Biotech Valuations, Funds in Spotlight –

A look back at 2003 will find headlines about hot new sectors like social networking, anti-spam software and patch management. But the big story was an old sector that has recaptured the fancy of both private and public investors – life sciences.

In the past year the number of life science venture deals has risen, valuations have climbed for late-stage deals, and several VC firms have repositioned their funds or started raising new funds to emphasize life sciences over IT investments.

Why the surge in interest? It’s a confluence of events. Steven Burrill, CEO of Burrill & Co., a San Francisco-based investment bank and investor specializing in life sciences, points to the Food and Drug Administration. “The FDA commissioner is determined to speed drug and device approvals,” he says. “There is plenty of investment money on the sidelines and the companies that are lining up have good product stories to tell.” By his count, more than 350 compounds are under development or awaiting regulatory approval.

In addition, the public markets have bid up biotech stocks in general. The American Stock Exchange’s Biotechnology Index surged 30% this year. The index, which reflects the performance of 17 biotech stocks, went from 348.5 points at the beginning of the year to nearly 460 points in November, outperforming the Nasdaq by more than 4% during the same period. If the ascent holds, this year’s performance of the AMEX biotech index will buck the negative trend from the last two years.

After five consecutive quarters of the market not seeing a single biotech IPO, more than a dozen venture-backed life science companies filed to go public in the fall, with eight launching IPOs from September to mid-November. “Were seeing a more active life science market as more investing is taking place. At the same time, we’re seeing how the biotech IPO is also coming back,” says Stuart Collinson, a partner at Forward Ventures, a San Diego-based health care investor that cashed in on the IPO of CancerVax in October.

A Bigger Piece of Pie

All that good news has helped the life sciences sector attract more venture dollars. VCs put $1.1 billion into 117 life sciences deals in the third quarter, accounting for 17% of the total. That’s up from 15% in the second quarter and made life sciences second only to software, where the number of deals and total dollar amount fell from the prior quarter, according to the PricewaterhouseCoopers, Venture Economics, National Venture Capital Association Money Tree Survey.

Among the most notable biotech investments during the third quarter were Reliant Pharmaceuticals Inc., a New Jersey-based drug company that secured $115 million in the first close of its Series D round. Invemed Catalyst Fund led the deal. Like Reliant, other life science companies dominated the third quarter. In fact, Seven of the 10 largest disbursements went to biopharmaceutical or therapeutics companies, including a $45 million deal for Renovis Inc. (which included Venrock Associates and Alta Biopharma Partners as investors), a $30 million infusion into Infinity Pharmaceuticals Inc. (backed by Venrock and Prospect Venture Partners, among others), and a $40 million deal for Rinat Neuroscience Corp. (with Prospect and Essex Woodland Health Ventures participating).

Not surprisingly, all the deal activity has driven up overall valuations for private life sciences companies. The median post-money valuation for a U.S.-based life sciences company was about $31 million for the past two years, according to Thomson Venture Economics. But that median figure rose above $37 million in the second quarter, a 19% increase.

Valuations Fall for New Deals

Notably, while valuations have skyrocketed for late-stage deals, they have plummeted for seed- and early-stage deals. For the past few years, there’s been an early-stage funding drought, since VCs could invest in later-stage companies at prices that were 10% to 20% of their peak valuations, says Daphne Zohar, founder and managing general partner of PureTech Ventures, a Boston-based life sciences venture consulting company that helps turn promising technologies into companies.

Interest should now pique in early-stage companies. The average valuation of a later-stage life science company was more than $56 million in the second quarter, up 33% from $42 million in the same quarter in 2002 (see Figure 1). Meanwhile, the average valuation for an early or seed-stage life sciences company was just over $11 million in the second quarter, less than half of what it was ($23 million) in the same quarter a year earlier (see Figure 2).

“Valuations at early-stage are becoming attractive again for investors as opposed to a late-stage deal,” Zohar says. “Meanwhile, the IPO market is opening up, so there’s definitely going to be a lot more interest in life sciences from venture companies, especially in those Series A deals when an investor can come in early.”

Fun with Funds

Meanwhile, there is no shortage of funds, both big and small, making life science deals across North America. In October, New Jersey started a $10 million venture capital fund to help launch new life science companies in the Garden State. In Indiana, a coalition of institutional investors in October announced a $72 million fund-of-funds called the Indiana Future Fund, which will invest in other venture capital firms nationwide. It will specifically encourage direct investments back into Indiana life sciences opportunities. Credit Suisse First Boston will manage the fund.

In Canada, Desjardins Venture Capital has invested nearly $12 million in four life science companies this past year, bringing its total portfolio to over 30 companies in life sciences, with more than $85 million under management.

Large venture funds are also increasing their focus on life sciences. Baltimore-based New Enterprise Associates is pulling together a $1 billion fund that will target health care and life sciences investments. Its strategy is part of an effort to rebalance a portfolio that tipped toward technology and communications opportunities during the tech boom.

At the same time, Sprout Group acknowledged in November that it will invest only in health care deals going forward and will spin out a new firm, Sprout Healthcare Ventures. The move marks a shift from its longtime focus on both life sciences and IT (see story, page 10).

“Investing in life sciences is no longer out of favor, if it ever was,” says Terry McGuire, managing general partner of Polaris Venture Partners in Waltham, Mass., an investor in drug maker Acusphere (Nasdaq: ACUS), which went public in October.

McGuire says he’s not worried about a biotech bubble. The valuations are still low early on, he notes. “Without a doubt, companies are getting well funded, and there’s a lot of new capital going into life sciences,” McGuire says. “But with each new round we see a level trajectory of valuations, so we’re not pricing ourselves out of the market. Instead, we’re seeing steady, normalized growth, which is what you want.”