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"Marvelous Opportunities" for Biotech VCs

At BIO 2003 in Washington, D.C., the Biotechnology Industry Organization's annual confab, the mood is one of optimism from all quarters, especially the investment community. The U.S. Food & Drug Administration has a new, reform-minded commissioner. Encouraging study results on biotech drugs made big news at the recent cancer meeting in Chicago. And a general willingness to take on riskier investments has helped send biotech stocks up 25% since the start of the year. "Those things together are big deals," says Buck Phillips, managing director of biotech venture-capital fund Vector Group in Deerfield, Ill.

All this bodes well for the VC market, Phillips figures. Scores of publicly traded companies will soon need to raise more money. And despite the run-up in the sector, many companies still have depressed stock prices and market caps of under $100 million, which means more bargaining power for VC firms like Vector.

Phillips sees more fallout ahead: "Companies have been trying to protect themselves by doing insider rounds of financing -- where they don't invite in new money so they can protect valuations," he says. "That can only last for so long." He spoke to BusinessWeek Online Reporter Amy Tsao at the BIO meeting on June 23. Edited excerpts from their conversation follow:

Q: How difficult has it been for biotech companies to raise money in the last couple of years?

A: Clearly, fundamental innovations are occurring in biotechnology. The other side of that coin is whether investors want to take a risk on biotech relative to other technologies. For the past few years, investors didn't want to take the risk. That's beginning to change dramatically because they have seen success stories.

Q: The last year has been slow for the biotech VC community. What has changed while investing has been quiet?

A: There's a major consolidation going on in investor groups who look at the industry -- both public and private. Investment banks have consolidated to a dramatic degree. Biotech isn't an area where bankers can get $50 million fees. The companies are too small, so efforts and coverage by analysts is down. Who's out there championing the industry?

We're seeing some serious consolidation on the venture-capital side, too. Over time there'll be fewer venture dollars. In 2001, $3.4 billion was invested. So far this year, some $400 million has been invested.

Q: What areas of the market are you interested in investing in now?

A: Cancer is incredibly hot right now, especially cancer immunotherapy plays. We believe that's a major area of development going forward. Immunotherapy is the ability to regulate a human's own innate immune response to disease. The immune system will fight a cold, and we know it also fights cancer. In cancers like melanoma, the immune system mounts a significant response to the disease.

Q: What kinds of metrics are you looking for from prospective investments?

A: Valuations are down dramatically. I want to accept as little risk as possible, and that means getting really hard data in this business. All of us are asking companies to bring us more hard, relevant data to justify valuation.

With tool companies, I want to see data from the actual commercial instruments. I think everyone is becoming much more disciplined in their investment process. That's very hard on young companies.

Q: What about funding prospects for small, early-stage companies?

A: Traditionally, late-stage capital needs have been satisfied by the public markets, but they've migrated away from these companies. A decade ago you could've taken a company public that had just animal data. There's a fundamental gap in financing with the IPO window closed. When valuations for biotech have these dramatic ups and downs, I can wait for companies to have a much lower risk profile at valuations that make my returns equivalent to a seed-stage investor.

Q: Do you find yourself doing a lot of waiting now?

A: Yes. In many cases, to wait is to our advantage. Companies burned through the money they raised in the last bubble. And they've got to come back to us and raise more. We really do believe over the next couple of years there will be marvelous opportunities for venture investors.

Some companies that raised money in 2000 at extraordinary valuations of $150 million or more are coming back to the market for cash today and are being valued at $20 million or $40 million. We're seeing dramatic retrenchments and a lot of consolidations, which is really interesting as well.

Demand for capital is being altered as the weakest names get weeded out. A lot more of that will happen. It's really a very healthy thing.

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