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Venture capital found its footing in biotech. Then came the virus.

There's been no better time for venture firms to invest in drug startups than the past several years. But when a virus upended the world, it raised new questions about what types of investors and investments would succeed moving forward.
Yujin Kim/BioPharma Dive

Amir Nashat has spent nearly two decades building biotechnology companies. The first he worked on, Alnylam Pharmaceuticals, pioneered a new way to make genetic medicine. He's since helped advise and nurture at least 16 others, several of which were acquired for hundreds of millions of dollars.

Despite this track record, Nashat, a partner at the venture firm Polaris Partners, says most of his career in venture capital took place under "really crappy circumstances" that made it challenging to invest in young drug companies. Only in the last five or so years did things really start to change.

It was during this period that public markets came to love young biotechs, buying into record stock offerings. Large drugmakers, starved for innovation, also turned to them for their next drugs. This created a "hyper-compressed, hyper-intense environment," according to Nashat, where venture firms had much clearer and quicker paths to earn returns on their investments. For venture capitalists, there had never been a better time to invest in drug startups and, coming into 2020, many expected another big year.

Their predictions were quickly upended by the spread of the new coronavirus, which has infected millions and brought the global economy to a halt. In the past, economic downturns shaped how venture firms fund and incubate drug companies. Now, a pandemic threatens to do the same.

BioPharma Dive spoke with half a dozen venture capitalists who grow drug companies, as well as legal and financial advisors who work with healthcare venture firms. Almost all said the spread of the new coronavirus is affecting to some degree how they manage existing investments or think about new ones.

"It used to be that we had a lot of chaos, but the rest of the world was predictable," said Noubar Afeyan, CEO of Flagship Pioneering, the biotech incubator which founded coronavirus vaccine developer Moderna along with more than 25 other companies. "Now, we have chaos and the rest of the world has chaos, and so there are some adjustments being done."

As venture capitalists assess the damage caused by the pandemic, they appear to be treading lightly — financial data provider PitchBook found biopharma venture deals are down roughly 16% compared to last year. Some firms told BioPharma Dive that, in the current environment, they'd be apprehensive to invest in certain kinds of drug companies.

Even small adjustments could have a lasting impact on the drug industry, given the vital role venture firms play in it. Many biotechs wouldn't exist without venture money and support, making these investors a powerful force over the drugs that could become available in the future.

Money harder to find?

After the recession in the early 2000s, scientific breakthroughs led to a surge in biotech investments, many of which would ultimately disappoint. When the financial crisis hit in 2008, healthcare-focused venture firms found it extremely difficult to raise money from their investors, who viewed biotech as a risky bet.

Their attitude didn't start to change until about 2013, by which time the recession was over and advances in drug research had made biotech more attractive to a wider group of investors and potential buyers. Biopharma acquisitions and initial public offerings, typically the two main ways venture firms receive returns, would hit record highs in the following years, giving these firms and their backers the confidence to keep putting in money.

Indeed, since 2013 there's been an annual uptick in the number of funding deals venture firms are doing, with almost every year having about 70 more than the one prior, according to PitchBook. By 2019, the deal count had hit 941.

The collective value of these deals, which range from small angel investments to the larger funding rounds that follow, has grown too. In four of the last five years it surpassed $10 billion.

Deal counts, and value, have surged in recent years

The total value and number of US venture capital deals in biotech from 2006 to 2019.
Nami Sumida/BioPharma Dive; data from PitchBook

The favorable conditions also made it so that venture firms could go back to their investors for more money. Polaris Partners, 5AM Ventures, Third Rock Ventures and Versant Ventures, among others, each secured hundreds of millions of dollars across 2018 and 2019, while Flagship, Arch Venture Partners and venBio closed new funds this spring worth almost $3 billion combined.

Deerfield, a type of investor known as a "crossover" because it invests in both private and publicly traded companies, also just completed raising $840 million to put into healthcare companies.

