The VC Ecosystem
Transcript of BioCentury This Week TV Episode 126
Carole Nuechterlein, Head of Roche Venture Fund, Basel, Switzerland
Kurt von Emster, Co-founder and Managing Partner, venBio, San Francisco, Calif.
PRODUCTS, COMPANIES, INSTITUTIONS AND PEOPLE MENTIONED
Amgen Inc. (NASDAQ:AMGN), Thousand Oaks, Calif.
Aragon Pharmaceuticals Inc., San Diego, Calif.
Baxter International Inc. (NYSE:BAX), Deerfield, Ill.
Bernard Munos, Founder, InnoThink Center for Research in Biomedical Innovation
GlaxoSmithKline plc (LSE:GSK; NYSE:GSK), London, U.K.
Novartis AG (NYSE:NVS; SIX:NOVN), Basel, Switzerland OrbiMed Advisors
Novo Nordisk A/S (CSE:NVO; NYSE:NVO), Bagsvaerd, Denmark
Roche (SIX:ROG; OTCQX:RHHBY), Basel, Switzerland
Shire plc (LSE:SHP; NASDAQ:SHPG), Dublin, Ireland
Johnson & Johnson (NYSE:JNJ), New Brunswick, N.J.
Eric Pierce, Publisher
ERIC PIERCE: Biotech raised more than $6 billion in venture capital last year. So why is the industry worried? I'm Eric Pierce. We'll find out on BioCentury This Week.
NARRATOR: Your trusted source for biotechnology information and analysis, BioCentury This Week.
ERIC PIERCE: The global economic downturn has hit venture capital hard. It's been harder to raise new funds as limited partners, like pension funds, have fled from risk. VC performance has been stymied by the slack market for IPOs. And in the biotech space, only a few are reaping the big windfalls by selling their startups to big pharma companies.
But VC's invested more than $6 billion into biotech last year, mostly in the U.S. and Europe. That's the second highest total in the past decade. And the total has not fallen below $5 billion in nine of the past 10 years.
How has this happened? One answer, corporate venture capital has stepped in to fill the breach. That means big pharmaceutical companies are investing in innovator biotechs, hoping to get access to the next big technology or product.
But how long can this continue? What will happen if traditional VCs and corporate investors tighten their belts? Today, we'll get both points of view.
To talk about this today, we're joined by Kurt von Emster of venBio. His firm combines traditional limited partners, like pension funds, with strategic investors, like Amgen and Baxter. From the corporate side, we're joined by one of the biggest pharma players, Carole Nuechterlein heads a venture fund run by Roche, the multinational giant based in Switzerland.
Kurt, I like to start with both of you. We're about to see a graphic here that shows the number of companies that were funded in 2012. We had over 345 companies that tapped the venture market last year. By certain measures, that's actually pretty good. What's your take on that?
KURT VON EMSTER: Well, last year was a good year. We were coming off a couple very poor years, relatively speaking. So with the resurgence, and the economic conditions, and the market, I think investors put more risk in their portfolio. And venture firms felt like they could put more into their own portfolios.
We also saw, I'd say, a little bit better deal flow, meaning higher quality companies. So there was a little more quality. And we recently had a couple major funds, two $3 billion funds raised that were healthcare and technology, which, again, added to the amount of capital that could be put into the market recently.
ERIC PIERCE: So the market had some new funds that were raised, which were also, some of which were deployed in 2012?
KURT VON EMSTER: Correct. Because from 2008, there was a real diminishing value in putting new money to work. And therefore, venture funds slowed down their investment pace, waiting for economic conditions to improve.
ERIC PIERCE: And Carole, in the opening package we talked about how the corporate VCs were sort of picking up some of that pace. Talk about what Roche Venture Fund is doing and seeing.
CAROLE NUECHTERLEIN: Sure. Roche Venture Fund, we invest for financial reasons. There's a lot of corporate venture funds that are out there investing. They do it for different reasons. Some of them are more strategically oriented, so they're looking to really fill their pipeline or to have a relationship with a company.
Others of us are more financially oriented. We believe that we bring something that the institutional VCs also bring, but we co-invest together. So for us, when we're investing for financial reasons, we are intending to invest with other funds like Novartis or GSK's fund, which is SR One, and Novo, and we can all invest together. So it's not so, looking for a strategic return, but looking for purely a financial return.
ERIC PIERCE: So really more aligned with the traditional corporate investors like Kurt, in terms of the financial return?
CAROLE NUECHTERLEIN: Yes, exactly.
