The first part of BioWorld Insight's Innovation Analysis showed that while biotech Series A funding jumped 39 percent between 2010 and 2011, the percentage of that money allocated to so-called specialty pharma firms jumped 45 percent.
While this might raise concerns that the creation and funding of new biotechs is not necessarily synonymous with the creation and funding of the biopharma industry's next generation of innovative breakthroughs, taking a longer view shows venture investors have become much more willing to support innovation over the past five to six years, as evidenced by a decrease in the percentage of Series A funding allocated to specialty pharma and clinical-stage firms.
The whole point of obsessing over funding for early stage companies is that the biopharma industry's increasing dependence on in-licensing has led to concerns that, at some point, big companies might look around and realize they've run out of assets to in-license.
Some folks view that as a real issue. "I'm concerned there are not enough really new innovative companies being funded," said George Golumbeski, senior vice president of business development for Celgene Corp., at a recent conference. "We've looked at almost every drug in the oncology space for over a decade. For the first time, there is a real dearth of assets now."
Others, like GlaxoSmithKline plc's vice president of worldwide business development Brian McVeigh, are less concerned. "I've gone from, 'The sky is falling' to, 'Well, maybe it's just raining right now,'" he said.
Countering Darwinism
Although biotech Series A funding increased last year, there's no debate that, as a whole, the life science venture industry is evolving under pressure. Some firms have shut down, others have merged, many are struggling to fundraise, and an increasing number are exploring new business models and new partnerships with academia, entrepreneurs and pharma. (See BioWorld Insight, Jan. 17, 2012.)
"The simplest way to put it is it's changing right now," Third Rock Ventures partner Kevin Starr told BioWorld Insight.
Many VCs see a silver lining to the relative decrease in available capital in recent years. "I do think the most innovative science will find funding," said Polaris Venture Partners managing general partner Terry McGuire. "Darwin was an optimist when you put Darwinian pressures on systems, really good things happen."
But Professor Matthew Rhodes-Kropf of Harvard Business School disagrees with the commonly-held VC notion that less funding available means the best projects will rise to the top. Rhodes-Kropf and colleague Ramana Nanda have a paper pending publication that shows quite the opposite.
Rhodes-Kropf and Nanda analyzed VC-backed start-ups that received their first funding between 1980 and 2004. They found that firms initially funded during "hot" VC cycles were less likely to go public and more likely to go bankrupt than firms funded during lean times. While that would seem to reinforce the Darwin theory that an abundance of venture money leads to more junk getting funded, further analysis showed that the firms funded during hot times that did go public had higher valuations, more patents and more patent citations.
The researchers concluded that an abundance of capital allows investors to experiment, resulting in more failure, but also more investment in start-ups that are not necessarily better or worse, but are more risky and innovative. They also said their data suggested the flood of capital in hot markets is not a reaction but rather plays a causal role in shifting investments to more innovative start-ups.
The Harvard analysis is not specific to biotech, and it only looked at firms that either went public or went out of business. Rhodes-Kropf said tracking the success of those that exited via an acquisition a more relevant measure for biotechs was not feasible because terms are often not disclosed, and it takes a long time to track if contingent payments are ever realized.
But Rhodes-Kropf knows biotech well; he is former chief financial officer of Avid Radiopharmaceuticals Inc., which was acquired by Eli Lilly and Co. And he told BioWorld Insight that with the current dearth of venture capital, "we are literally undermining the innovativeness of the economy."
What Goes Around
The good news, according to Rhodes-Kropf, is that venture capital is cyclical, just like the public markets. And although some folks say this time is different the venture world is fundamentally changing, the IPO window will never be what it once was for biotech Rhodes-Kropf is skeptical.
"People always think it's different it never is," he told BioWorld Insight. "We're in a lull. We've had lulls before. I suspect it will come back, whether it's next year or 10 years from now."
Correlation Ventures managing director David Coats agreed. "If you can learn one thing from history, it's that there clearly are cycles," he said. "I certainly would not bet against a major [biotech] IPO window opening up in the next five years."
Coats also noted that several of the contrarian investors his firm works with are "starting to look at life sciences" again.
Bruce Booth, partner at Atlas Ventures, also sees increasing interest in early stage biotechs. Over the past two years, he said he's been excited to fund companies "working on real innovation big science, big stories yet within the new model of capital efficiency and a rich ecosystem of partners."
The combination would appeal to many venture firms.
Third Rock's Starr is seeing the same interest. He noted that over the last 10 years, venture firms have seen that the focus on late-stage investments and so-called "de-risked" opportunities has not delivered good returns. "Venture should be about high-risk and high-reward capital," Starr said, which is why Third Rock focuses on founding new companies.
"One of the things we found, that was a little surprising, is our model resonates with our syndicate partners," Starr said.
Third Rock often seeds its newcos internally and opens the syndicate to other VCs only after the company has gained a little traction, but the firm has found no shortage of other VCs seeking to co-invest in its relatively risky, early stage portfolio.
"There is a growing recognition across all of venture that the early innovation model works," Starr said.
Editor's note: This article was written in a partnership between BioWorld and FierceBiotech. Part I of the series, which analyzed 2011 Series A funding, ran in FierceBiotech last month and in BioWorld Insight last week.