Virtual Biotechs a Real Business for VCs

VC eyes were poppin’ in February when Biogen Idec Inc. said it was acquiring Stromedix Inc. in a deal valued at $652.5 million.

The exit generated a nice return for investors Atlas Venture, Bessemer Venture Partners, Frazier Healthcare Ventures, New Leaf Venture Partners and Red Abbey Venture Partners, which had invested $38 million in two rounds into the startup, which is pursuing new treatments for fibrosis.

Overnight, Cambridge, Mass.-based Stromedix became the next poster child for the virtual biotech model, life science businesses built around a core group of founding executives. Typically, a virtual company is one founded on an idea and intellectual property, but with no more than a skeleton staff who, in small headquarters, oversee clinical trials and contracted R&D and other functions, such as accounting and HR.

Stromedix employed less than a dozen at the time of the announcement, including CEO Michael Gilman, who previously ran Biogen Idec’s research unit.

Virtual biotechs have become increasingly common as venture capital has staged a general retreat from life science investing over the past few years.

Brad Bolson, a partner at Versant Ventures in Menlo Park, Calif., says that the model “always been attractive because it brings capital efficiency into biotech, which is the real goal of the industry.”

Versant has a stake in Woburn, Mass.-based Flexion Therapeutics Inc., which licenses “de-prioritized” drugs from large pharmaceutical companies, and then contracts out the research and clinical trials, among other functions. In addition to Versant, 5AM Ventures and Sofinnova Partners invested $33 million in a Series A round in 2009, then Pfizer Venture Investments invested $42 million in a Series B round in early 2010.

“VCs have always been interested in capital efficiency. They want to get the most for the least amount of capital invested.”

Ted Driscoll

Technology Partner

Claremont Creek Ventures

Bolson says that Flexion’s two co-founders and current top executives, CEO Michael Clayman and COO Neil Bodick, ran the drug development program at Eli Lilly & Co. using the virtual biotech model before leaving in 2007.

The experience of running a virtual biotech operation was for a Big Pharma company was invaluable when it came time to launch a startup,” he adds.

Flexion is starting to shift toward a more traditional business model after having established itself as in the virtual realm. Meanwhile, Bolson says that he is exploring different ways to structure a virtual biotech.

For example, his firm has invested in Inception Sciences Inc. in San Diego, which is building a “drug discovery engine that could serve as a new industry model for funding, accelerating and monetizing drug development,” according to the firm’s website. Inception is the creation of former Merck & Co. scientist Peppi Prasit, who was chief science officer at San Diego-based Amira Pharmaceuticals Inc., which Bristol-Myers Squibb bought in June 2011 in a deal valued at $475 million.

Bolson teamed with Prasit to launch Amira in 2005, and was actively involved with the business.

He says Versant has invested $5 million into each of Inception’s first two spin-outs, Inception 1, which is investigating small molecules to treat Alzheimer’s among other neurodegenerative diseases, and Inception 2, which is investing small molecules to treat various cancers.

“We’re starting to get a little more creative in how we structure virtual companies,” he says. “It’s not just limited anymore to the traditional model. And as I look to the future, I see us trending more in that direction when making investments.”

“You have to minimize your costs while maximizing the ability to get your product to market. That’s the way it is now in the life sciences.”

Gail Naughton

President and CEO

Histogen Inc.

Ted Driscoll, technology partner at Oakland-based Claremont Creek Ventures, is an advocate of virtual biotech as a way to get the most for the least.

Two of the firm’s portfolio companies include Zipline Medical Inc., which is developing a next generation of suturing devices, and GigaGen Inc., a San Francisco-based startup developing technology to be used in the treatment immune disorders, infectious disease monitoring and non-invasive cancer detection.

Driscoll remembers that Amir Belson, Zipline’s founder, approached him at a Starbuck’s coffee shop in Los Altos, Calif., a couple of years ago with business plan in hand.

“At first I thought he was a little wacko,” Driscoll says. “But as he talked, I could see that he was a very creditable guy … an accomplished inventor.”

Driscoll says Belson, a physician, was looking for money to fund design of his first device, which he had developed out of his house.

