Capital infusions drive biotech ventures

The recent credit crisis and economic downturn have exacerbated the two related challenges that face any biotechnology company seeking financing to develop and license drug leads.

First, these companies need to raise venture capital to finance costly drug development and clinical trials. Second, since they will be licensing patents for drug leads to larger pharmaceutical partners, they are sensitive to the economic state of the industry and pharma’s openness to in-licensing drug leads.

Financing innovation is needed for product development.

A January 2010 PricewaterhouseCoopers report noted that U.S. venture capital investment in 2009 was only $17.7 billion (2,795 deals), the lowest amount invested since 1997 and the second consecutive year of decline.

Mark Heesen, president of the National Venture Capital Association, said this was due to a “weak exit environment resulting from an unstable public market combined with a challenged limited partner base.” Clearly, venture capital firms will not finance biotech startups until they see a profitable exit strategy such as an IPO or a sale to a pharmaceutical company.

Stock market trends – and the Pharmaceutical Index (DRG.X) in particular – indicate that these are not favorable short term options. Beyond planning their next investments, venture capitalists must also be able to raise their own funds and manage problems in their portfolio that have arisen as a result of the financial crisis.

Venture funds include consumer savings, especially pension funds, and are thus vulnerable to dips in consumers’ disposable income and declines in the stock market. A vicious cycle reveals itself: less money in the financial markets leads to less money available to finance small businesses, in turn stifling job creation and GDP growth.

Despite this seemingly grim situation, there were still 406 biotech deals totaling $3.5 billion in 2009. A Thomson Reuters survey that year asked more than 50 biotech venture capitalists if the economic crisis caused them to change their investment approaches. While they said their approaches remained the same, they were paying more attention to a company’s cash position.

Alas, the venture capital market may even be showing signs of improvement. According to a July 2010 PricewaterhouseCoopers report, venture capital investment in the first half of 2010 increased 49 percent compared to last year, with $7.7 billion invested and a 23-percent increase in the number of deals. Heesen concluded that this improvement was because the exit market was “showing signs of life,” as a number of companies were preparing IPOs.

Most startup biotech companies involved in drug discovery and development aspire to license their drug to a pharmaceutical company that will further develop it and ultimately take it to market. Their primary concern is whether pharma is willing and able to in-license the drug leads in this current economic environment.

Pharmaceutical companies’ financial health is unfortunately marked by dramatic downsizing – a recent Newsweek article estimates 90,000 pharma jobs were lost in 2009. In addition to those lost last year, in January of 2010 AstraZeneca cut 8,000 jobs and Bristol-Myers Squibb cut 4,000. GlaxoSmithKline, Merck and others are reporting similar cuts. Importantly, most of these were research and development jobs – those that fed these companies’ innovation engines.

Innovation is the lifeblood of economic growth for a society. It drives GDP growth, as well as individual industries like pharma. In the midst of the nation’s relatively flat GDP, it appears that pharma is stifling the innovation that drives growth.

Faced with this significant downsizing, dwindling stock prices and the industry’s trend toward consolidation, pharma’s most viable solution is to in-license innovation and drug leads from biotech startups. Glaxo serves as an excellent example. While the company has decreased its internal R&D staff by 20 percent, it has significantly increased spending on outside research. Even two years ago, in a Harvard Business Review article, Glaxo CEO Jean-Pierre Garnier noted a desire to “forge alliances with academia and biotech companies.”

“The days of a company concentrating its R&D inside its four walls is obsolete,” Garnier said.

This now industry-wide trend is good news for biotech companies and bodes well for the future of innovation in the pharmaceutical industry. There is, however, a caveat: Domestic biotech companies will face increasing competition from abroad. As a fraction of GDP, Japan and South Korea already spend more than the U.S. on R&D, and China’s investment is increasing at a remarkable pace.

Pharmaceutical innovation is alive and well, and young biotech companies are poised to take full advantage. How well they compete in a global marketplace, though, will ultimately determine their fate.

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