How VC funding for biotech has fundamentally changed—and what it means for the industry
Like so many other sectors of industry, biotech R&D got clubbed in the wake of the 2008 financial crisis. But now, as venture capital returns and the picture turns more optimistic, the money is being used in new ways that could represent major consequences for the future of life sciences.
Less overall venture funding, a smaller concentration of recipients
Between 2004 and 2008, VC firms invested $21.5 billion in biotech drug R&D. Over the next five-year period, that figure fell 21% to $16.7 billion, according to a report by the Biotechnology Industry Organization (BIO).
Perhaps the most striking shift between 2008 and 2013, other than the considerably lower level of overall funding, has been the therapeutic areas that are no longer receiving as much funding.
"The big takeaway for me, which we didn't expect going in to this [study], was the drastic drop in the large population diseases," said David Thomas, CFA and one of the two co-authors of the BIO analysis in a telephone interview with BioPharma Dive. "So, the diabetes, endocrinology, gastrointestinal, respiratory, and cardiovascular areas.
"When we looked at before the financial crisis and after, for those numbers to be down 50% or more for a lot of them, was very surprising. We instinctively knew there was a lot more interest in rare disease companies and platform companies, etc. But the degree to which there's been a decrease [for those major therapeutic areas] was pretty staggering."
BIO's analysis only extends through 2013. But according to Thomas, those trends mostly held true in 2014, too.
"All these [trends] with the big diseases, the effect on large population therapy funding versus rare disease, all that holds for 2014. More money came in overall [compared to 2013], but if you look at [cardiovascular diseases], etc, you continue to see less money," said Thomas, who is releasing an updated VC study in the next few days.
There's also a significantly lower number of VC firms specializing in biotech in general now compared to a decade ago.
"Venture capital really started to leave the life sciences in 2008," said Thomas. "There were 40% fewer venture investors in the field in 2013 versus 2007. Basically, what happened was a lot of investors that aren't necessarily hardcore life sciences investors, that weren't fully committed to biotech funds, said in 2008 and 2009, 'We're not going to take on the risk of funding drug developers, we're going to focus our efforts elsewhere.'"
So where is the money going now from the core group of 20 or so VC firms that really focused on biotech? For one, there's been a major shift to biologics in the wake of the Affordable Care Act, or Obamacare. The law guaranteed 12 years of data exclusivity for biologics -- and as a consequence, 50% of overall therapeutic venture funds now go to biologics. That's a sharp increase from the 27% that went to those therapies in 2004.
"The way I've been saying it to some people is, it's kind of like the 'haves' and 'have-nots,' " explained Thomas. "For example, you see a lot of oncology companies working in the immuno-oncology space getting a lot of funding."
The shift toward the rare diseases, immuno-oncology, and biologics spaces may potentially be explained by venture firms' unwillingness to deal with the regulatory burdens of the larger therapeutic areas like diabetes.
"Genzyme was purchased in 2011, I kind of view that as a turning point," said Thomas. "There's been a focus on much more targeted diseases where you run clinical trials that are not as large. If you contrast that with all these areas that are going down in funding, they've got clinical trials where you sometimes enroll 10,000 people for a phase III trial. There's a very high bar for the CVD outcomes trials for some of the studies, too."
Who's getting the money?
But what companies, specifically, are getting the funds? As industry observers might expect, companies that concentrate on highly specialized treatment platforms, including Moderna and Juno, continued to receive massive investments in 2014 (Juno went on to IPO in late 2014).
And a select few companies continued to rake in the green in the first three months of 2015.
There's another notable trend highlighted by the above table: a shift towards later rounds of funding.
VC firms in search of an exit strategy
"The biggest thing we've seen is the move to much larger, later-stage rounds," Lisa Urquhart, editor and analyst at EP Vantage and Evaluate, told BioPharma Dive. "And that has unfortunately been at the expense of the other end of the market.
"So we see a lot of fall-off in seed, we've seen more and more money go in particular to Series B rounds. And there's been an interesting change in the people involved in Series B rounds. We're seeing a lot of involvement of crossover funds, which invest in both public and private companies."
