As I write this column, we are now experiencing the biggest financial crisis since the stock market crash of 1929 and the Great Depression. Eventually this crisis will be resolved, and life and business will go on.
On October 19, 1987, the Dow Jones Industrial Average dropped 22.6%, and the closing high for that year, on August 25, 1987, was not attained again until almost two years later. Nevertheless, according to a 2002 report by Lena Andrews and Jerry Paytas of the Center for Economic Development of Carnegie Mellon University, venture capital (VC) funding of biotech companies was higher in 1987 than in 1986, and while it declined a little in 1988 (but still greater than in 1986), it surged in 1989.
The following perspective applies to normal times, which after all represents the norm.
Periodically, articles appear reporting that VC for biotech is drying up. For example, writing in the September 1 issue of GEN, Robert B. Dellenbach noted that VC funds invested in U.S. biotech companies and the number of such deals during the second quarter of 2008 were over 40% and almost 50% lower than during the first quarter.
Dellenbach believes that it is becoming more difficult for biotech companies to obtain investment capital because of increased competition for funds with the emerging sustainable energy sector—solar energy, wind power, biofuels, etc., as well as with life science ventures that anticipate a shorter return time such as medical device and equipment companies.
While recognizing that there are and have been from time to time short-term fluctuations in venture funding for biotechnology (as well as for other unrelated technologies), I thought it might be appropriate to review the bigger picture, with respect to how VC funding for biotechnology has fared over the years relative to total VC funds available and what the prospects for the future may be.
VC investment data was obtained from the MoneyTree™ Report, published by Pricewaterhouse Coopers this year. Total VC investments in U.S. companies grew from $8.0 billion in 1995 to $31 billion in 2007 (a 288% increase), except for a spike due to the dot-com bubble when VC investments totaled $54 billion, $106 billion, and $41 billion in 1999, 2000, and 2001, respectively.
During the same time frame, VC investments in U.S. biotech companies rose from $0.83 billion to $5.2 billion (a 527% increase). The total number of deals in U.S. companies made by VC firms grew from 1,842 in 1995 to 3,914 in 2007 (a 112% increase), except for the spike when the number of deals reached 5,503, 7,905, and 4,478 in 1999, 2000, and 2001, respectively. In comparison, the number of deals in U.S. biotech companies rose from 170 in 1995 to 488 in 2007 (a 187% increase).
The mean VC investment for all U.S. deals grew from $4.8 million during 1995 through 1998 to $7.3 million during 2002 through 2007 (a 52% increase), in comparison to the mean VC investment for U.S. biotech companies rising from $5.4 million during 1995 through 1998 to $11 million during 2002 through 2007 (a 104% increase). Clearly, the biotech sector has maintained its competitiveness for VC over the years.
With respect to obtaining start-up and early-stage (SU/ES) VC, the biotech sector also has performed relatively well. Total SU/ES VC investments in U.S. companies grew from $3.1 billion in 1995 to $6.6 billion in 2007 (a 113% increase), except for the spike when SU/ES VC investments totaled $15 billion, $29 billion, and $9.4 billion in 1999, 2000, and 2001, respectively.
During the same timeframe SU/ES VC investments in U.S. biotech companies rose from $0.46 billion to $1.5 billion (a 226% increase). The total number of SU/ES deals in U.S. companies made by VC firms grew from 940 in 1995 to 1,438 in 2007 (a 53% increase), except for the spike when the number of deals reached 2,518, 3,536, and 1,543 in 1999, 2000, and 2001, respectively. In comparison, the number of SU/ES deals in U.S. biotech companies rose from 106 in 1995 to 222 in 2007 (a 109% increase).
The mean SU/ES VC investment for all U.S. deals grew from $3.6 million during 1995 through 1998 to $4.2 million during 2002 through 2007 (a 17% increase), in comparison to the mean SU/ES VC investment for U.S. biotech companies rising from $4.0 million during 1995 through 1998 to $5.6 million during 2002 through 2007 (a 40% increase).
In addition to VC firms, angel investors (well-heeled individuals) represent a vital source of venture funding for privately held companies across all industries, especially since close to 90% of angel investment dollars target SU/ES companies, in contrast to around 20% of VC funds committed to SU/ES investments.
According to data obtained from the National Science Board’s Science and Engineering Indicators 2008, annual angel investments in U.S. companies during the last four years covered in the report—2003, 2004, 2005, and 2006—totaled $18 billion, $23 billion, $23 billion, and $26 billion, respectively.
These figures were similar to the comparable annual VC investments industry-wide reported in the MoneyTree Report—$20 billion, $23 billion, $23 billion, and $27 billion for 2003, 2004, 2005, and 2006, respectively.
The biotech industry’s share of angel investment capital increased from $2 billion in 2003 to $2.3 billion in 2004, $2.8 billion in 2005, and $4.7 billion in 2006 (coincidentally equal to the amount of VC invested in biotechnology for 2006). Thus, biotech’s share of angel capital grew 135% from 2003 to 2006, compared to just a 44% growth in angel capital across all industries during the same time period.
It is not surprising that over the long run biotechnology has maintained an enviable track record, as regards attracting investment capital. Earlier this year, I reported on the historical performance of U.S. biotech companies competing in the pharmaceutical marketplace.
From 1990 to 2005, the ten largest such companies, with respect to revenues, increased their total revenues almost 28-fold, from $1.1 billion to $31.7 billion, representing a 25% annualized increase. These same companies converted their combined loss of $0.3 billion in 1990 to net income of $6.2 billion in 2005. Moreover, the number of biopharmaceutical companies reporting annual revenues in excess of $1 billion grew from zero in 1990 to eight in 2005. Such performance provides the rationale as to why over the long run VC and angel funds have amply fueled the biotech industry.
In my opinion, despite short-term perturbations in staking development-stage companies, VC firms and angel investors will continue to provide substantial funds to the biotech sector. A major reason why the biotech sector will remain attractive for investors is the coming of age of personalized medicine.
Individualizing the diagnoses of people suffering from what would now be considered one disease into a number of related disorders will increasingly become the norm. The resulting treatment protocols will eventually be customized contingent on the future availability of a toolbox of new generation therapeutics, each one targeting a different biomarker.
Because of the highly definitive scope of personalized medicine, the costs of R&D should decrease considerably. The target population for a particular therapeutic will be less heterogeneous than it is now and, therefore, more likely to respond with fewer side effects to the therapeutic. As a result, the failure rate of clinical trials should be reduced, clinical trials, especially Phase III trials, should require lower enrollments, and the resulting FDA-approved drugs should be subject to fewer recalls.
The lower costs of R&D should therefore permit high rates of return on niche market-directed therapeutics. As the R&D success rate for personalized therapeutics increases, and as the number of therapeutics developed is stimulated further due to the large number of therapeutic targets, the economics of drug development and commercialization should dramatically change, resulting in lower prices and an increase in partnering worldwide.
What I have described may be sufficiently disruptive to the pharmaceutical industry such that the mobility and corporate culture of the younger, well-funded biotech companies may provide them with a distinct advantage over some of the larger pharmaceutical companies. This is the scenario that I believe will continue to attract VC firms and angel investors in growing the biotech sector, after the current financial crisis subsides.
To review Reed Smith partner Robert Dellenbach's take on VC funding, check out the Wall Street Biobeat column in the September 1 issue.