BB&T National Editor
Robin Bellas is a partner in Morgenthaler Ventures (Menlo Park, California), a prominent life sciences venture capital firm. He joined Morgenthaler in 1983 after 10 years of management experience with emerging growth companies. Bellas has spearheaded the firm’s investment in life sciences companies and serves on the boards of 10 current portfolio companies, with previous service on the boards of numerous firms subsequently acquired by larger med-tech companies.
He is a past director of the Western Association of Venture Capitalists and of the Stanford Business School Trust. A 1966 graduate of the U.S. Naval Academy, he served as a line officer on nuclear fast attack and nuclear missile submarines before receiving his MBA from Stanford Graduate School of Business in 1973.
Biomedical Business & Technology: How does a recessionary economy — or something much like it — impact venture investing in general, and life sciences investing in particular?
Bellas: I had a good case study of that over the past two weeks, because in week one, my company, IPC-the Hospitalist Company, was on a road show and everything was falling apart. The economy was declining, the stock market was declining, and everyone was worried about what was going to happen. And then last week, the Fed took the pre-emptive move, a 75 basis point reduction on interest rates on Tuesday morning, right after the holiday, and the market went back up and then the expectation was that the Fed was going to reduce by a half-a-point, which they did yesterday, so we priced the IPO within the filing range, which is highly unusual for IPOs within this volatile market.
The point is that companies with revenues and profits are always going to be able to go public, no matter what happens in a recession, but for two-thirds of our exits being strategic exits in sales to larger companies, that continuing market will always exist. and it’s pretty much the IPO markets that get impacted by recession. So we’ll be able to continue to be able to do our exits through sales to large buyers. That will continue regardless of the economy, because the large buyers have needs to fill their product pipelines. But we will see an impact on our IPO ability to get financing for the companies.
Now, when you tie healthcare to the concept of the pig going through the python, and the Baby Boomers being such a large generation in need of healthcare, despite the recession, there will always be a demand for the variety of products that improve the quality of life, both devices and drugs. So there should be less effect on the healthcare market during a recession than on other markets.
BB&T: It seems to me that we talk so much about demographics powering the companies that you work with. Is there a tendency to overstate that, or not? Is it simply that is what powers the growth in this field?
Bellas: If I were at the whiteboard and painting a picture for you of the effects of demographics on our investment strategy, I’d say that for the past decade, our investment strategy has been driven by the concept of graceful aging. So, we’re really investing in new-product companies — both drugs and devices — that assist this big old Baby Boom generation in aging gracefully. On the device product side, for example, think of all the products that help you look better and feel better so that you can continue to play tennis until you’re quite old. On the drug side, think of all the products that assist with lifestyle, like Viagra, or assist with cholesterol control, like Lipitor, that allow you to remain healthy. So the whole point is to not decline in health as you age, but rather, to sustain health. And then drop dead, you know, when Mother Nature says it’s time to go, after having been active in your elder years.
So graceful aging really defines our investment strategy. A complementary strategy which we’ve used for the past decade has been surgery without knives, and we’ve actually invested in companies that now perform what used to be nasty surgical operations using medical devices, we’re able to do them without cutting because we’re using different points of access. In short, yes, demographics does drive quite a bit of our investment strategy.
BB&T: Give me some examples of surgery without knives. I remember you talking about surgery without knives during one of your roundtable programs held during the time of the JPMorgan meeting in San Francisco.
Bellas. Yes, we did cover that a couple of years ago. I guess the oldest company in our portfolio, now public for a couple of years, is Thermage [Hayward, California]. They do the facelift, using RF energy to shrink the collagen under your skin. We’ve sold our stock, so we’re not involved with the company any more, but it’s been a procedure that’s been successful in shrinking the collagen and producing fresh collagen, which smoothes the surface. So that’s one example. A more recent example is a company we have called Satiety [Palo Alto, California] you might remember that one.
BB&T: Yes, I was going to ask you about Satiety. That would seem to me to be in a sweet spot right now.
Bellas: Satiety’s clinical data looks real good. Now, everybody’s pronouncing that we have an obesity epidemic, and Satiety’s clinical data, has shown that at the six-month mark now, heading toward a year, that patients have lost, I think it’s up to 46% of their excess weight, and it’s staying off because of the ability to go down the esophagus and re-size the stomach and create a smaller pouch in the stomach using the Satiety device. So the combination of switching that procedure from nasty surgical procedure to an outpatient procedure in a physician’s office has really perked up the patient population.
