Is VC’s insatiable appetite for biotech sustainable?

Last year saw unprecedented investment into the biotech space, with global VC backing in the sector topping $10 billion for the first time on record. Big-time US investments and ongoing developments in personalised care, AI and drug development were just some of the factors that helped biotech funding hit heights not previously dreamed of. How could 2018 ever surpass that?

By, er, breezing past $11 billion with more than four months of the year left, that’s how.

Global VC investment in biotech stands at $11.47 billion so far this year. As well as already beating 2017’s then-record-breaking amount, it’s 46% more than 2016’s total and a whopping 55% more than 2015’s figure. In fact, it’s more than all the capital invested in global biotech startups in 2012, 2013 and 2014 combined. And there’s still more than a third of the year left.

What’s behind this?

Heavy doses

A glance at the deals behind the figures shows that an increase in mega-rounds is one reason for the wider rise in biotech activity. In 2017, for example, the year’s largest round—a mammoth $1.2 billion fundraise by Grail—accounted for more than a tenth of the 12 months’ entire value, while the second-most-expensive investment was Ginkgo Bioworks’ relatively puny $275 million deal. In total, only 15 VC deals in biotech last year breached nine figures.

2018, by contrast, has so far been characterised by a much deeper well of nine-figure deals. There have been 26 $100 million-plus rounds already this year, according to PitchBook data, as well as 13 that totalled $200 million or more—including, once again, Grail, which raised another $300 million in May.

More cash available

On top of this, VCs focusing on biotech have larger war chests to deploy than ever before. Venture investors with a penchant for biotech raised more than $26 billion in 2016 and 2017 combined, per PitchBook, compared with $24.9 billion in the prior four years altogether.

This equates to a lot of capital that needs to be put to use. Investors with particularly large amounts to play with include Flagship Pioneering, a US-based science investor which closed its sixth main fund last year on $618 million, and Clarus Ventures, which held a final close on $910 million for its fourth life sciences vehicle.

The incentive to fund startups trying to find new drugs and therapies can be explained by looking at exits. In the biotech industry, there’s a history of small, early-stage bets paying off extremely handsomely.

For example, Prexton Therapeutics—a Dutch biotech focused on Parkinson’s Disease therapies—was sold to Lundbeck this year in a deal worth as much as €905 million (nearly $1.1 billion), having reportedly received less than €40 million in prior institutional backing. In 2016, Chase Pharmaceuticals was taken over by industry giant Allergan in a deal said to be worth up to $1 billion, having raised less than $40 million in previous funding. A year later, Novartis snapped up lightly funded dermatology specialist Ziarco in another takeover speculated to be worth up to 10 figures. And earlier this year, University of Bristol spinout Ziylo was sold to Novo Nordisk for around $800 million without any previous VC backing.

Hunting for a panacea

Yet as investors and LPs see these investments pay out multiple times over and hunt for major returns of their own, they may be inclined to hold their stakes in biotech startups for longer and to maintain more aggressive and expensive positions.

They might also be keen to hold on to their investments for longer given biotech’s track record of producing public companies which sell for much, much more than their initial IPO prices—the point at which VCs would usually grab their coats and leave.

To illustrate, consider the following question: What connects Wilson Therapeutics, Juno Therapeutics, ARMO Biosciences and Relypsa?

All are biotechs which venture capitalists have exited via IPO within the last 11 years. They are also all biotechs which have subsequently been acquired in the last two years at valuations ranging from three to nearly seven times what they achieved at their listings. You can’t help but wonder whether some private investors end up feeling that they left quite a bit of money on the table.

Hurdles to overcome

In practical terms, the biotech sector is filled with barriers to setting up a business that are not as prevalent in other industries, making it less easy to exit quickly. How many startups need access to Ph.D.-level scientists, lab equipment and the funds to sustain a years-long approval and trials process, all before producing a functioning product?

This is the reality for most biotech companies. And most of them won’t see the other side. According to research on clinical drug development between 2006 and 2015 conducted by the Biotechnology Innovation Organisation, Biomedtracker and Amplion, just 9.6% of all therapeutic candidates at Phase I stage make it to approval—a figure which drops as low as 5.1% when it comes to areas like oncology. Less than 2% of startups which received VC funding survive to a fifth round of backing, per PitchBook data.

Higher risks for higher rewards is one of the guiding principles of traditional VC, and is likely to be one of the drivers which will lead investors to continue to pump money into biotech. However, the increase in capital searching for investable assets is likely to drive up valuations, at a time when investors are incentivised to keep biotechs private for longer. The interplay of these two competing factors might decide just how high skyrocketing figures of VC investment in the biotech sector can go.