BioPharm Executive: Building Biotech's Next Boom
September 24, 2014
By Karl Thiel for BioSpace.com
Earlier this year, the Economist floated the idea that we are in the midst of a "Cambrian explosion" of entrepreneurship, due to the ease with which the basic "building blocks" of startups—mostly ubiquitous networking, easy coding, and plentiful talent—can be combined and recombined. Young, code-savvy folks, many perhaps frustrated with the traditional job market, think nothing of striking out on their own. Venture capital, meanwhile, floods into worthy concepts. It's a virtuous cycle that could lead to simple solutions for many of life's problems.
Which is funny, because it has seemed lately like Silicon Valley might be out of ideas. Venture capital has had a poor decade, with once-vaunted names like Kleiner, Perkins, Caufield & Byers reporting big losses in cleantech and mediocre results elsewhere. Slate magazine took a potshot at TechCrunch Disrupt earlier this month for naming a startup called Alfred as the winner of its 2014 Battlefield contest. (Alfred appears to be nothing but a butler service with the somewhat dehumanizing hook of calling all its workers "Alfreds."). "How many To-Do lists, email management, or calendar apps do we need?" echoes ZDNet's Tom Foremski.
People may complain about "me-too" drugs, but it's nothing compared to the half-hearted cloning of ideas going on in the software world. If this is a Cambrian explosion, the shrapnel looks a lot like crapware.
Where are all the VCs?
Which brings us to biotech. The IPO window has been wide open for the past two years, but we hear a lot less about the new company formation.
As Bruce Booth wrote recently over the LifeSciVC blog, "it’s a supply-constrained startup market with strengthened intrinsic demand." These should be the best of times—past entrepreneurial efforts are exiting into the public markets in record numbers, while demand for new medicines is running high and getting higher.
Booth suggests three factors leading to constrained supply. Two are, perhaps, immutable features of the industry: It's harder to come up with viable breakthrough biomedical ideas than it is to come up with new software concepts; and biotech is simply hard to succeed at and requires very specialized, highly sought-after people. The third factor, however, is different. It's the simple fact that, as Booth puts it, "there are very few biotech venture investors still active today, and fewer still that are focused on early stage company creation."
Indeed, even with a recent pick-up in venture activity, money is at best trickling into the sector at about the same old pace it has for the past several years. Some pundits have started to complain about a startup "glut" in software and tech. But even though this is on track to be the best year ever for biotech IPOs, we're not seeing an accompanying boom in fund formation. You'd expect VCs to follow market demand, but no.
Why should that be? One answer is that successful VC investing is hard, and many of the firms active earlier in the decade turned out to be pretty bad at it. The very best firms, by and large, are still in the game. But in fairness, there are another few factors keeping VCs away from the sector:
1. Consumer-focused companies garner the highest valuations while enterprise-focused companies create the best return on capital (despite what you might think, they tend to take less money to launch). Biotech is neither. It is, to some extent, the worst of both worlds—very expensive to fund in its early stages, like a consumer-oriented company, but without the massive exposure that can quickly drive multi-billion dollar returns.
2. Biotech's don't typically have network effects, a feature of many recent VC triumphs and something VCs surely look for in new ideas. They'd love to find the next Facebook, of course, but they'd be pretty happy with the next Waze or Retailmenot. While some firms are dabbling in the crossover of social media and medicine with companies like Mango Health, it's very doubtful this will be a major trend. Biotech doesn't fit the paradigm.
3. Biotechs are virtually never led by 20-somethings in flip flops. Paypal co-founder Peter Thiel started paying youngsters to drop out of college and pursue their projects, but he surely didn't have biotech in mind--skipping the long work of education, or passing over the professional experience, simply isn't an option. That kind of play-by-the-rules rigor doesn't always fit into the narrative Silicon Valley likes to tell itself about entrepreneurs and where the most successful new ideas come from. And the necessary experience is hard to find.
4. Working together leads to poor results. There is little more incestuous than the small world of biotech venture capital. Look at funding rounds and you'll see the same names appearing over and over again, with many little groups of firms that almost always work together. The problem is, as a recent Harvard Business School study showed, firms that frequently co-invest tend to underperform those that work with partners less like themselves. Being challenged in the early stages of investment leads to better decisions, but that happens less frequently in the limited world of biotech.
With all that said, the best ideas have found funding, rain or shine, through boom years and through busts. Large drug companies are increasingly taking up some of the slack when it comes to backing early stage ideas, and companies have gotten pretty creative about finding other sources of capital. VCs will only ignore market demand for so long, and the trickle of new fund formations we're now seeing will only build up steam. Low supply and high demand continues to make this a great place to invest.
-Karl Thiel
Read the BioPharm Executive online newsletter September 24, 2014.
Sign-up for the free monthly subscription to the BioPharm Executive.