ERIC PIERCE: Kurt, the institutional venture funds have been a bit distracted. You've been in the market quite some time, even prior to venBio, at MPM prior to that. What's distracting the corporate VCs?
KURT VON EMSTER: The corporate VCs have obviously had -- the corporate VCs being the Amgens of the world and so forth -- but they've had their own problems with patent expiries and so forth. So they've been focusing on their core businesses. There's been a long history of corporate venture in our biotech world.
But of recent times, you've seen Baxter, you've seen Shire and others step into the market in a major corporate investment way. And what they're really trying to do is fund the innovation that their own research pipelines, that their own companies, haven't been able to do as quickly as these small companies. So by reaching out and using their balance sheet as part of the process of engineering returns but engineering strategic opportunities commercially, their capital is almost better suited for funding small innovative companies, rather than continue to feed the R&D beast.
CAROLE NUECHTERLEIN: Let's be honest, with some of these companies, some of the corporate venture funds are looking to fund very novel technologies that are simply too high risk for their corporate parent to fund.
ERIC PIERCE: So in a way, it's a shift of capital allocation. Instead of putting it into R&D and maybe on the P&L of a, like a Roche, they're creating their own venture fund and deploying their capital in that way.
CAROLE NUECHTERLEIN: Yeah, and I think we work a lot with the traditional venture funds. I think we can align very well together, particularly in the series A, because the corporates are less afraid of the series A. They are more thinking the long timelines.
Of course, we all want to be able to get out of an investment in three to five years, but we're not afraid to be in an investment six to seven years. And so oftentimes, there will be two corporates with one traditional and a series A, or sometimes just two or three corporates in a series A.
KURT VON EMSTER: And that's where the traditional venture capitalists have been fleeing. So what's nice is you're seeing that the corporate strategic venture capitalists are moving into series A, while the groups, the financial venture capitalists who need to show returns to their LPs in order to get more money from them for funds three, four, five are moving later and later. So you're seeing a shift towards traditional venture players being later stage, filling in with corporate venture capital on the early, innovative side.
ERIC PIERCE: We've got about 15 seconds, but one of the ideas that I'd like to throw out there is, are corporate VCs really structured to really do that type of due diligence on the earlier stage companies? Carole? I don't think you guys do many early, early stage companies?
CAROLE NUECHTERLEIN: It depends on how you define due diligence, and there's certain aspects of due diligence. And what we're very cautious of is the due diligence that would breach a firewall between our research.
ERIC PIERCE: And we're going to come back with that. And we want to dig into the due diligence side and the differences there when we come back. But first, we want to take a look at last year. The average biotech venture capital round was about $17 million. Here's how those companies compare over the last decade.
NARRATOR: You're watching BioCentury This Week.
ERIC PIERCE: We're talking with the U.S. VC Kurt von Emster of venBio, and Carole Nuechterlein who heads the Roche Venture Fund. Carol, we came out of the prior segment talking about due diligence. Where does Roche feel that they can really assist on the due diligence side?
CAROLE NUECHTERLEIN: So when we do due diligence we look at the whole gambit. We look at the science. The science has to be there, biology has to be there, the management team has to be there. But we also look long-term, because for every product that's going to get approved in the future, it has to be differentiated.
You really need to be in a situation where your product is unique. And we, as a pharma company, we're always thinking in that sort of modality. And I think that's one of the things that we do bring, even to very early stage companies, is thinking about the long-term.
ERIC PIERCE: Are companies getting better about, sort of, understanding that they need to have that commercial relevance early on?
CAROLE NUECHTERLEIN: The ones we invest in are. But we hope so. But still, for an academic, when they come with the target and you sit there and say, OK, but which patients is this going to hit? What's your market share going to look like? It's a different mentality.
ERIC PIERCE: Kurt, what do you see?
KURT VON EMSTER: The venBio model is to incorporate the corporate strategics, which are limited partners, into the process, so that we can say that look, if the capital markets aren't there for an IPO for this company, and it's not going to stay independent, what is the strategic outcome?
So how do we design clinical studies that matter for Carole's company, or for Amgen, or Baxter, or any of these other companies, so that we answer the right questions, rather than what we've done over the last 30 years in venture, which is answering questions that we think will lead to IPOs, or value creation in different ways. But the focus on commercial or strategic value is really what's forcing our industry to be much more capital efficient right now.
ERIC PIERCE: It seems like you really, from an institutional investor, you need to be more plugged in on what pharma may or may want.
KURT VON EMSTER: And that hasn't normally been the typical venture style. Each venture firm has a few contacts within pharma. But when you incorporate them in, you use their capital, you get access to the know-how and knowledge that regulatory commercial groups, to really help you assess what's really valuable. It's one thing to say the science is valuable. It's another thing to say that we can sell this drug and we can sell it for X to this patient population.
