Jan. 19 (Bloomberg) -- Venture capitalists pumped a record $9.1 billion into privately held U.S. biotechnology and medical device companies last year, in hopes of making discoveries they can sell to larger drugmakers.

Biotechnology and medical device companies raised 20 percent more cash in the U.S. last year than in 2006, according to a report by accounting firm PricewaterhouseCoopers and the National Venture Capital Association. More than 4,000 biotechnology companies manipulate genes and cells to develop drugs for diseases including cancer, and arthritis.

Older drugmakers that have long relied on chemistry to develop products have paid for alliances with biotechnology companies, aiming to develop drugs to replace products with expiring patents. New York-based Pfizer Inc., the world's biggest drugmaker, is bracing to lose $13 billion in annual sales when generic copies of its top-selling cholesterol pill, Lipitor, enter the market as early as 2010.

``A grim prognosis for Big Pharma is actually music to our ears,'' said Sherrill Neff, founding partner of Quaker Bioventures, a Philadelphia-based venture fund with $600 million under management. ``We are in the early stages of a deepening symbiosis between venture-backed biotechnology companies and large pharma.''

Venture capitalists invested a total of $29.4 billion in 3,813 companies across all industries, the most since 2001, according to the report.

About 31 percent of the cash went to biotechnology and medical devices, a record share of venture investment, according to the report. Software investment rose 2.7 percent to $5.3 billion, while Internet companies raised $4.6 billion, a 12 percent increase, according to the report.

Science and Patents

Investors continue to funnel money into biotechnology because it has innovative science and long-term patents that large drugmakers need, Neff said on a Jan. 18 conference call with reporters. Pharmaceutical companies have cash, development and marketing expertise that the smaller companies don't, making them natural partners and acquirers, he said.

``We've been saying it for a while, but now it's playing out in dramatic ways,'' said Ashley Dombkowski, a general partner with MPM Capital in South San Francisco, California, in a telephone interview. MPM has $2.5 billion under management in biotechnology and medical device companies.

Pfizer, for instance, said on Dec. 18 it will buy closely held CovX for an undisclosed amount to acquire experimental drugs for cancer and diabetes. CovX, a La Jolla, California- based biotechnology company, has one diabetes drug and two cancer drugs in early stages of development, Pfizer said.

Acquisitions

The acquisition of Pharmion Corp. by Celgene Corp. of Summit, New Jersey, for $2.9 billion and Tokyo-based Eisai Co.'s $3.9 billion purchase of MGI Pharma Inc. are other examples of the desire for large drugmakers to acquire smaller innovators, Dombkowski said.

Still, there are reasons for concern among biotechnology and medical device investors, Neff said. The budget of the U.S. National Institutes of Health, which produces many basic discoveries for biotechnology companies to develop further, is under pressure, Neff said.

Patent law changes could undermine biotechnology companies, and legislative efforts to control high drug prices could also harm the industry, he said.

Not all types of biotechnology companies are flush with cash, Neff said. Cancer drug developers are having a hard time raising new venture capital. So many companies are pursuing the same opportunities that it's becoming difficult to enroll patients in new clinical trials, he said.

Infectious Diseases

Infectious diseases, eye disorders, and metabolic conditions such as diabetes and obesity remain popular fields for venture investment, Neff said.

Venture capitalists also no longer consider an initial public offering the path to riches, as public investors have lost their appetite for biotechnology. Only 25 companies in the industry went public in 2007, according to Signals magazine, an online industry publication.

Venture investors now plan to sink more money, over a longer period of time, so they can sell a biotechnology company to a large drugmaker.

``I almost see the IPO market as a serendipitous plus,'' Neff said. ``Right now, we're not counting on it.''

To contact the reporter on this story: Luke Timmerman in San Francisco at ltimmerman@bloomberg.net

Last Updated: January 19, 2008 05:14 EST