This is bad news for many of the smaller and more experimental firms in "riskier" therapeutic areas that badly need initial seed and Series A funding to form their companies and launch preclinical studies. But it does make economic sense from a venture capital perspective.
"What we're tending to see happening is the fact that you get a lot of crossover funds coming in at Series B and they'll be investing much larger amounts of money to kind of shepherd these companies to the IPO market," said Urquhart. "And it makes sense, because if you invest in Series B and get to IPO, there's less dilution for you."
"Companies like Juno and Spark, the most recent I can think of, managed to IPO with Series B after quite big investment rounds, and they were quite heavily invested by the crossover funds," added Urquhart. "It helps if you're oncology, because companies are interested in that and might IPO from Series B rather than D and E."
Legislation, shifting regs change the game
There does seem to be more overall private capital coming back into biotech, leaving aside for a moment the precise parts of the sector that are getting funds. And a lot of that has to do with legal and regulatory changes over the last five years.
As we stated above, Obamacare heralded more interest in biologics thanks to its data exclusivity provisions. But another law that's had a big effect in VC funding in general—and for biotech in particular—is the JOBS Act of 2012.
"Without a doubt [the JOBS Act] affected biotech more than other sectors," said Thomas. "The key change was that companies could go and talk to investors more than one time, and not in a very formal setting like it had been structured before. Being able to pitch their story over multiple meetings, that basically tore down these walls that were there and allowed investors to test the waters and ask a lot of questions and get a lot of feedback.
"Biotech is a very complex area, and each company has its own nuances and own unique issues that take a long time to digest. The JOBS Act was approved in 2012, and we really saw the boom in 2013, which means there was a little bit of a lag... Basically, the law allowed the investors to really get behind their stories and pitches, and that was the key change with the JOBS Act. And now we've had 150 IPOs since the law was passed in 2012, and that's amazing for biotech. It's really unprecedented... Allowing executives to have that dialog, that really changed everything."
The 21st Century Cures initiative, which is rapidly winding its way through Congress, is also likely to exacerbate the trend of funding biologics and rare disease spaces through its shifts in the regulatory pathway and marketing exclusivity provisions for orphan drugs.
Is the money beginning to come back?
Thomas indicated that BIO's upcoming, updated analysis of VC trends in 2014 will largely be in line with the previously released 10-year trend report. But that doesn't mean that changes, including renewed enthusiasm for VC funding in biotech, aren't on the horizon.
"It takes a long time for people to really get back in with both feet into this industry from the venture side," he said. "You can only go so far with just that [core] group of investors. And so what it would take to get more money is more investors who aren't involved, or are on the fringe. But we haven't seen all of the money that's been made from exits via IPOs re-enter the space."
Those exits, via M&As and IPOs, are decidedly on the rise, which makes Urquhart more optimistic (as does the huge influx of venture funding in biotech in Q1 2015, which suggests 2015 could easily beat out 2014's numbers).
"We think that we're actually climbing out," she said. "So if the IPO market continues like the way it has picked up in the last two years, then we will see the return of VC capital because the exits are now available, whether it's M&A, which we're seeing in biotech and pharma with pharma buying more biotechs, or if it's IPO.
"And the IPO markets have done outstandingly well—very well in 2012, 2013, and 2014 was a completely stellar year. VCs I think are going to pick up since there are good exits now available for them."
Warning signs for Series A, science, and serendipity
Thomas and Urquhart both indicated that there are some warning signs in the current VC trends that should draw the industry's attention.
"I think we need to worry about the fact that the investments are going into well-established companies in very popular areas at the expense, perhaps, of the smaller companies that aren't getting that seed capital," said Urquhart. "We really need to start looking at seed capital, otherwise we're going to run out of innovation."
"We still see Series A financing down from the peak," noted Thomas. "And that's an interesting discussion. I think there's a debate as to whether or not we're funding enough small companies. And there are a lot of entrepreneurs that have a difficult time getting seed money, and a really hard time getting Series A money, which goes back to there being a very small pool of core life science venture groups.
"And some people argue that's not enough... A lot of great science has come out of serendipity and by putting a lot of ideas to test, and sometimes you come across things you would never expect. So people can't always predict where the next best drug might come from," he said.