The original patient target, of course, was the clinically obese patient that absolutely needed to lose weight for his or her personal health. An emerging market, which we thought could emerge, is the whole vanity market, where someone says, ‘I’ve got a major college reunion coming up next year; I’m going to go have the Satiety procedure and lose 50 pounds.’ And those two markets combine for the potential to develop a billion-dollar company.
BB&T: At a couple of American Diabetes Association meetings, I’ve heard presentations, from the perspective of the diabetes-related doc, touting gastric bypass surgery as a great aid in diabetes, so I would think that Satiety’s approach will fit very well in that argument as well.
Bellas: Well, they both accomplish the same result, except the patient doesn’t have to go through a horrible open surgical procedure with the Satiety procedure, unlike bariatric surgery. The results have been good.
There has just been a recent New England Journal of Medicine article talking about the disappearance of diabetes in obese patients who have lost their excess weight. The article talks about how the co-morbidities go away just by themselves without treatment as you lose excess weight. Those include, obviously, orthopedic pain, so the weight on your joints diminishes; diabetes, because obviously your lipids are dramatically reduced when you lose a lot of weight. All the co-morbidities of hypertension, where obese patients sometimes have trouble exerting themselves, shortness of breath, all those things sort of go away as you become a bit more healthy.
Let me tell you about one other type of patient that’s benefiting also. We have a company called Emphasys [Redwood City, California]. This is for ... lifelong smokers who have developed emphysema. With emphysema, you know, your chest expands, you’re breathing at the top of your lungs, every breath is difficult, you can’t walk or hike because you can’t transport the oxygen in. And the old solution used to be to cut open the chest, pull the lungs out and use a soldering iron to cut off the bottom lobes of the lungs, where the tar resides, and the diseased tissue, then put the lungs back in the chest and close up.
Emphasys has developed a little duck-bill valve — if you can think of a valve that lets air in one side, then has a long, duck-billed shaped piece of rubber on the other side. It allows the air to escape from the patient’s chest, thus allowing the heart and the diaphragm and lungs to move back into their normal positions. And then over time, by preventing fresh air from coming in, the diseased portion of the lungs, the body naturally necroses the diseased tissue and you’re able to restore lung function.
The company has completed its pivotal trial here in the U.S., with beautiful data that’s statistically significant, so they’re in front of the FDA soon for panel approval and are planning a public offering. And they did several hundred patients — I think it was almost 300 patients — in their clinical trial. So now emphysema patients have a noninvasive solution — in going through the airway, you avoid cutting, and it’s an outpatient procedure in a doctor’s office.
BB&T: Are respiratory and pulmonary diseases a hot area, kind of a growth area, kind of a hot area for venture investing?
Bellas: Again, it is because the Baby Boomer generation which used to smoke a lot of cigarettes, is kind of like the World War II generation, where people smoked for fashion in the 1950s and 1960s. Yes, there are a lot of emphysemic patients out there.
BB&T: I want to know what you would choose as one of the most surprising areas for VC investing in life sciences over the period you’ve been involved.
Bellas: Probably most surprising to me is the difference between medical device investing and biotech investing. There are two surprises there. One surprise was that the large pharmaceutical companies often take a decade or more to develop a new drug. In our venture business, we’ve been able to do that in a reduced amount of time by focusing on diseases that have very discrete clinical end-points and very short clinical trials.
We take these indications that allow more rapid clinical trials and end-point results. This has been important to the large pharmaceutical companies. because they are so focused on consolidation rather than research. The result has been that the number of drug approvals for pharma companies has been declining, and the number of drug approvals from biotech has been rising. That crossover occurred in 2002 and now you’ve got twice as many.
The surprising result of all that has been that the large pharmas are using their cash flow to buy our little biotech companies early, to add those product platforms to their R&D groups. It’s been very rewarding in the venture business because we’ve been able to sell pre-clinical companies, pre-revenues obviously, for several hundred million dollars, whereas before we had to develop them all the way to Phase III clinical trials.
The other surprising thing on the med-tech side is that by creating new companies within our incubators — The Foundry (Redwood City, California) and ForSight Labs (Menlo Park, California) — do rapid prototyping in developing new medical devices and then getting them into humans early, surprisingly we’ve been able to get very large step-ups in valuation in the follow-on financings from our colleagues, many of whom are doing later-stage med-tech investing.
BB&T: Let me jump to that question. How do the Foundry and ForSight Labs go and find the good ideas, and how do you incorporate those ideas into as full-scale company development program?
Bellas: The “secret sauce” at our incubators is the management team. The folks at the incubators used to be CEOs of our portfolio companies and produced very significant capital gains for their investors, so they’re trusted. And now they have a national reputation for having created successful companies in the past. It turns out that the deal flow comes to them.
