Private drug developers awaiting a thaw in the last few years' frigid financing conditions will take heart at the recent flurry of new funds raised by life science-focused venture capital firms. The past few months have seen the huge US healthcare investor Orbimed raise $735m and early-stage California investor 5AM Ventures raise $250m, while in Europe Edmond de Rothschild Investment Partners and Gilde have both managed to close funds.
At firms flush with new cash the mood is inescapably upbeat. “You are about to see a huge resurgence in venture capital in healthcare,” says Jonathan Silverstein of Orbimed. “This year a few funds managed to raise – next year there will be a bunch more.” However as investors return to these high risk propositions, venture firms will remain under tremendous pressure to prove that they can turn the biotech bull run into returnable profits.
Much of the optimism emanating from the venture capital community is being forged by the buoyant US IPO market and a belief that the FDA is becoming more co-operative, particularly over the most innovative products.
A collegial regulatory environment is clearly a plus for the sort of start-ups that venture capitalists seek; they will typically be working on the most novel therapies and techniques. However, the immediate benefit of a wide open IPO window is less apparent; floating has not been considered an exit for venture investors for many years.
This is certainly still the case in the US, Mr Silverstein admits; in any case the lock-up periods for many of the recent IPOs have yet to lapse. But he believes that market conditions are improving to the point where opportunities for early investors to sell up will emerge. He points to two pure secondary offerings this year – Intercept and Chimerix – where the only shares sold were by insiders, with no new stock issued.
“Before Intercept did their secondary there had not been a pure secondary since 2004. Now there have been two of them. I don’t know if that’s going to start a trend, but if it does continue there will be exits,” he says.
Chimerix floated on Nasdaq in April, while Intercept was one of the few companies that got away in 2012, selling shares in October that year.
“We had about 50 IPOs in the last two years. As those returns filter through to the venture capital firms, you are going to see funds that looked like money losers starting to make money. And then investors will realise they are drastically under-allocated in venture capital.”
Managing an exit
Still, even after passing a portfolio company into the hands of public investors, venture firms have to extract those paper profits so they can return them to their own limited partners.
Bruce Booth, partner at Atlas Venture, has calculated that the aggregate market cap of this year’s biotech IPOs in the US is about $16bn, and he estimates that 60% of the shares in these companies is still owned by venture investors, representing a huge pile of unrealised profit. How to sell down these substantial holdings without hurting company valuations will be the big challenge for venture firms in the coming years, he argues in his blog on Forbes.
And of course locking in profits requires shares in any newly listed company to perform well. The Nasdaq Biotechnology Index (NBI) has ploughed onwards and upwards this year in a remarkable display of strength, advancing 56% year to date, and ongoing investor enthusiasm for all things biotech will certainly help venture firms achieve profitable and quicker exits. Any retrenchment will make this task harder.
However, even in a bull market exiting from an investment that has gone public can and will take time. Denis Lucquin, managing partner at the French VC Sofinnova Partners, says the statistics on their portfolio indicates that it has taken them roughly two years to exit an investment after IPO. Sometimes this can take a lot longer – Sofinnova only managed to complete its exit from Ablynx last month, having first invested in 2002; the Belgian antibody researcher had floated in 2007.
A recovery in Ablynx’s share price over the past 12 months – driven by success with a rheumatoid arthritis candidate subsequently licensed by AbbVie – allowed Sofinnova to sell its remaining stake through a private placement.
“With Ablynx we needed to be more patient with than we expected a few years ago,” Mr Lucquin says.
The European life sciences sector has remained largely immune to US enthusiasm for biotech – flotations have been far fewer, for example, and valuations of public companies remain relatively much lower – so keeping returns flowing to limited partners arguably remains an even bigger problem for Europe-focused venture firms.
Those firms that have managed to raise new funds are, however, sanguine, being able to cherry-pick the best investments is a frequently cited reason for cheer, as is a belief that US buoyancy can only help.
“The optimism of the US is reaching Europe now. When you talk to the bankers there is optimism on equities. They are already investing in IPOs and secondary offerings in the US, and now they are looking at Europe,” says Mr Lucquin; Sofinnova raised its seventh life science fund of €240m in December 2012.
He points to French allergy specialist DBV Technologies, which completed a €30m private placement earlier this month, with the majority of shares bought by US investors. Half the shares were supplied by existing investors that had backed the company before its IPO in early 2012, providing them with an exit.
More recently Innate Pharma raised €20m from a placement of new shares directed exclusively at US investors (Innate financing confirms importance of US to European biotechs, November 21, 2013).
But the fact remains that enthusiasm is much more muted in Europe, where it seems very unlikely that a venture capitalist will make the same pronouncement as Andy Schwab, a partner at 5AM Ventures: on closing their fourth fund this month he was quoted as saying that the $250m was the easiest to raise yet.
“Europe is tough. Many pension funds for example still won’t invest in venture capital in Europe,” says Alfred Scheidegger, founding partner at a Swiss venture firm, Nextech Invest. “If you have a good long-term track record then people will invest. But there is a second tier of firms that are not as well known and have not done as well, and they have to work hard.”
Despite this cash is being raised – this month Gilde Healthcare closed its third fund at €145m, and in November Edmond de Rothschild Investment Partners closed its fourth life science fund at €192m. That took 15 months to raise but was 25% larger than its previous fund, says Gilles Nobécourt, head of life sciences at the Paris-based firm.
“In the current environment we were very happy to be able to increase our investment capacity,” he says. “Our strategy is to pay significant attention to management of liquidity. We have managed to sell one company per year, and been able to return cash to investors every year since 2004,” he says.
“But you always face limited partners with serious questions about the asset class.”
Even in the US, where investors have been much quicker to return to biotech after several fallow years, scepticism remains. Mr Silverstein’s acknowledges that Orbimed’s success with its new fund has a lot to do with the firm’s size – safety in numbers for investors – and says he knows that smaller venture capital outfits are still struggling to raise new funds.
Overall, the amount of money flowing into life science venture capital firms and on to start-ups has yet to return to pre-crash levels; when it will, or whether it ever does, will depend a lot on the success of these firms that have recently raised new funds.
Outside the preferred exit route of a straight takeout, venture capital firms remain under immense pressure to prove that they can keep returns flowing to limited partners. The emergence of new asset-centric models and moves by companies like F-Star and Forma Therapeutics, which have legally structured their assets to allow for an easy sale, demonstrates that extracting a relatively quick and simple return on investment is a priority (F-star forges immuno-oncology spin off in latest test of asset-centric model, October 23, 2013).
But these models have yet to be proven. And while a buoyant IPO market is a great sign of public sector confidence, venture firms need to demonstrate that they can turn public stock into profits, preferably over a short period of time.
|Significant early-stage life science-focused VC funds raised in last 12 months (+$100m)|
|Announcement date||Firm||Fund size|
|Europe||Jan-13||Wellcome Trust (Syncona Partners)||$323m|
|Nov-13||Edmond de Rothschild Investment Partners BioDiscovery 4||$265.2m|
|Feb-13||Gimv N.V. Health & Care Fund||$132m*|
|Jan-13||Hatteras Venture Partners||$125m|
|*First closing **Also investing in energy and tech sectors|