Private Equity vs. Venture Capital: Two Very Different Approaches to Investing in the Life Science Sector

7 Jan

By Danielle Silva, Director of Research, Life Science Nation

Venture capital (VC) and private equity (PE) investments in the life science space differ greatly from the typical private equity and venture capital model in other sectors. Typically, venture capital groups will be earlier stage investors – investors who will consider smaller or even pre-revenue firms – that require a small amount of capital ($750,000-$20 million) in order to get their companies up and running, as well as scale their business. Venture capital funds also tend to focus on firms that have little to no debt.

Private equity groups that invest in areas outside of the life sciences space, on the other hand, usually invest in firms that have a greater amount of debt on their balance sheets, and companies that are more mature and have predictable revenue streams. Typically, private equity groups (PEGs) will make equity investments starting at $2 million to $100 million, and larger groups can write checks that are in the hundreds of millions.

It is also worth noting that VC funds typically invest in a greater number of firms because their typical equity investment is smaller, versus private equity funds, which invest in a smaller number of firms, but write larger checks. VC funds also invest in a larger number of firms for diversification reasons, while private equity groups typically have fewer portfolio companies because they are investing in firms based on their financial statements, which presumably makes an investment less risky.

Recently, venture capital funds have faced a number of challenges; due to lackluster performance, many limited partners (LPs) have pulled their investments from underperforming funds, causing many venture capital groups to collapse. Thus the number of VCs that are operating in the life sciences sector has significantly declined. Accordingly, the percentage of funding the life sciences space has received as a whole from these investors has decreased over the past several years. Additionally, many VC funds have drastically changed their investment strategy in the space. [1]

All this has caused VC funds to have a more risk-averse approach to investing in life sciences firms, generally moving to later stage investing. This in part is due to the firms desiring a shorter-term investment period. And because later-stage investments are more appealing acquisition targets for big pharmaceutical companies, many are also now focusing on drugs that have lower FDA standards in terms of efficacy and safety, such as orphan drugs. Thus, VC funds in the life sciences space are now devising exit strategies prior to the firm even making the initial investment in a company.

Private equity funds take a very different approach in the life sciences space. Some of these funds are now investing in biotech firms as early as the pre-clinical phase of development in order to fill the gap for many life science firms funding needs. One way in which funds have started to invest in life sciences firms earlier is through a process called project financing, in which the private equity group will purchase the rights to one or more lead candidates early on in the development process, and finance the life sciences firm through the end of phase II clinical trials. If the firm has positive data in the clinical II testing, the investor will then have the right to repurchase the candidates. Thus, private equity has adopted more of a growth approach to investing in the life sciences space as of late.

Some private equity funds in the life sciences space are still looking for firms that are generating revenue so that they can eventually sell the firm to larger strategic partners. This is especially true for firms that are investing in CRO’s and medical device companies, as private equity funds will typically acquire these companies when they have around 2-4 products on the market, scale their businesses, and subsequently sell them to the larger strategic partners in the space.

Although venture capital is sometimes categorized as a subsector of the private equity space, these two types of investors could not be more different in terms of their approach to life science investments. Venture capital funds have been forced to become more risk-averse and focused on exit strategy in order to survive as life science investors, while private equity groups are becoming increasingly focused on scaling up these firms, and accordingly, are filling a portion of the void in funding for earlier stage firms.


[1] Hamilton, Michael D. Trends in Mid-Stage Biotech Financing. Hanover, NH:     Dartmouth, Winter 2011.


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