While money has been plentiful, the economic disruption caused by the coronavirus raises doubts about whether that will continue.

Bob Nelsen, managing director at Arch, said he'd be surprised if any new, first-time funds can raise cash at all this year. Firms with existing networks of investor relationships may be able to pull off follow-on funds, he added, but they'd likely take longer to complete.

If a slowdown persists, young biotechs could find it difficult to close their next rounds of financing. Already, the pace of biopharma venture deals appears to be lagging, as PitchBook counted 228 deals between early February and mid-May this year, down from the 271 seen in a similar time frame in 2019.

One top concern is that crossover investors, who often come in later and supply a substantial amount of the funding that props up a company until it goes public, will back away from biotech startups. Without those investors, early-stage venture backers might have to dig deeper in their pockets to push their companies forward.

"It can take $1 billion to get a drug to market," said Kristopher Brown, a partner in the life sciences group at law firm Goodwin. "There are few venture capitalists who can afford to fund that."

Nelsen predicts some crossover investors will take a break from biotech startups and focus on public stocks that are now cheaper because of a turbulent market. But Jon Norris, a managing director at Silicon Valley Bank who works on deals with healthcare venture firms, isn't so sure.

Biotech stocks have held up relatively well this year compared to the rest of the market, which Norris said bodes well for continued crossover interest. What's more, the number of biotechs that have gone public this year — 14 as of May 26 — is just a tick down from the 17 IPOs completed by the same date in 2019.

"It just means to me that people continue to see this sector as one that's worthy of investing," Norris said. "If you see good returns, people are not going to be quick to exit the market."

After dip, biotech stocks have outperformed the market
XBI vs S&P; 500, values indexed to Jan. 2, 2020=100

Still, much is unknown about how the pandemic will further unfold.

For drug companies, the impact of social distancing and its ripple effects on the economy are expected to be more dramatic in the second and third quarters. In a possibly foreboding sign, industry bellwethers Merck & Co. and Johnson & Johnson have lowered their revenue forecasts for the year by billions of dollars.

"I do worry about the delays that are inherent to having this whole economy come to a stop and hospital systems being overwhelmed," Norris said. "To me, that's a big deal over the next quarter."

'Safer' bets

In the meantime, venture firms need to put the money they've already raised to work.

Early-stage investors who spoke to BioPharma Dive said their core strategies are still intact in spite of the coronavirus. Flagship and Arch prefer companies with technology platforms that, in theory, can give rise to multiple drugs. Polaris, as it has in the past, works its close relationships with academic institutions to find new startup opportunities. Atlas Venture remains fairly agnostic, while San Francisco-based venBio looks for companies on track to hit a meaningful milestone in the next three to five years.

And yet, the pandemic does weigh on their thinking.

To attract new investors, development partners and potential acquirers, biotech startups need to hit goals like moving a drug into and through human testing. But they've found a new obstacle in the coronavirus. By late May, nearly 100 drug companies of all sizes had reported impacts to their clinical trials related to the pandemic.

"There could be significant dollars lost and significantly extended timelines" for biotechs on the verge of, or already in, clinical testing, said James Flynn, managing partner at Deerfield.

As such, some firms are investing more selectively. Aaron Royston, a managing partner at venBio, said his team will be "very cautious" when putting money into any drug company that's close to starting an important trial or launching a new product.

Funding also might be harder to come by for biotechs built around a single drug program, as there's not much cushioning if that program runs into complications.

"Companies that are purely based on single assets with a clinical readout are in deep shit," Nelsen said.

By contrast, companies at the earliest stages of research may benefit. Investors assume that, by the time these companies reach human trials, some of the challenges and uncertainties surrounding the coronavirus will have been ironed out.

Royston, for instance, said he has little apprehension investing in biotechs that will be working on early research for the next 12 to 18 months.

"Preclinical investment is almost a safe place to hide while everybody else is on the later-stage side, trying to figure out how to deal with delays in clinical trials," SVB's Norris said.

