VC Strategies Diverge in the Valley of Death

By Lucy Parkinson, Research Manager, LSN

We’ve talked about the fact that many venture capital firms have withdrawn from investing in early stage biotech startups, contributing to the so-called “Valley of Death.” However, there are still a number of life science VCs that remain active, so what are they doing with their dry powder now and why?

Talking to VCs recently, we found that the bulk of these funds are diverging in two directions. Some VCs are looking for nascent technological breakthroughs that are, generally, still a long way from becoming biotech startup companies. These VCs are building companies around these breakthroughs, gaining access to new scientific works either by maintaining a network of leading academics or by performing initial research entirely in-house.

There are some clear benefits to VCs taking this approach. Firstly, they can acquire assets for very low prices, before any of the classic value-inflection points. Secondly, the VCs can control a company’s direction from start to finish; they can select a management team and make strategic decisions, without a scientist entrepreneur getting in their way.

However, this strategy requires that VCs have a lot of connections and expertise. Scientists must be willing to hand their work over to the VCs, and the VCs must be capable of selecting and developing the most promising of these risky, very early stage assets. These VCs can cherry-pick the most compelling breakthrough ideas and build companies in-house, from the ground up, around these new assets. This then leaves real biotech startups—companies with pipelines and management teams—out in the cold (as far as VC investment goes). As a representative anecdote, an investment partner at a VC firm told us that in the past year, the firm reviewed 982 outside plans and invested in none of them. Another partner at the same firm later told us that it would consider investing in an external biotech startup but only in opportunities that were about three years pre-IND.

Other VCs have abandoned their appetite for technological risk and are instead focused on finding promising late-stage assets that they shepherd towards a rapid exit. These VCs typically look for investments that can be realized (often via a sale to big pharma) in a timeframe of 18 months to 3 years. Some have adopted a virtual pharma model and are focused solely on investing in assets rather than companies, either by in-licensing or simply acquiring late-stage product candidates and then managing the entire development of the asset until the exit point. Others do make equity investments in biotech companies, but some of these investors nevertheless see the company’s existing management as an optional add-on; one partner at a late-stage VC firm told us, “The development team is not necessarily the commercialization team.”

So what’s the takeaway? If you’re a late preclinical or early clinical-stage biotech company with a fully-formed team and a long development path ahead of you, this may actually be good news. More non-traditional investors will likely continue to move into this piece of the market to take advantage of the opportunity left by the VCs. The turbulence in the VC arena is far from over, however, and LSN will continue to monitor the latest trends in the investor space as the sands continue to shift.