The entrepreneurs know of their background and history, they know of the success of The Foundry, so they bring their business plans early to The Foundry and ForSight Labs executives for review, asking, “Hey, how do we shape this up and go raise venture capital?”
So The Foundry guys get to see the plans — or lack of plans — one step earlier than we do. And that way they get to review all the hundreds of fresh new ideas, and then when we fund a new company at The Foundry, we spend the first year sorting through all those opportunities before actually deciding what to pursue. And then we go get some clinical data, and then a new investor comes in and leads the Series B round, and then we give the company a name and hire a CEO. So the incubators are magnets for entrepreneurial deal flow.
BB&T: What’s more important, the idea or the people? The people at the level of the incubators, that’s really as important — and maybe more so — than the people you end up enlisting to run the companies that you’re investing in.
Bellas: Well, they’re both equally important, but at different stages of the company’s life. When you say incubator, a lot of people think you’re just renting out space. You’ve got good engineers that are on staff, you’ve got a machine shop in the back, you’ve got a couple of managers who used to run portfolio companies, and you’ve got the board of directors, and everyone is brainstorming about where the next good idea is coming from. The chief engineer at The Foundry has a hobby of going through old medical texts and finding these old surgical procedures, and then he invents less-invasive devices to replace the old procedures.
That’s really very cool. We’ve got a hot young company called Ardian Medical [Menlo Park, California] which is doing renal enervation for hypertensive patients and congestive heart failure patients. When you have CHF, the hormone signal from your brain tells you kidneys to hold water and salt back to increase the volume in your blood vessels because the heart’s having trouble getting adequate blood flow out to the organs. That results in an even tougher load on the heart, so by “tricking” the kidneys into continuing to de-water the patient, you actually help the CHF patient and allow the heart to remodel back into the football shape.
This is just so amazing. These ideas often are generated by the guys at The Foundry as we sit around the board table talking about, what have you seen or what have you thought about that’s new and exciting?
BB&T: So which is more important, the idea or the people behind it?
Bellas. I’ve often heard the phrase, “We don’t finance inventions, we finance companies.” We get approached by a lot of inventors who have cool inventions, but the invention isn’t enough — you’ve got to have people there to execute on the plan. We usually decline inventors who have a cool idea. Rather, we go to universities and out-license technology from a group at a university then create a management team around it. You need both in a successful company, but the invention or the idea itself is worthless without the successful team to execute the strategy.
BB&T: Is there a life cycle for the CEO who comes in to take the idea and move it forward?
Bellas. Very much so. We think of it in terms of sort of an automobile gearbox. Some of our start-up entrepreneurs have a first, or a first and second, gear, but no way do they have a third or a fourth gear. So often you’ll see that start-up executives who are good at getting things going quickly to grow, but once you get up toward the $100 million revenue mark, sometimes you need people who have the experience of running $100 million+ companies, who have a different view on life and are capable of taking companies to public offerings.
It’s rare to find an entrepreneur that has all the gears in the gearbox. We have across our history replaced about 50% of our CEOs because often they realize they don’t have the gears in the gearbox to take it to greater growth.
BB&T: What’s up next?
Bellas. We think lifestyle medicine is something that’s very hot. Aesthetics, for example. We recently started a company at The Foundry which is focused on excessive sweating. It turns out there are a couple million people in this country who suffer from excessive perspiration.
We’ve developed a way to ablate the sweat glands in the armpit. This emerging market is called “hyper-hydrosis.” This is one example of the continuing thrust toward looking good and feeling good. Lifestyle medicine sector is a high-growth area.
BB&T: How about ophthalmology?
Bellas. We started this second incubator, ForSight Labs, because there are a lot of unmet medical needs in the eyeball to address diseases of the eye. We’re continuing to look at interesting areas in ophthalmology.
There are important challenges to be met. We think the ophthalmology area if rife with opportunity.
BB&T: What haven’t I asked you that you wish I had?
Bellas: There’s this interesting trend among the venture firms that are financing med-tech companies after a significant IT emphasis in the 1990s, to come back and add partners to invest in healthcare. What has been surprising to me is the amount of capital that has been flowing into the med-tech universe, and the percentage of that being applied to later-stage investing, so we early-stage investors have been almost without exception been able to get step-ups in valuation in follow-on financing rounds with human clinical data. That’s the critical part — you’ve got to have some human clinical data to convince the new investor that this concept actually has been proven.
First of all, it’s the flow of money. Secondly the emphasis on later-stage investing and therefore the ability for our incubated companies to obtain follow-on financings, with such high demand from investors. It’s been interesting, and something I wouldn’t have predicted.