For now, venture firms say they've been more frequently checking in with companies that could face setbacks because of the disruption and, if needed, helping devise plans to conserve cash.

"At the end of the day, data is the currency of how we value our progress," said Atlas Venture partner Bruce Booth. "So, as long as the biotech has enough capital to get it through those data collections and can get out from some of those R&D delays, then I think we'll be in an OK place coming out of this crisis."

Clues from the past

In responding to the disruption brought by the pandemic, venture capitalists may revisit approaches honed after the last big economic downturn in 2008.

Then, a dried up IPO market alongside difficulties raising money led some venture firms to leave life sciences investing altogether. Others doubled down on their existing strategies or adopted new ways to build companies.

Versant, for example, was known to start companies with a prearranged buyer in place. Atlas gave some companies, like Nimbus Therapeutics, a limited liability structure that made it easier to sell individual drugs to buyers, though more complicated to go public. Such tools are "less critical now than they were during that challenging period" because biotechs can still conduct IPOs, Booth says.

At Polaris, hard economic times reinforced the firm's trust in a type of group investing called syndicates, which can spread risk between firms. Flagship, on the other hand, backed away from forming biotechs with other investors because the process felt too restrictive.

"What we found was that, when people were traumatized through financing risks and through uncertainty, a syndicate was only as strong as its weakest link," Afeyan said. "In other words, if you had five investors sitting around a board table, the weakest one was the one that got to decide what you did."

Flagship has since shifted resources to focus almost exclusively on creating startups in its own labs. And it isn't alone. Firms such as Third Rock have become known for an intensely hands-on approach, incubating companies and ultimately owning significant stakes when those biotechs go public.

Another popular strategy has been to stagger, or tranche, investments to limit risk. Typically, this means firms give smaller chunks of cash early on and larger chunks later, once a startup has provided more evidence that its medicines might pan out.

Top Series A biopharma deals for U.S. venture capital

The top 50 U.S. Series A deals in pharma and biotech from 2006 through the first quarter of 2020. Each bar represents the deal value. Each circle marks when the deal occurred.

Sort by:
Nami Sumida/BioPharma Dive; data from PitchBook

And yet, despite the unprecedented challenges posed by the pandemic, venBio and others appear optimistic that a 2008-like shakeout isn't coming, and that they won't have to rely on unorthodox strategies to navigate the future. Royston's view on 2020 opportunities hasn't changed; Nelsen doesn't foresee the pandemic preventing Arch from investing right now; and Flagship is still on track to spin around 10 projects into full companies over the next year and a half, Afeyan said.

There's a key difference this time around, several firms and advisors said, and that's the money which has so far stayed readily available to healthcare investors. Cowen Healthcare Investments just last week finished raising nearly half a billion dollars, adding to the string of recent hauls from other firms.

"We've seen these things come and go, and frankly we've done some of our best companies in the down cycles," Nelsen said.

A pandemic, however, isn't just another down cycle.

Past downturns didn't threaten to overwhelm the healthcare system, as the outbreak of the coronavirus has. Hundreds of thousands of Americans have been sickened by coronavirus infections. And for millions of people with diseases other than COVID-19, how they seek and receive care changed overnight.

The widespread shutdown of businesses across the country, meanwhile, has created economic hardship not seen since the Great Depression, and it's unlikely a stop-and-start reopening will quickly heal those wounds.

"No one fully can comprehend, even in a world as smart as the biotech scientific world, the trajectory and the impact of the current situation," said Amy Schulman, a managing partner at Polaris.

Whether the pandemic persists into next year or lingers much longer, venture capitalists do acknowledge it will have profound effects on society and, by extension, the drug industry.

Nashat envisions that "new kinds of entrepreneurs" will rise amid the chaos, while others will be "scared off." Nelsen predicts big changes in how healthcare is delivered, which will "shock" the system and create new opportunities.

That means investors will need to adapt too.

"It would be incredible, to me," Afeyan said, "if people just forgot this and resumed their old normal."