Broken in biotech: the VC financing model doesn’t work

2007 will be a bumper year for biotech initial public offerings, according to the Burrill report on the state of the global life sciences industry, published earlier this month.

As we report elsewhere in this issue, the biotech guru and investor Steve Burrill is forecasting that 30 US biotech companies will IPO this year, compared to19 in 2006.

But take a closer look at the numbers: yes, IPOs are up in the year to date, with 16 worldwide in the four months to the end of April, up from 10 in the same period of 2006.

But the value of these deals is down, from an average of $52 million from January to April 2006, to an average of $42 million for the first four months of 2007.

At these prices, IPOs no longer represent an exit for VCs – they are more akin in size to a traditional private round. Rather than cashing out, VCs get a ticket to stay on for a white-knuckle ride.

A case in point is Pharmasset Inc of Princeton, New Jersey, which raised $45 million when it listed in April, far short of the hoped for $75 million. Or take the UK tissue replacement specialist Intercytex Group plc, which raised £15 million when it joined the Alternative Investment Market in London just over a year ago. Earlier this month when the company came back for a further £12 million, Richard Moulson, chief financial officer, acknowledged that the VC investors are still on board.

Just too long

Starting with novel technology, taking it through discovery, into development and onto the market is too expensive, too risky, and takes too long for VC investors. This has been staring the industry in the face since the post-genomics bust five years ago. The response was to temper risk by changing the business model, buying in advanced-stage products, developing services offerings, or licensing platform technologies. But the expectation persisted that at some point the IPO window would open and there would be a return to the good old days.

Hopes have been raised by the rise of Web 2.0 companies and the fact that counterparts in information technology are once more being lavished with cash.

The true bright spot at present is not the increasing numbers of IPOs, but the high level of merger and acquisition activity prompted by big pharma’s need to expand its pipeline.

Put simply, VCs don’t have the time or the money to invest in the A to Z of drug development. There is an expanding gap at the bottom end, between the traditional end point of academic research, and the point at which VCs are interested in making an investment.

As discussed in our other top story this week, this is prompting a range of schemes – mostly funded with public money – to advance products to the point where they are de-risked enough to attract (private) investment.

Similarly, at the higher ends of the development pathway, few VCs are in a position to hang on in there through clinical development. Currently, the best hope for an exit is through a trade sale.

It is time the industry acknowledged that the established model for commercialising intellectual property – in which a few hundred thousand in seed funding, followed by three venture capital rounds produces an IPO – doesn’t work any more, and come up with a different recipe.