ERIC PIERCE: And does it helps to have a Carole or another corporate VC at the table that can bring that sort of balance?
KURT VON EMSTER: We syndicate almost all of our deals. We like working with other corporate strategics, because they've assessed it internally. And if they agree with our assessment, it means that there is a real commercial outcome that's valuable for us.
ERIC PIERCE: So the numbers -- we looked at the numbers -- company fundings are pretty strong right now. But clearly there's companies that are not getting, not attracting capital. What types of companies are having trouble right now? Carole, we'll start with you.
CAROLE NUECHTERLEIN: Well I think, I've always taken the position that the really good companies are still getting funded. The problem some of the companies have is, companies that should have been, or in past years would have been IPO'd and would have had access to the capital markets, they're the ones that are struggling a bit.
Not because there's anything necessarily wrong with them. But because they're having to raise so much money to run a clinical trial. And if you work back from that and try to get to the multiples the VC needs to get, it puts pressure on the valuations. And that's what's really tough for the companies.
KURT VON EMSTER: But I think cardiovascular and metabolic diabetes companies, because where the regulatory agencies, the FDA, has been tough, is not moving those through the regulatory process as smoothly. So the venture community sees that and they stop funding those opportunities, because the cost of capital becomes enormously high.
CAROLE NUECHTERLEIN: But then you look at Marcadia -- for every one of these there always seems to be an exception of a early stage metabolic or cardiovascular company that does get taken out. So it's so hard to make assessments of these companies.
ERIC PIERCE: And in terms of the series A funding -- what we talked a little bit about earlier -- that seems to be still relatively strong in terms of company formation. There were 84 series A companies in 2012, funded 2012, down only slightly from 94 in 2011.
So the early stage companies are finding that investment. They're also raising a lot of money. Some of those rounds, though, although they're billed as series A, are, kind of, expanded rounds. Kurt, why don't you explain a little bit about what's going on there.
KURT VON EMSTER: Well the industry has moved to milestone tranching of capital. So where a series A might be $2 million or $3 million to get the proof-of-concept in an animal model, what the market has gone to is giving them four years of funding in a tranche metric, where everything is laid out as far as all the milestones they have to hit. But it relaxes the management team so that they're allowed to make their milestones and move ahead.
ERIC PIERCE: So really, companies attracting more capital to get further along, so they take out some of the financial risks.
KURT VON EMSTER: Exactly.
ERIC PIERCE: OK, great. Well we'll be back in a little bit. More on that discussion in just a moment.
NARRATOR: BioCentury, named the 2012 Commentator of the Year by the European Meta Science Awards, for excellence in communications, and clear, concise commentary.
NARRATOR: Now, back to BioCentury This Week.
ERIC PIERCE: We're talking about how to keep money flowing into young biotech companies with Kurt Von Emster of Venbio and Carole Nuechterlein of Roche. We left the last segment talking about the amount of capital that's been raised, which is a pretty significant number, $6 billion in venture capital globally. But we also talked about the tranching. How much of that $6 billion is really not raised for this year, but it's going to be in 2013, 2014?
KURT VON EMSTER: Yeah, it's substantial. So what used to be an early seed round and a small amount of capital, like we said, is extended to -- instead of $3 million, it's $25 to $60 million, but that's over a five year period. So the money raised and announced in 2012 or even '13 is really supposed to last over five years.
So it'll be interesting to see what next year's numbers are because a lot of those companies have now been funded for a very long period of time.
ERIC PIERCE: So they may not need to go back to the capitalists?
KURT VON EMSTER: To the well for a long time.
ERIC PIERCE: Yeah, yeah. Carole, what are you seeing from your side?
CAROLE NUECHTERLEIN: We see exactly the same thing. And what we also see is larger syndicates coming. We do a lot of series A. So the syndicates used to be one or two people in the series A.
Now, our recent series A have all been three, four VCs who are all committed, who are all coming in at the same valuation. We're thinking of this as a long-term play.
ERIC PIERCE: Mm-hm. Here's the circle that I have trouble squaring. We talked to a lot of VCs. And everyone's complaining about, oh, it's a challenging market, and there's a lot of people not putting money to work. But then, to Carole's point, there's a lot of people jamming into series As and having really large syndicates at early stage companies. How do we square that?
KURT VON EMSTER: Well, there are a few much larger players. So you have your OrbiMeds, and NEAs, and corporate large dollars into each deal. But there are a few really high quality deals that everybody wants to be in.
