Venture Capital
Lessons learned
Investing in the life sciences industry is a high-risk activity. Less than 5% of drug discovery projects ever make it to the market, not just because of setbacks in science, but often due to macroeconomic headwinds. The latter, coupled with a shift in how venture capitalists approach deals after the sugar high post-COVID, led to a significant correction in VC investment in the biopharma industry in 2023. The outlook for the remainder of 2024 remains cautious, although early signs have shown that biotechs and their backers are optimistic that the sector’s downturn might be nearing its end.
Strategic pivots in response to downturns
The explosive growth in VC investing seen during the pandemic is but a distant memory for biotech executives. Back then, a whole new ecosystem of investors piled into the industry: Traditional investors, generalist investors, as well as worldwide investors such as the sovereign wealth funds and other players that do not traditionally invest in the biotech sector, all looking for a piece of the action. VC backers that we interviewed recalled that biotech investment firms could not afford not to participate in IPOs, as each offering was generating excessive value.
That capital has since rotated out of biotech into other sectors, and as the industry must rely on traditional means of raising funds, many firms are feeling the pinch: A GlobalData report shows that 607 venture-backed companies headquartered in the US are currently affected by the downturn in biotech funding, with over 1,500 drugs at stake (including pre-clinical). Most dramatically, approximately a third of these firms have not raised any capital in the past three years, the period coinciding with the start of the post-COVID correction. Venture financing for US-headquartered companies with innovator drugs peaked in 2021, reaching US$20.7 billion, and many early-stage biotechs went public that year, often with inflated valuations. This resulted in many overvalued biotechs that were unable to deliver milestone outcomes, causing a decline in investor confidence and increasing selectivity in new investments.
“During 2023, investment capital was still in short supply and the industry saw very few financings and IPOs. With limited funds entering the sector in 2023, only the companies that had meaningful data, regulatory approval, and truly value-creating events were able to raise financing.”
Christiana Bardon, Co-Managing Partner, MPM Capital
In response to public and private market downturns, VCs have made a strategic pivot towards quality and clinical data validation in the latter part of 2023 and so far in 2024. With limited funds entering the sector in 2023, only the companies that had meaningful data, regulatory approval, and truly value-creating events were able to raise financing. Data from McKinsey shows that innovative platform technologies such as drug discovery enabled by machine learning (ML), cell therapies, and gene therapies have dominated biotech funding over the past few years because they typically promise to address a broad array of indications over time. In the current risk-averse climate, exacerbated by the uncertainty that the current geopolitical environment brings, investors remain focused on clinical validation, with standard clinical milestones being pushed to earlier funding rounds.
Biotechs must now be in the clinic or possess a unique Phase 2 asset in a “hot” indication to receive VC attention, whereas many firms listed at Phase 1 in 2019-2020. Gone are the days when biotechs could quickly pivot from Series A to a “crossover” round, and then an IPO. In 2023, Xontogeny co-led a US$200 million Series A financing for CARGO Therapeutics with a CD-22 CAR-T treatment for lymphoma. Chris Garabedian, CEO of the biotech aggregator, explained the trend: “In recent years, there has been a noticeable shift towards data-driven valuation in the biotech sector. We have seen a return to fundamental principles, where specialized investors engage in thorough due diligence, and with discipline and selectively invest in the best opportunities with the highest probability of success.”
John Pennett, partner at EisnerAmper, commented: “There is a trend of increased due diligence by financiers seeking to invest in companies at all stages of development. The overarching theme appears to be a “return to quality”. Investors are eager to reduce risk by backing companies with higher chances of success. They emphasize stronger science, robust teams, and reputable investors.”
Going forward, seed-stage investments may require in vitro data and mouse models, while Series A funding may demand a complete demonstration of AI & machine learning algorithms sourced from academia or validated with high-throughput biology platforms. In 2021, many biopharma companies went public without advanced clinical candidates. However, a larger proportion of biotech IPOs in 2022 and 2023 had phase 3 trials underway at the time of their public listing, and we anticipate this trend will persist. James Gale, founding partner at Signet Healthcare Partners, touched upon what VC are looking for in a biotech: “Effective validation in the biotech industry hinges on real-world clinical evidence in humans. To succeed, biotech companies must articulate a clear market (therapeutic) potential. Drug development today must consider factors like reimbursement, clinician utilization, and market differentiation. A well-supported market study, robust clinical data, a defined regulatory path, and realistic timelines are essential components of a compelling pitch.”
VC funding outlook
Despite drug developers having been slow to experiment with AI for their lead candidate, VC investor sentiment is insistent that early-stage biotechs incorporate this technology. During the J.P. Morgan Conference in January 2024, Pitchbook reported that the AI firm Alphabet’s Isomorphic Labs dominated VC conversations after the firm signed two partnerships with Eli Lilly and Novartis worth US$3 billion.
Industry leaders have learned their lessons. There is a consensus that too many biotechs were created in recent years, many formed around the same technologies and targeting similar diseases, leading to companies fighting for the same pool of capital. Hopefully, unlike in previous downturns, VC companies are flush with cash. Several early-stage life sciences investors, including Arch Venture Partners, Versant, Flagship Pioneering, and Third Rock Ventures, have recently closed significant new funding rounds in 2022-2023. This provides them with substantial resources to either bolster existing companies or launch new ventures.
Overall, 2023 figures indicate that VC funding has stabilized from the peaks seen in 2021. But in this environment, biotechs still do not have an easy path to Wall Street. Those that will focus on strong building blocks like clinical data, an experienced management team, and innovative platforms will likely emerge as leaders in securing the substantial VC funding necessary to advance transformative drugs toward approval. Despite their caution, the tone among investors is more upbeat than in 2023, and technologies that have the potential to have life-changing impacts on patients will most likely receive attention.
“Investors are looking at satellite stories, where they can calculate the inflow of revenues and profits, and good quality clinical stories. They want to find those 'game changers', like we have seen in the diabetes space or some cancer drugs –the next success stories carried by the strongest management teams.”
Andreas Grassauer, CEO, Marinomed
Article header image courtesy of LaVoie Health Sciences