Cautious optimism returns to biotech investing
By Nancy Weil
IDG News Service, Boston Bureau
09-05-2003
BOSTON - A lot of attention has focused on the decline in biotech investment and growth in recent quarters, but a renewed sense of optimism, coupled with a healthy dose of realism regarding the natural ebb and flow of business cycles, is emerging among analysts, investors and vendors in the market.
Despite upbeat comments and optimistic forecasts, however, the freewheeling days are over when it comes to funding "science projects," as San Diego-based venture capitalist Joel Martin, calls startups without a good business plan. Caution will be the operative approach for the near term because there is still plenty of uncertainty out there.
For instance, the year-end 2002 MoneyTree Survey of venture capital investment from PriceWaterhouseCoopers, included this comment from Tracy Lefteroff, global managing partner of the company's venture capital practice: "We may finally be near the bottom. This level of investing is more realistic and more sustainable. By historical standards, the current run rate is healthy for venture capitalists and entrepreneurs alike. If the public markets and liquidity opportunities improve in 2003, we could see the return to a more stable venture capital market." The life sciences sector, comprised of biotechnology and medical devices, was termed the "bright spot" for 2002, reaching US$4.7 billion of venture capital for 22 percent of all such investments in the year.
But in the first-quarter 2003 MoneyTree Survey, Lefteroff had this to say: "The reality is that venture capital will not lead the economy out of this slump. It will follow it out. Restoration of global stability appears to be under way. But, until the public markets and liquidity opportunities show signs of sustainable improvement, venture capital will not rebound."
First-quarter biotech investing was flat, but moved to the number-two spot, behind software investment, with US$490 million invested in 49 companies. Investments in medical devices dropped 48 percent compared to the fourth quarter of 2002. The flat quarter was due in part to war in Iraq and uncertainty caused by that conflict and other world events that made investors continue to be wary and affected the stock market.
"I think there is a natural business cycle that really is at work here," says Darren Carroll, chief executive officer of InnoCentive Inc., an Andover, Massachusetts-based startup funded by Eli Lilly and Co. that matches scientists with companies searching for someone to help with research and development challenges. "For a short while we had collectively forgotten that the business cycle cannot be ignored. I think all of us are completely disabused of that notion these days."
Like others interviewed about the state of biotech investment, Carroll expressed surprise at how dramatically the events of Sept. 11, 2001, and the aftermath, affected markets. "I think that event so completely upset their sense of what was normal, they just needed some time to recalibrate" he said of investors.
"It seems to be never-ending," says Martin, a partner at Forward Ventures, a biotech investment firm. "There's a general mood toward risk aversion."
And that translates into an aversion toward early-stage biotech investments because those carry the most risk. When it comes to pharmaceutical investment -- which tends to be what the venture capitalists talk about -- investors today look for solid business plans with strong management teams that can take a company from the early stage of discovery through drug development.
"We know very well that to get positive tech value, to see a strong return, we need to see drugs either being sold or close to being sold," Martin says."So we're looking for companies that are like that, but we also find that today you can buy those companies very inexpensively."
The decision to invest takes longer than it used to. "It can easily take nine months now between the first meeting and cash in the bank," he says. "That's because we're checking everything. We're checking under every rug."
But after all of the rugs have been checked and an investment is made, Martin says that his firm's investors are "really minding our children very carefully because we want to see them be successful," and that also means requiring them to be financially frugal. Because more effort is going into both the decisions about which companies receive investments and then the nurture of those companies, in the long run that means that successful biotechs will find more money is available to them because funds aren't being mindlessly handed out.
"In the long run, I think that's a good thing," Martin says.
Also in the long run, as investing picks up, the Boston and San Francisco Bay areas will, perhaps, have less to fret about. Worried studies from biotech trade groups and analysts have noted that growth in those areas, which are the top two regional U.S. clusters in the industry by most measures, has markedly slowed and state governments have been called on to help push biotech back into gear. Growth will pick up, agreed those who were interviewed, but those regions will have to cede some biotech-leader bragging rights to San Diego, and need to be mindful of competition from North Carolina and Pennsylvania.
California already has seen a display of state government support for the industry, and Massachusetts Governor Mitt Romney has pledged to support the state's biotech market and that his administration, which took over in January, will do what it can to help, including assisting with investments.
Most new biotechs will still take root in Boston, San Francisco or San Diego, which has an advantage because many of its biotechs as well as research institutions are within walking distance of each other, Martin says. Smaller markets like Research Triangle Park in North Carolina will also continue to thrive, particularly given that area's push to become a manufacturing and commercialization center.
Boston and San Francisco in particular just don't have much available, affordable land for large manufacturing sites. Some industry analysts have suggested that biotech is moving toward a distributed model, with some business clusters organized around early-stage companies, research and development and others focused on manufacturing and commercialization centers.
If anything, the funding situation now is "more realistic and more sustainable," Lefteroff said in the 2002 year-end MoneyTree survey. "By historical standards, the current run rate is healthy for venture capitalists and entrepreneurs alike."
Hype over the human genome project has died down and the effect of the dot-com bomb has also begun to wane. The hype and the dot-com bust are "what we're suffering the hangover from," says Larry Wittenberg, a partner at Boston-based Testa, Hurwitz & Thibeault LLC, which specializes in emerging-growth companies and the venture capital and private equities markets. He discounts the role that Sept. 11, the economic downturn and the war in Iraq have played on biotech investing.
"I think that the health of the biotech funding market is really very tied to the health of the technology funding market generally," he says. "You need public markets and public markets are still in the midst of a really big hangover."
Even so, biotech is "very sexy" to investors, Wittenberg says. Investors, many of whom have solid science backgrounds themselves, are captivated by the science underpinning the companies they finance and like the idea of contributing to a market that holds enormous promise to enhance people's lives by controlling or even curing diseases.
"I think near term, it will be cautious," Wittenberg says, "but I have a lot of optimism for the future just because I think the science is there and the need is there."
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