Biotech's Tough New Taskmasters

Venture capital is flowing again -- with restrictions and a cold eye for results

From the look of the raw numbers, it seems that just about any biotechnology company can get venture capital these days. After raising $1.3 billion in venture funding in 2003, a 32% jump, the biotech industry hauled in $485 million in the first quarter; for the full year, the tally should handily beat last year's. Says John Gabbert, vice-president for worldwide research at VentureOne, which tracks VC funding: "People are ready to get back into biotech."

So is this the biotech boom of 2000 revisited? Not quite. A close look at some recent deals suggests that VCs are applying the harsh lessons they learned from the hundreds of biotech investments that went sour over the past few years. No longer will they throw money at grandiose promises about potential genomics discoveries or new technology platforms. These days, VCs are demanding deeply refined plans for developing potential blockbusters that are likely to hit the market in the next couple of years.

VCs call their new approach to identifying future winners "NRDO": No Research -- Development Only. And NRDO is likely to be the mantra during the week of June 6. That's when many biotech CEOs will be trolling for funding at two of the most widely attended and closely watched events in the sector: the Biotechnology Industry Organization's conference in San Francisco and the American Society of Clinical Oncology's annual meeting in New Orleans. "These biotechs have to change course," says G. Steven Burrill, CEO of Burrill & Co., a life-sciences VC firm. "They must morph from the 'Genes 'R' Us' strategy to the 'Rx 'R' Us' strategy."

Nucleonics Inc. CEO Robert Towarnicki understands that transition all too well. The Malvern (Pa.) startup was founded based on an emerging science called RNA interference, which may offer a new way to suppress disease-causing genes. Until last year, Nucleonics was pursuing too many potential drugs to attract VCs. "So we pulled back and rewrote the business plan," Towarnicki says. The company is now focused on a drug to treat hepatitis B -- a virus that afflicts 350 million people worldwide. With a market expected to grow sevenfold by 2011, to $2.8 billion, Nucleonics recently raised $49.2 million, one of the biggest biotech deals this year.


But nucleonics won't be getting all the money at once. Investors will hand it over in pieces as the company achieves specific goals, such as positive trial results. These deals grew in popularity after VCs watched in horror as many experimental drugs they funded in the boom ultimately failed. "We have a major focus now on milestone-based investing," says Chris Ehrlich, a partner at VC firm InterWest Partners. InterWest is about to join a $45 million biotech funding, but only about 25% will be given up front. "You've got to sing for your supper," says Ehrlich.

Some disappointing recent initial public offerings have made VCs more picky. Although eight biotechs and pharmaceutical firms went public in the first quarter, raising a total of $549 million for their VCs, the sector's two most recent IPOs flopped. Critical Therapeutics Inc. (CRTX ) and Acadia Pharmaceuticals Inc. (ACAD ), which went public in May, each raised little more than half what their investors had originally hoped for. "It's blood on the wall," says Alan G. Walton, senior general partner at Oxford Bioscience Partners, which funded both Acadia and Critical. "How can we fund innovation if the public isn't interested?"

Even so, biotechs are still knocking on VCs' doors. Ron Cohen, CEO of Acorda Therapeutics Inc., ditched a planned IPO in January and instead went looking for private investors to add to the $55.3 million in VC capital Acorda raised last year. In March, the company pocketed $11.3 million more, much of which will go to developing a drug for multiple sclerosis and spinal cord injury. "The terms may be more stringent, but there's still a robust market for companies with good prospects," he says. Provided, of course, they've got a clear path to actual products -- not just empty promises.

By Arlene Weintraub in Los Angeles

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