The year 2000 marked the largest year of life sciences capital fund-raising ever recorded, with more than $35 billion raised by public and private life sciences companies. This slowed in 2001. So what are the market dynamics this year?
The public market biotechnology indices are down significantly (43% and 45%, respectively, for the American Stock Exchange and Nasdaq biotechnology indices). But, private funding of biotech companies, including PIPE (private investment in public equity) transactions, was actually up year-over-year in the first half of 2002. Life sciences venture investments totaled $1.8 billion in the first half of 2002, compared to $3.4 billion for all of 2001, according to the PriceWaterhouseCoopers/Venture Economics/NVCA MoneyTree survey. And although third quarter numbers experienced a sharp decline of 52% to $468 million, the drop-off follows a strong string of quarterly investing results.
Analyzing the data in more depth provides great insight into the types of deals getting done and what we should learn from these trends. Although the life sciences industry is enjoying strong venture activity, this activity is in the context of an overall venture market where financing has fallen from quarterly levels of $29.5 billion in the first quarter of 2000 to $4.5 billion in the third quarter of this year. That represents an 81% decline, which means many entrepreneurs are finding a very hostile fund-raising market across industries. Many seasoned venture capitalists liken this period not as a trough in investment levels but as a return to normalcy following the technology bubble of the late 1990s.
The stability of life sciences venture investing has resulted in a significant increase in the overall share of venture dollars going into life sciences. In the second quarter, life sciences investments represented 27% of all venture investing, which was second only to software. Notably, the life sciences percentage increased from just 10% for all venture investment in 2001. Approximately 170 companies received financing in the first half of this year, compared to 316 last year.
The number of VC-funded biotechnology companies has retreated slightly from 2000 levels, but in the first half of this year, as many companies received funding as in 1994. What is definitely changing is the average round size for biotechnology companies. Early-stage venture capitalists are raising $15 million and $20 million Series A rounds for serial entrepreneurs in order to provide companies with significant runway to achieve multiple milestones before returning to the capital markets. An amazing example of this trend is the $45 million first round completed in late September by Alexza Molecular Delivery, led by Frazier & Co. and Versant Ventures. Remember, despite the significant capital being raised, the pre-money valuations for these deals are not likely rising: Investors are buying significant stakes in these companies.
Why does the market feel so difficult with money coming into the sector? The quick answer to why the market “feels” so difficult is that the amount of venture money being invested is increasing, but it is being invested at decreasing valuations. This means current investors and management teams are experiencing the “D” words: down rounds and dilution.
Following the significant public market interest in biotechnology in 2000, the valuations placed on companies have retreated significantly. Despite the progress we’re seeing at companies developing drug candidates and technology platforms, our team at Vector Fund Management sees down rounds as the norm for the majority, if not all, later-stage financings. Discounts of 30%-50% are common. This is interesting, given the significant amount of money recently raised by health care-focused venture firms. For example, MPM Capital recently announced the largest health care venture fund ever at $900 million. Instead of driving up prices for deals, VCs with capital to deploy are driving down prices. With liquidity prospects tight for the foreseeable future, this is likely to continue for a while.
Is biotechnology fund-raising closed for the short term? Clearly not, but seed- round financings will continue to be far and few between. We all must look critically at these early-stage companies and ask tough questions, like, “Is this company developing technology to be licensed?” If the answer is yes, the company is seeking institutional capital at the wrong time.
When Douglas Reed, a managing partner with my firm, moderated the closing iBIOmarketplace panel in Chicago, he lightheartedly noted that the discussion, titled “Raising Funds in a Challenging Market,” might be more appropriately called “Swimming Upstream in a Bear Market.” We should not be discouraged by Doug’s comment, just realistic. The fund-raising market for biotechnology will improve as the market moves through the current cycle. Entrepreneurs and VCs alike must navigate the current environment to build companies that will be best positioned to take advantage of the next positive cycle.
Timothy “Ted” E. Davis, Jr. is a vice president of Vector Fund Management, which is based in Deerfield, Ill. Prior to joining Vector in 1997, Davis worked at Gemini Consulting Group Inc. and Parke-Davis Co. He Davis received his bachelor’s degree in Biomedical Engineering from Vanderbilt University and his MBA from the J.L. Kellogg Graduate School of Management at Northwestern University.