So a lot of money chases those deals. And therefore, valuations are strong there. It's really haves and haves not. A lot of things are not getting funded.
And the number of VCs that are out there is declining much rapidly than most people think. I'd say there's 20% less venture firms around than there were a couple years ago. And next year, it's going to be even fewer.
ERIC PIERCE: Would you put the same 20% on the amount of capital raised? Or are those NEAs and OrbiMeds of the world actually getting--?
KURT VON EMSTER: They're taking in much more capital. And again, as we discussed earlier, the corporate strategics are stepping up with a lot more capital as well.
CAROLE NUECHTERLEIN: And what's interesting also is there is a bit of a follow-on mentality among many VCs. One of our portfolio companies that had $50 million raised last year that was led by OrbiMed. And I must've gotten five phone calls within two or three days from other VCs who wanted to participate.
And of course it was closed, and there was no more room left. But it is interesting how once you close, you get a lot of interest.
ERIC PIERCE: So there's sort of a prime mover. We have a group of companies that are hot or considered or fundable. But what's happening to the other companies that maybe don't fit that circle?
KURT VON EMSTER: Well, biotech has always been a very Darwinian business. So a lot of things should fail, and a lot of things should go under. But historically, over the years, 2000 to where we are today, corporate -- or I should say venture -- capitalists felt that they could continue to fund those so they wouldn't have to write them off on their books. And therefore, they could raise more capital from limited partners.
I think reality is just sinking in that one out of every five projects shouldn't be funded and isn't going to work. And we've just got to let those go.
CAROLE NUECHTERLEIN: And there's nothing wrong with that because, as we always say, if you don't have something that fails, you're not taking enough risk.
KURT VON EMSTER: Yeah.
CAROLE NUECHTERLEIN: So the trick is knowing when to shut it down.
ERIC PIERCE: Are companies and managing teams getting better about, say, the drowning of the proverbial puppy in terms of shutting something down when you need to shut down as opposed to just continuing to move forward?
KURT VON EMSTER: Well, there are a lot of companies that, if they shut down after their first failure, we wouldn't have the successes of Amgen's and Centocor/J&J today where they had massive failures in their early programs.
So venture capitalists like to let the companies run into a wall once. It may be a second time. But right now, there's no third chance.
CAROLE NUECHTERLEIN: That's exactly right.
ERIC PIERCE: Yeah. We've got about 40 seconds left. We talked earlier about the number of investors playing in the early space, early stage rounds. Does that mean if you don't get into the early rounds, are we basically like -- are there no more mezzanine investors, later stage investors for VCs? How does that dynamic play out?
KURT VON EMSTER: There's always an opportunity to get in if you want to pay enough. So it becomes a valuation issue. And what they can do is they can not take any more of their existing tranche capital that they have reserved, and they'll take your higher priced capital instead.
CAROLE NUECHTERLEIN: And we've done that. We've done that. We've brought in the new VC at a higher price and released some of our tranche.
KURT VON EMSTER: And we funded Aragon a couple months ago that no one thought was raising capital. We liked the asset. And we just offered a very nice price to them.
ERIC PIERCE: Carole, let's pick up on the topic about companies raising a lot of money early on. It seems like it's giving companies and boards a little bit more of a survival timeline to make decisions. What's your take?
CAROLE NUECHTERLEIN: That's absolutely right. When a company has four years or five years worth of funding, they can focus primarily on executing on what they need to get done. And then, they don't have to be worrying about raising money sometimes in an economy that's difficult to raise money.
I think the other thing is it also gives them a little bit of peace of mind. They can go to the board and say, look, we've had some little signal here in the talks. We'd like to go back and play with this compound for a little bit longer. It's going to delay, potentially, the IND for six months. But we think we'll have a better compound at the end of the day. And in those cases, we've said, go ahead. Do it.
ERIC PIERCE: Kurt, what are you seeing from your chair? You've seen both public as a public investor and also a private investor. So are companies that are coming through this process, are they better developed and have made decisions more based on reality?
KURT VON EMSTER: Sure, because IPO investors are looking for the weakest party. So if your cash is dwindling and your board's forcing the company to go public, you could lower the value expectations throughout the bidding process on the IPO.
So if a venture capitalist is in at $10 and the company is strong, well, the IPO will happen at $15. But if it's weak, you could say, well, I'll give $8. And that might be OK for a venture capitalist because your money is going down the drain as time moves on.
So the opportunistic side of tranching gives a lot of companies capital. It gives boards options. And again, you can always sell the company on your own timeframe.
