $40 million or more with at least one of the most active crossover investors involved. After a record 48 such deals in the first three months of 2021, they’ve become fewer and fewer each successive quarter, Norris said, a hint that crossovers aren’t investing in biotech as much.
"Because of what we've seen in the public market, the private deals are staying private longer," Norris said. "And because of that the crossover investors don't want to hold as many private investments."
Biotechs and their venture investors may consider other ways to raise cash, like partnering with pharmaceutical companies or selling themselves, earlier than previously. Creative workarounds, like the "build-to-buy" deals between venture firms and drugmakers that became popular during the last downturn, could become more common, Nayeem said.
Differentiation is becoming more important
By and large, the companies with the largest IPO valuations have been preclinical, particularly those with technology platforms that have broad potential. Cell therapy developers Sana Biotechnology and Lyell Immunopharma, for instance, raised more than $1 billion combined in 2021, and debuted with valuations exceeding $3 billion and $2 billion respectively. Both are now worth a fraction of that.
But amid the rush to go public, more biotechs began crowding into the same fields. Areas like precision cancer drugs and cell therapy have been particularly active, Stampacchia said, making it difficult for less specialized investors to identify the best investments. Many gene and cell therapy developers, for example, are targeting the blood diseases beta thalassemia and sickle cell disease.
"There’s a lot of competition in some of these areas where the differentiation is not clear," Jerel Davis, a managing director at Versant Ventures, said in a January interview.
So while platform approaches still draw interest because they enable companies to spread risk between different drugs, investors are now scrutinizing development plans more closely. Being the next player in a "hot space" is no longer sufficient, according to Nayeem.
"There is more focus from the investor community on how you are getting your first program to the clinic, how it is going to compete there and how it's going to be differentiated," said Nayeem.
"It'll be a necessity for companies to focus on that more than they have in the last couple of years."