May 1, 2009 (Vol. 29, No. 9)
William Bains
Venture Capitalist Takes Issue with the Idea of Relying on Stimulus Funds to Buoy Biotech
In the February 1 issue of GEN, J. Leslie Glick, Ph.D., argued that one use for the incomprehensibly large fiscal stimulus packages being argued over by governments across the world was to support VC investment in new technology companies. He is not alone in this idea. From the end of 2008, VC and its supporters in the U.K. have been clamoring for government coinvestment, together with a plethora of new and improved tax breaks for institutional investors, creation of new funds, and investment in old ones. Dr. Glick’s idea is a variation on this—hand out a billion dollars to existing VC groups to manage through their existing and (it is assumed) effective investment mechanisms.
Dr. Glick cites impressive statistics on the value that venture capital has created in the economy. Such figures are usually padded out with substantial double counting—in my study of the U.K./VC scene I have analyzed a wide range of claims on creation of jobs, profits, products, businesses, and always found that the reality falls far short of the claims.
Claims for job creation in biotech by VCs usually include all jobs in any company that was VC backed, although public funds have created the large majority. Even if we argue that VCs allowed that to happen by creating the companies, that itself is dubious, as many of the first-generation giants of biotech were founded around direct corporate investment, not venture capital. But in the U.S., at least, VC has been a powerful and creative force in new technology, and to claim otherwise is myopic.
Their record in the U.K. is far less impressive—the companies that are arguably the U.K.’s only major biotech success stories (Celltech, Enzymatix [which morphed into Chiroscience], and Cambridge Antibody Technology) were all founded without VC money.
And it is this U.K./U.S. comparison that is critical, because it is related to the VC’s fundamental business model. Allowing U.S. VC to plunge its bucket into the well of government money will drag it into the same whirlpool of decline that has wiped out the U.K. industry over the last five years.
How do VCs make money? Any MBA will tell you that it is by raising a fund from investors, investing it on their behalf in new, highly risky but enormously promising companies, managing the investments, selling the shares when the time is right (exiting) and getting a cut of the profits. They are, therefore, motivated to make those investee companies as huge and rapidly successful as they can—greater company success means more profit for the VC group and their investors. And of course it means the companies will end up, if they are really lucky, as the next Amgen, Gilead, or Millennium, The Takeda Oncology Co.
But, this is not how it works in U.K. Here the business model for biotech VC has been based, not on profit, but on management fees, for at least a decade. The VC fund management group cannot wait 10 years before getting a paycheck, so they take a management fee, typically 2% of the fund each year, to keep the management group running. In early-stage U.K. biotech VC it is also usual to take directors fees from investee companies as well, and quite often, consultancy fees from them. So the revenue today is substantial.
In the U.K., and to a large extent elsewhere in Europe, these fees have come to dominate how VCs carry out business. Growing funds, and hence getting more fees, comes to take priority over growing companies, and so companies are engineered not to be successful in themselves, but to be PR material for the VC’s next fundraising. Of course, there is no better PR than success—the two are not inherently incompatible. But outstanding success—a Millennium or an Alnylam—is rare. The rest are cannon fodder for the PR machine.
As a direct result, the U.K., which started with a biotech industry comparable to that in the U.S. on a per head of population basis in 1980, now has no substantial biotechnology companies left and a public and private biotech sector crumbling faster than any other in the world, dominated by undercapitalized companies with little hope that they will survive long enough even to be the subject of a fire sale.
Things have been different in the U.S. I am met with incomprehension when I explain this business model to U.S. VCs. Surely a fees-driven business model is not the way to build for success? No, it is not, but if you assume failure is the norm then it makes perfect sense, and if the business model ensures that failure happens, it becomes self justifying.
Why should the U.S., the powerhouse of biotech, care for the woes of a small island off the edge of Europe? Because pumping up VCs with government funds risks distorting the U.S. VC business model into one resembling the U.K., and that just might send the U.S. into the same death spiral that has affected us. Government funds, inevitably, will not be profit driven—they are activity orientated, not results orientated. The objective of the fiscal stimulus is to stimulate, to make things happen. Exactly what happens is less important. That is perilously close to a business model where getting hold of money is more important that making that money work to success.
Governments are talking trillions— enough cash to discover, develop, manufacture, and launch a thousand new drugs—so surely some should go to biotech? Yes, it should, but not through the investment mechanisms that have failed in the U.K. so spectacularly over the last 10 years and are starting to teeter on the edge of the precipice in the U.S. Please, invest in science, yes, but leave venture capital to the private sector. If the government should spread largesse to the sector, let it imitate the Israeli approach described in the same issue and give it to the companies themselves. It is they, after all, who employ scientists.
William Bains ([email protected]) has been a VC and company founder in the U.K. and teaches company creation and financing at Cambridge University, U.K. His book Venture Capital and the European Biotechnology Industry was published by Palgrave Macmillan in November 2008. Web: www.williambains.co.uk/vcbio.
