Events on the financial markets over the last couple of weeks made it patently clear that shock waves from the global credit crunch are still capable of inflicting damage in many regions and sectors of the economy. This would not have been a revelation to those trying to raise money to fund very early stage drug research, an incredibly high risk investment area that has suffered along with many others from diminished funding.
However, the full impact of the credit crunch on venture-capital backed drug developers might only be emerging now. While the number and value of financing deals has been on a gradual downward trend since 2007, data from EvaluatePharma for the first half of 2011 show a dramatic decline in venture dollars raised by companies researching human therapeutics. Follow-on funding rounds in particular are being hit, prompting investors to increasingly seek stronger and broader syndicates from day one. All of which points to tough times continuing for these companies and their backers (see tables below).
Scarcity of capital
All the data shown below comes from the EvaluatePharma universe of companies focused on developing human therapeutics, across the globe. As such, this analysis provides a unique insight into the highest-risk end of the healthcare sector. It also offers a contrasting view to recent reports which suggest an increase in venture capital investment in life sciences so far this year, which are drawn from multiple sectors including diagnostics, devices, medical instruments and more, obscuring the picture for novel therapeutic research.
In the first half of the year, 98 private financing deals were completed, securing commitments from venture firms to invest $1.9bn. Assuming a similar rate and value of deal flow in the second half of the year indicates 2011 will be the lowest for venture capital investment in this sector for some time, and continue the downward trend (VC funding for human therapeutics remains depressed, April 20, 2011).
|Year||Total VC Investment ($bn)||Financing Deal Count|
“This is a natural trend when you look at the general scene of VCs which have struggled with fundraising in the last few years”, says Bart Bergstein, managing partner at Forbion Capital Partners. “The amount of new funds is scarce which in the end translates into the declines in deals and values we are seeing at the moment."
Mr Bergstein expects this depression to continue into 2012, a view shared by Antoine Papiernik, managing partner at Sofinnova Partners.
“Performance data needs to improve before LPs increase their commitment to life sciences, but this is likely to take a few years,” he says.
Mind the gap
Drilling down into the number and value of financing deals stuck across the rounds of investments reveals the extent to which a gap could be opening up in the middle stages.
In the first half of the year just eight series C deals were completed to raise a paltry $131m. Unless there is a sudden surge in the second half, the total for 2011 will be significantly lower than the $1bn raised last year from 50 series C deals. Put another way, of the $1.9bn VC money committed in the first half, just 7% was placed on series C investments, compared to a prior five-year average of 22% - historically series C has attracted the second biggest pot of VC dollars after series B.
|Total Investment ($m)||Total Finance Deals||% Investment per Financing Round|
|Financing Round||H1 2011||2010||2009||2008||2007||2006||H1 2011||2010||2009||2008||2007||2006||H1 2011||2010||2009||2008||2007||2006||5yr average (06-10)|
Of course the series C data so far this year could just be a blip and it is possible that deals in the second half of the year could redress the balance somewhat. However, several factors at work make that look unlikely.
One key driver and a trend that has developed since the credit crunch is the desire amongst VCs and the companies themselves to get as broad and strong an investor syndicate together as possible from the start.
For investors, this strategy carries the downside of diluting potential returns to those willing to commit early, compared to the classic ‘escalator model’ where as each financing round passes the valuations and profits to the earliest investors should improve. On the upside, a company's management can avoid the hassles and distractions of having to seek fresh funds every few years.
“We are definitely seeing bigger series A deals, which are becoming A, B and C wrapped into one”, says Chris Hollowood, partner at Apposite Capital. “This avoids misalignment between investors and having to restructure capital every few years, which VCs are increasingly sensitive about”.
“In the old days you could build a vision, now these are pre-packaged deals with milestone based tranching of the investment, with all paths leading to an exit through a trade sale,” he says.
Bobby Soni, principal at Novo Seeds – set up in September 2007 by Novo A/S and the Novo Nordisk Foundation to fund very early stage projects in Scandinavia – agrees that syndicates are getting broader at an early stage, largely through necessity. “It’s an issue of dilutional risk versus syndication risk. By bringing more investors in early you reduce some upside but on the other hand you have a stronger syndicate to finance the company in this environment,” he says.
Another more straightforward reason for the apparent near extinction of series C rounds is likely to be the overall lack of money available. With many venture capital firms themselves still finding it hard to raise new funds, those that have been successful are investing early, while those running low will favour later stage propositions.