“It’s the classic virtual company,” says Driscoll, who adds, “Board meetings continue to be held at the Starbucks in Los Altos.”

The company mostly operates out of a small office nearby in Campbell, Calif.

In August, Claremont Creek invested an undisclosed amount in a seed round in GeneWeave Biosciences Inc., a medical diagnostics business launched by Cornell University grad students Jason Springs, who serves as CEO, and Jason Rey.

Claremont Creek did a follow-on $12 million Series A round in February that included participation from Decheng Capital in China and X/Seed Capital in Menlo Park, Calif.

The Ithaca, N.Y.-based GeneWeave is developing an inexpensive kit that can used to detect life threatening pathogens, such as the MSRA superbug and the deadly E. coli bacteria.

“The business started out with just these two guys, so I told them to go rent a room in an incubator where they would have everything that they would need, right down to the espresso machine in the kitchen,” Driscoll says. “And they did.”

He says that they found space in an incubator, but have since moved into a more spacious lab as product development continues.

“VCs have always been interested in capital efficiency,” Driscoll says, “They want to get the most for the least amount of capital invested.”

In San Diego, more than half of the newly formed companies in recent years have followed the virtual biotech model, according to Terry Moore, managing partner of San Diego-based boutique VC firm Moore Venture Partners.

The large number reflects in part the absence of major venture firms there, which means money is scarce for local entrepreneurs.

“Less money favors the virtual startups that know how to conserve cash,” Moore says.

In fact, the traditional startup requiring costly labs and others facilities may be going the way of the dodo bird, he says.

“Only one in 10 drugs make it through the FDA maze,” he says, “and getting one drug to market can cost up to $1 billion. No one wants to deal with that.”

To be sure, the virtual biotech phenomenon is just not extant on the two coasts.

David Scholl, a partner at Athenian Venture Partners in Athens, Ohio, says Proctor & Gamble Co.’s 2009 sale of its global pharmaceutical business to Dublin, Ireland’s Warner Chilcott plc has led to the formation of as many as eight startups over the past three years in Ohio—around Cincinnati, Cleveland and Columbus—are using the virtual model.

“With the release via licensing deals of a wide range of its pharmaceutical assets at P&G, in conjunction with the release of significant human talent from dismantling its pharma organization, the stage was set for the creation of a number of new startups,” he said.

And he notes that several prefer to stay “quasi-virtual to make the milestones necessary to drive asset valuations up.”

Several of Athenian’s 10 portfolio companies listed at Athenian’s website could be classified as virtual, Scholl says.

In San Diego, Gail Naughton, president and CEO of virtual biotech Histogen Inc., says that her 5-year-old business is outsourcing most of its important functions, including sales and marketing, as it closes in on the release of its first product. The virtual biotech company is developing a series of products to restore hair and skin using stem cell technology.

Naughton says she completed a $10 million Series A round in 2009, and has received $17 million in commitments for a $23 million Series B round.

Investors include the co-founders of Paul Mitchell Systems Inc., famous for its beauty salons and hair products, and the owner of Secure Medical in Tempe, Ariz., which provides software and IT services to the health care industry.

Histogen and its brethren have spawned a sub-industry of contracts research organizations, or CROs, which undertake such chores as research and clinical studies, and they are now woven into the fabric of the region’s burgeoning life science economy, Naughton says.

San Diego life science trade association Biocom reports that 70 of its 550 members are CROs, and have become part of the fabric of the region’s burgeoning life science sector.

Naughton says virtual biotech’s reliance on CROs allows for better use of investor monies, and eases the fears of increasingly reluctant investors.

They can bail with large amounts of upfront cash, she says, if a drug or device doesn’t pan out in the R&D phase.

In fact, Naughton says VC’s retreat from the life sciences continues to shake up the way startups are organized and operated in the sector.

“We realize that if we are going to do this, we are going to have to do it differently,” she says. “You have to minimize your costs while maximizing the ability to get your product to market. That’s the way it is now in the life sciences.”

Tom York is a San Diego-based contributor. He can be reached at