CLEVELAND, Ohio — A good diagnostic, drug, device or therapy may not win money from a traditional investor or in a traditional way this year. That’s the cold truth wrought by a triple whammy: a global financial meltdown, U.S. banking industry rescue and trough in the business cycle.
Biomedical entrepreneurs and their advisers are still getting deals done, but they’re smaller deals and may include several investors instead of one, or the deals may involve government grant programs.
Venture capitalists — the traditional investors in high-risk medical product development — are having trouble justifying past biomedical investments as well as calling in capital already promised by investors in previous fund raises. The problems for VCs were underscored on Monday in a report showing only 17 venture funds raised money in the last quarter — the fewest since 1994.
“A number of venture funds have had to triage their portfolios in ways that they never have before,” Harry Rein, general partner in the venture firm Foundation Medical Partners, said during a recent venturing panel at the Cleveland Clinic. “We’ve had capital partners who have said, ‘Don’t give me another capital call.’ ”
Because of the difficulties, some venture capital firms are throwing in the towel on raising future biomedical funds. At Three Rivers Fairin Pittsburgh this September, ”there was a lot of bellyaching going on by the VCs that we’re closing this fund. We’re doing great, but this is the last fund, we know there’s not going to be a fund No. 2,” said Joe Jankowski, associate vice president for technology management at Case Western Reserve University in Cleveland.
That’s partly because some institutional investors, such as banks, are not investing in risk capital this year, probably because of fallout from the nation’s banking crisis, Jankowski said. ”You could get better returns or almost equal returns in safer money,” Jankowski said.
Rein said that market and industry pressures give corporate investors of venture funds like those at Johnson & Johnson, Eli Lilly, GE Healthcare and Medtronic an advantage in negotiations. These corporate investors often invest first for their own companies, but are increasingly investing in outside companies and their technologies as part of the practice of open innovation.
Corporate investors at the recent Clinic panel said they’re still investing… kind of. “It’s a more selective process,” said Mark Vachon, president and CEO of Global Diagnostic Imaging at GE Healthcare. “But clearly the appetite is still there.”
Roy Davis, president of Johnson & Johnson Development Corp., said his organization has started investing earlier in promising companies. “We’re very hungry for innovation and growth, and we know that dominantly comes from the outside,” Davis said.
Historically, Medtronic Ventures and New Therapies has looked to incubate internal ventures with a portfolio approach and a centralized venture fund, said Ven Manda, vice president of the ventures unit. ”We funded 24 new projects this year,” Manda said. These were ”research initiatives most businesses would not be able to do because they are not expected to bear fruit until five or 10 years from now.”
Medtronic also historically looks for external investments that it can “bolt on” or “tuck in” with existing businesses. And it looks to invest in enabling technologies, like bioinformatics, that it does not develop on its own but could expand its device and therapeutic areas.
But Jankowski said valuations for companies — the dollar value on which prospective investments are based — are low. That means smaller deals for the entrepreneurs with which his office works. ”It’s no more difficult” to find investors for deals, “it’s just that the valuations are obscene,” Jankowski said.
“But at the same time, we’re still spinning off companies, and they’re still raising money, just it’s at a decreased valuation,” he said. “But it’s not as if the funds have dried up.”
Because of the fund-raising problems, some biomedical partners at venture firms are leaving to do other things — sometimes leaving entrepreneurs they’ve nurtured in the lurch. That’s “very detrimental to the portfolios of those firms” because the fund managers often “are the godfathers of a lot of these companies in the portfolio,” said Mark Coticchia, vice president of the university’s Office of Research and Technology Management.
Afif Ghannoum, managing member and founder of Cleveland law firm Ghannoum Law Firm LLC, said he has seen the investment dynamics for biotechnology companies change. “A few years ago, if you had a great idea in the biotech world, people would throw money at you,” said Ghannoum, whose firm does intellectual property and transaction work solely for life science and technologies companies. “Now, it’s more than ever that things are done with a long-term strategy, keeping yourself attractive to future investors.”
Ghannoum’s clients still are getting investments for their “game-changing or truly innovative technologies,” he said, but at lower valuations. ”We saw VCs go from funding innovation to funding growth,” he said.
In addition, client companies are taking on more investors. “What we’ve been seeing is, instead of the traditional idea of a start-up biotech coming up with some great technology and looking for a venture capital firm” to take its products to market, “some companies are looking for partnerships or joint ventures” with bigger companies in their industries, known as strategic investors, Ghannoum said.
While finding such partners may provide entrepreneurs with like-minded industry leaders, ”you may have to take the reins and find funding to take this device, drug to market yourself,” he said. That means today’s biotech entrepreneurs have to be more engaged in fund-raising than they have in the past.
Ghannoum also sees more interest among biotech companies in government grant programs. “We have one client that has raised multiple millions through [Small Business Innovation Research] grants,” he said. Winning such grants is a “multiple month project,” not one for a long weekend, he said.