Stephen Bunting, managing partner at Abingworth, believes the data “shows that the majority of re-financings are difficult, whereas those that are deemed to be the last amount of capital before exit are much more doable”.
“The intermediate stepping stone is much more problematic, because there will still have to be further financing and people don’t have visibility on that source of capital. Public markets are closed, there is less VC money available, pharma companies are there of course - and probably the best source of that capital - but they have increasing budget constraints as well.”
Looking at the average investment per financing round over the last five years also illustrates the degree to which series C, and to a lesser but still significant extent series B, have been in decline. In 2006 the average series C round was $30m, last year it had dropped to $21m and just $16m in the first half of 2011. In contrast average series A deals are holding up pretty well, consistently around $15m.
|Average Investment ($m) per Financing Round|
All of which points to tough times ahead for companies seeking new investors at such a crucial stage of their development.
“B and C rounds can be known as the ‘valley of death’ for companies that have not yet been able to demonstrate value”, according to Mr Papiernik. “A company that may have spent $30m so far and is looking for a $20m series C may have a long wait”.
Mr Hollowood also warns that, “Unless you’ve got a strong syndicate, life could be very tough for these companies”.
Only this week Pulmatrix raised what it called a Series B1, tapping the same syndicate of investors that provided the Massachusetts respiratory company with $30m almost two years ago for another $14m. Robert Connelly, chief executive, says his investors, including Polaris, 5AM Ventures and Novartis Venture Fund, were happy to top up the round to fund a new set of clinical studies with the company’s lead product (EP Vantage Interview - Pulmatrix tops up Series B to reach next milestones, August 15, 2011).
However he also agrees with the strength in numbers philosophy, saying the funding environment has not improved much from when the company raised their first tranche of money.
“It may have loosened slightly but not much,” he says. “The strength of the syndicate is incredibly important because they are going to have to finance the company for longer. And those people coming in are making sure there’s enough money to get to get to really valuable endpoints."
Similarly, Mr Soni sees the mid-stage, follow-on financing deals as the biggest challenge. “Our experience is that we can start companies together with our local co-investors, but getting an early stage asset to a clinical stage is getting very difficult. Many of the funds we speak to are actively fundraising at the moment, and those that are open are investing later stage. It’s a tough environment.”
To illustrate the point further, the top ten financing deals of the first half include a couple of series A, a number of F and G rounds, but no series C or B rounds.
With very little sign of the IPO window opening up for development stage drug developers, these larger and later rounds of private financing are likely to become more common as venture firms have no choice but to hang in there. As long as big pharma keeps buying, this is not always a bad thing.
“Some companies with late stage assets are increasingly attractive, especially since valuations have come down,” according to Mr Hollowood.
Overall, however, this year is showing clear indication of being a big disappointment for venture financings in this sector, suggesting that the real impact of the credit crunch is only being felt now for high risk, private drug developers. The recent stock market plunges and slowing economic indicators across the world do not point to a recovery anytime soon.
The second half of the year has yet to play out, but for mid-stage companies in particular, in search of funds to reach the next milestone, life looks likely to remain tough.
|Top 10 VC deals in H1 2011|
|Rank||Finance Date||Company||Country||Financing Round||Investment ($m)||Lead Investors|
|1||Jan 2011||Symphogen||Denmark||Series F||143 (€100m)||Novo; Essex Woodlands Health Ventures|
|2||Apr 2011||Ascletis||USA||Series A||100||Hangzhou Binjiang Investment Holding|
|3||May 2011||Intrexon||USA||Series E||100||Undisclosed investors lead the round, supported by Randal Kirk (CEO) & Third Security|
|4||Apr 2011||Circassia||United Kingdom||Series D||98 (£60m)||Imperial Innovations; Invesco Perpetual|
|5||Apr 2011||Merrimack Pharmaceuticals||USA||Series G||77||Credit Suisse First Boston Next Fund; Crocker Ventures|
|6||May 2011||Radius Health||USA||Series D||66||BB Biotech; Brookside Capital; Ipsen; Nordic Bioscience; Saints Capital|
|7||Apr 2011||Sangart||USA||Series G||50||Leucadia National|
|8||Feb 2011||Chimerix||USA||Series F||45||New Leaf Venture Partners; Morningside Group; Pappas Ventures|
|9||Jun 2011||Revance Therapeutics||USA||Series D||45||Essex Woodlands Health Ventures; NovaQuest|
|10||Jun 2011||Ultragenyx Pharmaceutical||USA||Series A||45||Fidelity Biosciences; TPG Biotech|