NVCA: Biodefense Offers a Big Investment Opportunity –

Post 9/11, it is widely recognized that our country was grossly unprepared for asymmetrical warfare directed at civilian populations. To quote Sen. Majority Leader Bill Frist (R-Tenn.): “The risk is real. The risk is increasing. Our vulnerability remains high.”

Regrettably, we can expect that the events of 9/11 and the subsequent anthrax letters will not be isolated occurrences, but the start of a transition to a new, more hazardous homeland security situation. International terrorists, disenfranchised individuals, rogue organizations and minimally equipped governments can now significantly “level the playing field” with militarily sophisticated countries.

Bioterrorism is only one of the threats, but a particularly insidious one, and future advances in biotechnology over the coming years will only increase the diversity and complexity of the threat. Just as in past decades, in which the United States developed skills and tools for conventional warfare overseas, today this country must do the same for the new potential attacks on the homeland – creating countermeasures and defenses for biological, chemical, nuclear, radiological, cyber and traditional explosive attacks.

In responding to this urgency, it is imperative that we harness the private sector, where the product development and scale-up skills and assets reside and where – given adequate commercial incentives – companies can move swiftly and competitively to create and serve markets. However, it takes more than just providing incentives to established bioscience companies, which are currently oriented towards conventional health care products. A fundamentally new industry is needed. This industry will be born at the intersection of biotechnology, health care, information technology and defense.

This industry will have several unique characteristics, but will need to draw capabilities from each of the three other industries:

The health care sector possesses the necessary product development skills, including understanding of product use and safety and regulatory approval, along with key intellectual property. In many cases, there are candidate technologies available for commercialization, having already been developed for other markets, but they require modification and testing to address the new homeland defense needs.

The IT industry has the skills needed for integrated solution development, which will be required to interface surveillance systems, biosensors, diagnostics or other biodefense devices with centralized analysis and decision systems.

The defense industry holds the key to the necessary marketing skills, with its strong government focus. Even when the government is not the purchaser, it will often be a key influencer. Winning companies will need to develop deep relationships with key government players, understand the intricacies of government procurement and build exceptional contracting capabilities.

Biodefense products and services cannot be developed in a vacuum. The new industry will need to be party to the Department of Homeland Security’s thinking on the most probable threats of the new asymmetric era in the CBRN (chemical, biological, radiological and nuclear) arena.

Whatever threat scenarios emerge, we may expect biodefense solutions to focus on key “choke points,” both nationally and locally. Choke points are those areas of maximum impact within communities, commercial transportation systems and high-risk facilities – from government buildings to shopping malls. These are places where maximum disruption could be caused, but also where early detection and prompt response will have the largest positive impact. Thus, our customers will be federal, state and local government as well as private companies.

There is a growing understanding in the nation’s capital of the need to act decisively to create the conditions and incentives for the emergence of the new industry, one with different development risks than the defense industry or those of commercial biotechnology. Government must provide participants with a sufficiently stable purchasing environment and appropriate rewards for the technology and market risks they face.

Legislative Progress

Over the past year, with new legislation, such as Bioshield, some of the challenges in engaging the private sector are beginning to be addressed. Recently proposed legislation tackles issues such as limiting product liability and streamlining the approval process to make development more attractive. Some of the key advances anticipated from the Bioshield bill (consistent with both House bill 2122 and Senate bills 15 and 1504) include providing the Secretary of Health and Human Services with expedited procurement procedures for bioterrorism-related products and services. It also allows for contracts to purchase countermeasures up to five years before they are delivered and the use of products that lack FDA approval.

If some of the needs of the new industry are unfamiliar, it should not be too surprising. This is a new era with new demands. While research of countermeasures for chemical and biological weapons have been undertaken in a host of government laboratories over many years, few within government have the background to design, scale up and commercialize integrated civilian solutions that incorporate the results of this research. Many of the possible technologies that exist in small companies and government labs are not progressing rapidly enough to reach the market, in absence of a clear commercialization process. Government funds (especially DARPA and SBIR grants) have often played an important role in getting them to this point, but most are faced with very limited personnel and financial resources, and these new programs are unlikely to receive high priority without access to new funds.

Despite the federal government’s proposals for substantial funds for biodefense, and despite the potential for rapid commercialization of biodefense products, the venture community has been extremely slow to enter this new segment. VCs are familiar with the kinds of technology risks inherent in biodefense, but they are more concerned about the sustainability of cash flows and a general reluctance to enter any segment where government is the primary or only customer. Recently, we have seen a change in VC interest and activity, with some top tier venture firms making investments in this space and the announcement of several new homeland defense-specific entries, such as the $400 million Giuliani/Bear Stearns fund. As examples of successful homeland defense investments become known and these role models in bio-business defense can be studied, others may begin to feel more comfortable moving into this new space.

To this end, the government has already directed billions of dollars to homeland defense product purchases, training and services. Money has flowed down to state and local levels. In the 2003 budget alone, almost $4 billion was directed to first responders at the state and local levels. Now that the “spigot is on,” we expect money to continue flowing for many years to come. Both H.R 2122 and S. 1504 authorize specific appropriations of $5.6 billion for bioagent countermeasure procurement over the next decade. Additional procurement funds will be found in other areas of the coming budgets, and we believe legislators will come to terms with the other needs on product liability and pricing that may discourage venture investors today.

Critical Mass

But the industry needs more investment, on a more sustained basis, to create the critical mass of skills, products and solutions needed. We believe the time is ripe for some VCs to take a hard look at this area. There is real opportunity to share risks with federal funding sources. VCs can do this by leveraging R&D grants from the newly formed Homeland Security Advanced Research Projects Agency (HSARPA), and from DARPA, the NIH/HHS and other agencies.

Unlike the past where most money was for early stage research and revolutionary ideas, homeland defense funds are to be directed in large measure to more mature development projects. For example, HSARPA plans to devote 90% of its funding to rapid prototyping and commercial adaptation, and it is focused on improving flexibility in the arrangements so that it is increasingly easier and more desirable for small companies to participate.

Many of the products will be dual use. For instance, diagnostic equipment for the ER could also be used for SARS and products for protection against dirty bomb exposure could also be used in conjunction with radiation therapy. Therefore, investors can leverage government development funding to realize a blended return based on both government and commercial pricing. While the biodefense application may have a moderate investment/return/risk profile, the commercial business alongside it may present a potentially high return for a relatively small investment that carries low risk.

It is hard to generalize because homeland defense projects and companies will have differing risk profiles, cost structures and returns. But incremental returns from venture investments may become quite attractive since government funds will support initial platform development.

There are many challenges in building businesses, especially in a market as dynamic as biodefense. New leadership skills are needed and a different investment paradigm must be applied. To make this new industry a reality, those of us in the venture community, alongside innovators, entrepreneurs and the government, must stand committed to find a formula that works and which earns participants attractive returns.

Valerie Ceva, Richard Barker and Ken Jennings are Founding Partners at Homeland Defense Ventures. For the last two years, they have been focused on biodefense strategy and investment. Ceva may be reached at