More on Those Biotech Numbers...

Sarah Lacy

I think everyone was stunned by the decrease in venture capital disbursements in the first quarter—given the flood of deal press releases and strong anecdotal evidence that valuations and frenzy were picking up around the valley. But if you’ve been reading Deal Flow, you shouldn’t have been surprised that money going to lifesciences companies was down a steep 31%.

As much as some people keep disagreeing with me, there’s no way around it: It has been a tough year for healthcare. We’ll gloss over the details of how bad the IPO market is for the moment, since I’ve spent many a blogging hour writing about it. Go here, here or here for your fix. But let’s just say the market isn’t back. No doubt some new issues will make it out by year end, but not at banner prices.

It’s not so simple to say, “The window is closed, so deals aren’t getting funded” in the healthcare world. As we’ve stated before, an IPO for a biotech company is like another funding round. It doesn’t have to get out at a great price—just getting out is success. It’s not the time when VCs cash out.

Still, the VCs who make that disclaimer are also finding themselves with handfuls of companies valued at way less than $500 million and thinly traded—this after pumping $100 million into them. No matter how you rationalize a modest IPO, those numbers are not going to sustain a portfolio.

This has created a business model identity crisis in the biotech world and that’s why early stage deals in particular are down. No one is entirely sure what to fund. They’ve been burned on companies that are focusing all their efforts on one drug, burned on companies that are trying to develop many drugs, burned on companies that are focusing on leveraging some new technology to discover a bunch of new drugs then sell them off to big pharma.

The only business model that the public markets have rewarded of late is the so-called specialty pharma or “No research, development only” one. That’s when a company buys up compounds that a bigger pharmaceutical company doesn’t have the time or inclination to take through clinical trials. Sometimes they find a new use for existing compounds other times they focus on a niche market. The biggest hits from last year, Pharmion and Eyetech, were both specialty pharma, as was Aspreva, the only company to break the $100 million IPO barrier this year.

But many VCs are wary of this business model, even as it has gained favor with Wall Street. After all, it can take just as much cash, and depends on startups finding a diamond in the rough that another company is willing to part with. And most of the big successful biotech companies were built around really good internal R&D and that’s not getting developed in many of these companies.

The irony is that big pharma couldn’t be hungrier for biotechs to discover new compounds. With thin pipelines, they’re increasingly throwing bags of money at anyone with some good early clinical data. You’d think that big pharma’s bad news would be good news for small biotechs. But it's not a zero-sum game. It takes two things to come up with a novel new drug: really good science and a lot of money. And, you do need both—all that money can’t buy good science, just like the Yankees $205 million payroll can’t seem to buy a winning season.

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