How Covid-19 has affected investment in life science startups

After years of sustained economic growth, the Covid-19 pandemic suddenly has unleashed an economic catastrophe, with unemployment in the U.S. now reaching levels unseen since the Great Depression, notwithstanding the jobs report Friday that showed a dip in jobless numbers. Amid the crisis, startups also face what one article called an “existential threat” as they may struggle to find funding. But taking a more granular look at life science startups, in particular, reveals a slightly more complicated reality.

In PitchBook News’ May 4 email newsletter, executive editor Alexander Davis wrote that “hundreds, if not thousands, of venture-backed companies are staring at dire conditions – and a real threat of running out of money.” He estimated that assuming that startups typically raise fresh capital every 12-18 months, there are about 7,200 companies due for fundraises. But they’ll be conducting them at a time when venture capitalists are demanding more protections, while also becoming more selective about whom to invest in.

Davis’ analysis covered startups across all industries, so what does this mean for life science startups in particular?

While money has become tighter in life science as well, interviewed venture capital insiders said startups that aren’t struggling to conduct clinical trials of drugs for non-life-threatening diseases and that have not yet entered the clinic are relatively well-positioned. In addition, the industry is better positioned than the information technology sector thanks to life science venture capitalists’ more conservative approach to investment, as well as the lack of excessive valuations often seen in tech.

“I think the resilience of life science companies is going to put this industry in a slightly different position when it comes to the impact of Covid-19,” said Mike Pellini, a managing partner of VC firm Section 32, in a phone interview. “There will certainly be some negative fallout on the funding side for life science companies: Sometimes the terms won’t be as favorable as they were six months ago, and some companies won’t get funded.”

Jim Healy, a general partner for Sofinnova Investments, has already noticed a dip in terms of funding.

“Generally speaking, I think that the investment pace for new companies has gone down,” Healy said in a phone interview. “I do feel like the number of new deals seems like it’s going down, and the deal pace has slowed.”

While it may be harder for life science startups to get money than it was before, just as it is for startups overall, Covid-19 has presented some additional challenges unique to the industry.

Perhaps the most obvious of these is companies’ ability to do clinical trials. With hospitals across the country forced to devote many of their resources to helping patients with Covid-19, even many large drugmakers have been forced to pare down or suspend some clinical development operations. In response, the Food and Drug Administration has issued guidance on ways to conduct trials during the pandemic, particularly using technologies like remote monitoring.

“I think for companies that are trying to develop drugs for non-life-threatening indications, it will be difficult to manage those studies over the next year or two,” Healy said. “Those are the types of companies that are going to be more challenged.”

But it’s not as if startups developing life-saving therapies will find it a walk in the park, and in fact those developing cell therapies for cancers have felt negative effects already. Multiple oncologists from major cancer centers interviewed during the recently-concluded virtual American Society of Clinical Oncology annual meeting reported that their CAR-T development efforts have had to face some adjustments.

“We continued recruitment, and studies are still open,” said Ibrahim Elhoussieny, VP and head of medical affairs at Kite Pharma, part of Foster City, California-based Gilead Sciences, which markets the CAR-T Yescarta (axicabtagene ciloleucel). “However, with competition for healthcare resources and their diversion to Covid-19, that resulted in some slowness of recruitment.”

While Gilead is a large, publicly-traded company and can withstand such challenges, smaller startups may not have the financial wherewithal to take it in their stride. 

“Cell therapy will potentially face challenges because of the costs associated with manufacturing the drug and the fact that many of those are bespoke drugs,” Healy said.

Overall, where a company is in terms of clinical development could also play a major role in the headwinds it faces due to trial-related difficulties, with those that haven’t entered the clinic perhaps best-positioned.

“If you haven’t yet started the trial, you’re in a good place, or if you’re interacting with the FDA or having Type C meetings, that’s also fine,” Healy said. “The challenge is for companies that have drugs to treat non-life-threatening diseases, where patients would have to show up at the medical facility for part of that, for analysis or data gathering. That’s going to be difficult – you put patient safety first.”

Indeed, some startups reportedly have concerns but are still chugging along.

“I actually was speaking with the CEO of a startup that has good science, 80% of their Series A round still in the bank, and they’re in preclinical, and he said that’s all they’re doing, is keeping their heads down and getting their work done because the Covid-19 pandemic has enabled them to not have to be out in the world giving talks,” said Laurie Halloran, CEO of Halloran Consulting Group. “While he was a bit concerned about the availability of cash a year from now, as long as they meet their milestones, there’s not much reason to be concerned.”

However, while saying it is “intuitive” that some funding terms might be more challenging today than six months ago, Pellini said that would likely be the exception rather than the rule.

One advantage the life science world has going for it is that it has avoided the exorbitant valuations that have been common among companies in the tech sector.

“Valuations have not been excessive in the life science industry – this is not the tech world,” Pellini said. “Life science VCs tend to be very thoughtful and conservative in how they approach a particular investment.”

Indeed, Healy said that the problem getting money amid the Covid-19 pandemic and the economic havoc it has wreaked is not because there’s less money, but because investors have become more careful about how they dole it out.

“People are being more cautious and more selective about where they’re placing their bets,” Healy said, noting that there have been a number of life science funds raised in the last few months.

Some of these include ARCH Venture Partners and Flagship Pioneering, which together closed new funds worth nearly $2.6 billion in April, along with the $394 million fund that venBio closed that same month and Israel-based Arkin Holdings, which closed a $140 million fund in March.

Still, part of the problem for startups looking to raise capital isn’t just financial, but also cultural, and that’s where social distancing, lockdowns and travel restrictions could become an issue. Healy noted that Sofinnova had two investments for which it already had term sheets out, and its staff had already met the companies’ management teams in person before the pandemic. But as the year goes on, VCs may find themselves having to make decisions on whether to back companies whose executives they have never met in person.

“We do use Zoom and Skype a lot more than we used to, but it’s still not the same thing,” Healy said.

But Halloran said this reflected old-fashioned thinking, noting that some colleagues of hers had already been raising funding virtually.

“A lot of it has to do with whether investors and boards are open, and if they’re not then they might have some problems down the road,” she said. “They kind of need to change their mindset.”

Nevertheless, it’s existing companies that already have investors and a proven ability to enroll patients into clinical trials and produce good data that are probably best positioned to weather the storm, Healy said.

“Pandemic or not, bad data is a good predictor of a bad outcome,” Healy said. “I think it’ll be more about fewer companies being funded as opposed to existing companies not being able to raise follow-on capital.”

Photo: Feodora Chiosea, Getty Images