Lack Of VC Funding Has Biotechs Ailing

While U.S. lawmakers mull health care reform in the nation's capital, another important question is nagging at various biotech capitals from coast to coast: Who will finance new drug development?

Venture capital has been the lifeblood of biotech startups and their new technologies. But in the current difficult economic climate, VC money has largely dried up.

Now some industry watchers are concerned that an overly aggressive health care bill may erode drug prices, squeeze profitability, and make it even harder to lure VC money to biotech.

As it stands, not only is it hard to find new money, but VCs must also husband the cash they do have to keep existing projects going.

"The vast majority of VC funds are doubling the reserves for their existing portfolios, shifting cash away from new investments," said Jay Lichter, president and chief executive of Avalon Ventures.

Meanwhile, many biotechs are in dire need of financing. A recent report from consulting firm Ernst & Young says that 44% of U.S. publicly traded biotechs have less than one year of cash on hand.

Last year biotech financing of all types -- including IPOs and acquisitions -- fell by 19%, says Glen Giovannetti, head of Ernst & Young's global biotechnology unit. It's been worse in 2009, though numbers are incomplete. For startups looking for VC money, it's been "a financial implosion," Giovannetti said.

Without more capital, discovery of genetically based treatments for cancer, neurological disorders, cardiovascular disease, age-related blindness and other diseases could be delayed -- maybe for years.

A lot is riding on those drugs to provide medicines aimed at the patient's or the disease's genes. They could in the long run be more cost-effective than any therapies to date, despite their high cost.

For VCs, finding the next potential blockbuster requires more than a little creativity. Some scout bargains on stock exchanges and among distressed private equity funds, Giovannetti says.

There's even a new term: VIPE, for venture investing in private equity.

Startups Compete For Cash

VCs whose charters permit them to invest in public companies can buy devalued shares or company assets. And they can buy companies out of bankruptcy if there's good science to be had.

That can be a better use of capital in this economy than backing a startup, Giovannetti says.

To get VC interest nowadays, a biotech startup must have an outstanding innovation, preferably a platform technology. That's a scientific base from which many products can spring.

For now, VCs can't find a platform from which they can spring the big amounts they've been accustomed to.

A VC trying to pull together $500 million may get $300 million. One trying to create a $200 million fund may get nothing, Giovannetti says.

One reason is that major capital pools have shriveled. VCs raise money from large university endowments, insurers and state retirement plans such as the California Public Employees' Retirement System.

Avalon Ventures has a different model. It looks for new opportunities where most VCs don't.

"In some ways we're an angel investor because we get in exceptionally early," Lichter said.

Other VCs that are still investing are looking at projects among companies that are more mature and closer to an existing strategy. It's easier to turn an investment of $3 million to $5 million into $100 million than it is to get $1 billion on a $100 million investment, Lichter says.

His firm has even initiated some of the companies in its portfolio, getting its own patents. In this climate, a VC has to be not only an investor but an entrepreneur as well.

That's also true of scientists with a commercial prospect, says Bob Zaugg, head of business development at the Burnham Institute for Medical Research. "There's growing interest among faculty in starting their own companies without VCs."

To do that, they look to other forms of funding, notably grants. The Small Business Administration funds such startups through its Office of Technology. That office runs the Small Business Innovation Research program and the Small Business Technology Transfer program.

Meanwhile, the Obama administration's stimulus package is putting more money into the National Institutes of Health, the main financial backer of basic research. Without that basic research, there would be much less fundamental drug development.

The Burnham Institute has applied for $50 million in stimulus money. That will pay for more scientists to do more research that Zaugg hopes to commercialize.

The Joint Venture Approach

The institute has its first partnership not with a VC but with a big drugmaker: Johnson & Johnson JNJ. While VCs sniff around, they're not putting up cash, Zaugg says.

Another model for funding new biotech prospects could be one like that of Isis Pharmaceuticals ISIS and its partner, Alnylam Pharmaceuticals ALNY. The two firms put in a total of $30 million, pooled some compatible science in a genetic technology called RNAi, and created a joint venture called Regulus Therapeutics.

Regulus' mission is to discover, develop and commercialize micro-RNA-targeted therapeutics. It could serve as a template for other biotech funding, says Regulus CEO Kleanthis Xanthopoulos.

But "the idea itself must be big," he added.

Given the uncertainty of markets, Xanthopoulos suggests that young biotech innovators steer clear of VCs and focus on government grants and angel investors. When they have something the market wants, that's the time to consider venture capital.