ERIC PIERCE: And then, how do you deal with the valuation topic? Because prior to this sort of tranching, you get a series A for $5 or $10 million. If you succeeded, you could do a series B at a moderate step-up. How are VCs structuring these? Are there step-ups at all in these rounds?
KURT VON EMSTER: We're incorporating step-ups because we want the management team to know that if they achieve a milestone, their stock is going to be worth X. And that's a natural progression that you would do through a series A, B and C anyhow.
So as long as you lay out the timelines and the prices and the milestones, it really keeps the company chugging, the phones quiet, and investors happy.
ERIC PIERCE: Carole, what's your position on the tranching and the milestones?
CAROLE NUECHTERLEIN: Well, we have done a lot of tranching. We have not seen a lot of the upticks with the tranching. So it makes perfect sense. And I think that's a good idea.
ERIC PIERCE: Could be a model for moving forward.
CAROLE NUECHTERLEIN: Yes, exactly.
ERIC PIERCE: We'll have some final thoughts about the VC climate for 2013 when we return. After the show, read more about the biotech investment landscape in 2013 at biocenturytv.com.
ERIC PIERCE: In our time remaining, let's get some final thoughts about venture capital in 2013 from VCs Kurt von Emster and Carole Nuechterlein. I'd like to raise the general question of corporate VCs have been increasing their activity in biotech, does that, make it, perhaps, handicap the industry for success, the fact that corporate VCs are playing in the space? Carole, I'll start with you.
CAROLE NUECHTERLEIN: Well, I think there's been some studies showed that if you have one corporate VC as an investor, your returns have improved. And if you have two, you even do better. And I think that's for a couple reasons.
One is when you still have a corporate VC that does give an implant of validation to the company, to the technology. And when you have two, it doubles that validation. But it also creates a competitive tension.
So with one, people may still think, well, you're sort of tied to that corporate. When you have two, it's very clear that you're not tied to either one of them. And we've had situations where I know we've done deals where people -- we got a better deal because they thought that the corporates and the company were probably competing. And so I think it does help quite a bit.
ERIC PIERCE: Kurt, do you see that institutional VCs and corporate VCs are going after sort of different companies and for reasons -- for different technological aspects?
KURT VON EMSTER: Well, I'm not so sure. I mean, traditional VCs want to make money. And corporate strategics want to make money.
So we're all looking at the same opportunity sets. So anything innovative is going to really be top of list. Large markets are top of list as well.
But back to what Carole was saying for a second, which is these are small companies. They don't have corporate infrastructure. They don't have clin-reg. They don't have commercial expectations.
So having corporate VCs on board means that you can make that call into the regulatory group of the corporation that has 2,000 people and ask very good questions. And hopefully, they feel like they're partners with their equity and provide you the information that will advance your program faster with less risk. We think that's really important. So we actually view the whole industry as starting to consolidate to become partners, rather than competitors.
ERIC PIERCE: One of the things that I'm sort of picking up on in this discussion is we're sort of searching for the optimal place to really innovate, whether it's biotech, or pharma, or the venture capital picture. What could a pharma company look like 10 years from now if we continue to move down this chain?
CAROLE NUECHTERLEIN: Well, that's an interesting question. A pharma company can look like a -- I personally think that the pharma companies are going to be much more focused on personalized medicine, very specific, targeted therapies. And I think that's really the wave of the future.
And I think, when you're doing that, a lot of that work can be done -- the biology -- pharma companies can be great at biology. But also, that's a thing that biotechs can be very good as well. And so I think you're still going to see pharma companies and biotechs working very closely together, and probably even more closely than they are now.
ERIC PIERCE: Do you think the corporate venture activity is going to continue to increase as we move forward?
CAROLE NUECHTERLEIN: Yes, I think, absolutely.
ERIC PIERCE: Kurt we've got about 30 seconds for a final take.
KURT VON EMSTER: There's no doubt that -- and just if you look at Bernard Munos' study that shows that R&D productivity is the lowest it's ever been. It costs about $3 billion to get a new molecule to the market. For small biotech companies, they can do it a lot cheaper, a lot faster.
I think pharmaceutical companies are going to be distributors. And they're going to use their immense knowledge to help with personalized diagnostics, just like Amgen, buy and decode for information. It's going to be a very different way.
ERIC PIERCE: So lots of M&A. We'll continue to watch --
KURT VON EMSTER: Exactly.
ERIC PIERCE: -- that as it plays out. Thanks to this week's guests. That's our show for this week. Kurt von Emster and Carole Nuechterlein.
For Steve Usdin, I'm Eric Pierce. Thanks for watching.