Life-Sciences Venture Capital Drought Continues

Chicken Little: “Help! The sky is falling!”
Henny Penny: “How do you know?”
Chicken Little: “I saw it with my own eyes, heard it with my own ears, and part of it fell on my head!”

Life-sciences skywatchers, take note: Despite intimations to the contrary, our planetary lid is firmly intact and is expected to remain so for the foreseeable future. The sky definitely is not falling.

But the heavens are looking considerably more ominous. A near-perfect storm of economic malaise, decimalization, regulatory risk and gun-shy investors has decimated the life-sciences venture capital (VC) orb. Nationwide, VC funding fell 14 percent last year to $6.6 billion, its lowest level since 1998, and first-time investments slowed to a crawl, sinking to 17-year lows, according to “Double-digit Dip,” the latest MoneyTree report from PricewaterhouseCoopers LLP (PwC) and the National Venture Capital Association (NVCA) based on Thomson Reuters data.

Such abysmal statistics exemplify the steady evaporation of life-sciences funding since the start of the Great Recession more than five years ago. Over the course of 48 months (2011 was an exceptional growth year), investments have fallen an average 13 percent annually and deal sizes have slipped 15 percent. “If you look at the amount of venture capital in…life sciences and medical devices, it’s essentially disappearing,” William Sahlman, a Harvard Business School entrepreneurship professor, told MedCity News. “That’s cascading back through the system, so the likelihood that you’re going to end up with the kinds of products that Amgen [Inc.] created when it started, or Genentech [Inc.], or the early pioneers like Genetics Institute, is actually smaller and smaller every day.”

The pace of contraction picked up substantially during the first half of 2012 as funding shrank 22 percent in the first quarter and 39 percent in Q2. The hemorrhaging slowed a bit in Q3 (ended Sept. 30), falling 12 percent from 2011 but growing 16 percent in dollars over the previous three months. Analysts attributed the gain to a 64 percent jump in biotechnology funding.

Though it continued to attract investments in the final quarter of 2012, the biotechnology sector was unable to maintain its momentum from the fall—venture capitalists bankrolled only $1.3 billion in 135 biotech firms between Oct. 1 and Dec. 31, a meager 3 percent rise in dollars and 13 percent increase in deals compared with Q3, the MoneyTree report concluded. Most of that fourth-quarter growth was driven by solid gains in biosensors, biotech research, and biotech-human funding, which grew 415 percent, 58 percent, and 41 percent, respectively. The biotech-human sub-segment proved to be the most popular sector faction among investors, garnering a leading $1.1 billion in Q4 and $3.2 billion for the entire year. Despite its acclaim though, the sub-segment still attracted fewer dollars last year than it did in 2011.

“Last year’s investment levels came in lower than what we saw during 2011,” said Tracy T. Lefteroff, global managing partner of the venture capital practice at PwC U.S. “As the number of new funds being raised continues to shrink, venture capitalists are being more discriminating with where they are willing to place new bets. At the same time, they’re holding on to reserves to continue to support the companies already in their portfolio. Both of these factors are taking a toll on the amount of capital available for young start-ups, which is reflected in a 38 percent drop in the number of seed-stage companies receiving VC dollars in 2012.”

The early stage funding cliff wasn’t as steep in the life-sciences sector, where overall investments fell just 14 percent. Medical device startups fared better than their bio-technology counterparts, fetching $881 mil-lion in 153 deals, a 1 percent rise compared with the $869 million the freshman Class of 2011 collected. Investors backed 19 percent fewer biotechnology newcomers in 2012 despite a fourth-quarter influx of $648 million, a 31 percent increase over the previous year.

Oddly, financing seemed to loosen up as the year ended. Early stage life-sciences funding jumped 39 percent to $907 million in the final three months of 2012; the increase likely was driven by the growth in early stage biotech support, a 62 percent hike in appropriations for medical device startups ($259 million in 38 deals) and a 15 percent rise in late-stage funding for established device companies ($322 million in 36 deals).

Those stellar Q4 performances, however, virtually were powerless against the stronger forces of investor discretion and financial risk. Capital funding by stage, deal volume and sub-segment continued their downward spiral last year as lenders sought out low-risk ventures.

“We need to encourage people to pursue opportunities, knowing that they might fail. We need to encourage people to invest, knowing that they might lose their money,” Sahlman said. “The first Kleiner Perkins fund invested in Genentech and Tandem—their failure rate was 60 percent. You don’t get Tandem and Genentech unless you invest in 60 percent that fail.

“We have a great, great concern in the U.S. now about the level of risk,” Sahlman continued. “People looked at the financial crisis and said we had too much risk, that we need to protect people from losing money. We need to make sure that no person gets into a situation in which they might lose their hard-earned savings. And in the attempt to mitigate the financial risks to which we were all exposed, they actually began to drive out risk-taking in the real economy. Risk-taking in the real economy, with financial support, is what we desperately need.”

Yet it remains so dreadfully out of reach. Early stage companies—which typically carry the most risk—were venture capital pariahs last year, failing to maintain their 2011 funding levels. Overall life-sciences startup money was scarce throughout 2012, with quarterly losses averaging 17.7 percent (seed money was particularly limited in the spring; funding plummeted 36 percent to $598 million, according to the second-quarter MoneyTree report). Biotechnology rookies fared even worse, sustaining average quarterly deficits of 23.2 percent, thanks to a staggering 49 percent Q2 decrease.
Early stage medical device companies bucked the trend with nominal quarterly losses (the median was 6.2 percent) and a barely calculable end-of-the-year rally. Late-stage device funding took a considerable hit, losing an average 23.7 percent in the second, third and fourth quarters despite a solid 11 percent gain in Q1.

Overall medical device venture capital followed a similar trajectory in 2012, rising 33 percent in the first quarter to $687 million (ranking behind software, biotechnology and industrial/energy in dollars invested), then remaining flat in Q2 in spite of capturing a larger share of funding. Device investments took a nosedive in Q3, dropping to their lowest level since 2004 and falling to sixth place among all industries for total dollars advanced. The $434 million invested in 65 deals that quarter represented a 37 percent drop in dollars and 27 percent decline in deal volume. On a year-over-year basis, dollars invested fell 42 percent and the number of deals tumbled 27 percent.

The device industry ended 2012 on a positive note—investments jumped 32 percent to $581 million in the fourth quarter and deal volume climbed 9 percent. The rebound, however, did not quench the industry’s overall thirst for capital; total investment dollars still fell 13 percent for the year (bottoming out at $2.4 billion) and deal volume slid 15 percent to 313 transactions, the MoneyTree report showed.

But all hope is not lost. There may be some silver linings in those storm clouds. NVCA’s president believes the tightfisted funding mood among investors and dwindling number of venture funds will create a more disciplined environment. “Most people would say, ‘Oh my gosh, the sky is falling,’ ” Mark Heesen said. “But the companies that are going to be funded are going to be really good, and a lot of the ‘duplicative’ companies aren’t going to be funded.”

So much for those falling skies.