Gold rush over: what happens to biotech now that venture capital is out of reach?

Biotech VC firms

If you were to look back just a little over two years ago to the start of 2021, then putting money into a biotech company seemed like a pretty safe bet. After all, the COVID-19 pandemic had shined a positive spotlight on the biopharmaceutical industry, and initial public offerings (IPOs) were booming.

But the last two years have seen venture capital and overall funding within the industry dry up due to the economic downturn, which has heavily impacted many biotech companies. 

In fact, financing for biotech companies is down by 48.6% compared to 2021, and in 2022, the IPO market plummeted, with volatility and market uncertainty driving down IPO proceeds by 93%

Furthermore, this year saw the collapse of the Silicon Valley Bank. It sent shockwaves across the biotech industry and added fuel to the fire for many small biotech companies that relied on the bank, which played a large role in financing early-stage life sciences and healthcare companies. 

Venture capital drying up

With economic downturn comes added risk, and, naturally, because of this, venture capital firms have become more selective around which companies, and how many companies, they invest in. 

“An unfavorable and overall bleak economic landscape has made the appetite for dealmaking in biotech and life sciences industries dry up. Meanwhile, venture capital companies are hanging onto their cash to survive and cover operating expenses for their current portfolio companies while riding out the storm,” said Carl Foster, chief business officer at Standigm, an artificial intelligence (AI) drug discovery company.

Foster noted that a drop-off in demand for drugs and treatments for COVID-19 since the pandemic subsided has also acted as a “sharp return-to-baseline” for many industry players.

And, according to Garri Zmudze, co-founder and managing partner of LongeVC, perhaps another reason for the recent downturn in venture capital is that the “hype” cycle surrounding biotech breakthroughs during COVID-19 – like mRNA technology – has now drawn to a natural halt. 

“There was significant ‘hype’ around emerging technologies that promised to transform health. Not all investors who joined the space during its peak had the expertise to evaluate scientific soundness. Early companies often raised significantly overvalued rounds on the pre-clinical level hypothesis alone, without any data to accompany it,” said Zmudze.

He gave gene therapies as an example of another “hype cycle” that investors flocked to before certain failures led to more cautious investments being made. 

“Enthusiastic investment led to overvaluation that didn’t achieve forecasted potential. These failures to deliver value and promised pre-clinical/clinical outcomes caused investors to write off significant portions of invested capital. They either slowed down on the biotech investment altogether or prioritized deep scientific due diligence, leading valuations to drop and requirements for investments to raise,” he said.

Venture capital downturn: overall effect on the biotech industry

“Biotech companies and venture capital firms hesitate to make any major deals, and therefore, the biotech consolidations and acquisitions that are happening are dramatically undervalued from previous highs. There is real scarcity of deals compared to previous years,” said Foster.

Meanwhile, Kristofer Mussar, chief operating officer (COO) of VectorBuilder, said that big pharma is also being forced to significantly cut back its R&D expenditures, which, of course, has a consequential effect on biotech companies.

“These massive R&D budgets are what companies like mine and other small to medium biotechs rely on to grow. If the big players start tightening their belts, this directly trickles down to the rest of the industry reliant on these contracts with the major players. Without promises of major strategic partnerships with the juggernauts in our field have created hesitation among investors,” he explained.

In a time of economic uncertainty, companies need to try and find ways of ensuring their survival, namely by conserving cash and optimizing their financial situation as much as possible. 

Some companies were fortunate enough to raise a lot of money before the crunch. “Often biotech companies oversubscribe their rounds when they can. For example, if the market is positive, it makes sense to raise more and suffer from the additional dilution but ensure a minimum of a two-year runway by doing so. Given that the burn rates are typically high, we are looking at some companies that were fortunate to raise ‘just a bit more’ in the good markets and now have an additional buffer,” said Sergey Jakimov, who is also co-founder and managing partner of LongeVC alongside Zmudze.

This means that these companies that were lucky enough to raise a good amount of money before the economic downturn, now have the opportunity to conserve their money and use it wisely.

For example, according to Jakimov, instead of overspending on multiple clinical programs that run simultaneously, they can simply focus on primary disease indications and not overspend on their R&D.

Some companies are also considering other strategic options, such as selling off lead assets, licensing their lead assets out in various regions, and M&A.

Furthermore, perhaps one of the biggest trends of late is the wave of layoffs within the biotech industry. This is one of the major ways in which companies are attempting to stay afloat during the crunch, with more than 5,000 employees thought to have been laid off from both biotech and pharmaceutical companies this year, according to data published in April from BioPharma Dive.

Is the situation really as bad as it seems?

The situation for biotech funding at the moment may sound pretty dire, but Simeon George, chief executive officer (CEO) and managing partner of venture capital firm SR One thinks that perhaps the situation isn’t quite as bad as it seems, noting that, despite the constraints, the capital is still there. 

“From our perspective, all of the key ingredients are there and will continue to be there. I think what is challenging is that obviously there are some external headwinds – inflation and public markets – but I would argue that there is no better time than right now to be investing in biotech, to be building companies,” he commented. 

As an example, he said that SR One has actually been able to raise a brand new fund of $600 million, so the venture capital firm can invest in early-stage life science innovation startups in the U.S. and the U.K..

Meanwhile, in what might be a positive outcome for the industry, Zmudze and Jakimov pointed out that the “biotech winter” has played a cleansing role, weeding out the industry’s “lemons” and making room for scientifically sound ventures, as venture capital firms are now focusing more on due diligence in order to avoid future mishaps. 

A hopeful future for venture capital

Although there may be some disagreements on just how bad the current downturn situation is regarding venture capital, what is certain is that it will begin to improve at some point in the future, as is the fluctuant nature of the economy. 

But when that will happen is uncertain. The hope is that it will improve within the next year or so, and Zmudze said that activity has already increased within the sector compared to January. 

“In other industries like fintech, slower periods typically last around a year before a significant acquisition or technological advancement changes the narrative. In biotech, one of the major forces restoring investor confidence in the sector will undoubtedly be M&A activity from big pharma and other stakeholders. We are starting to see it happening now – look at Eli Lilly closing multiple deals recently.” 

Meanwhile, the common consensus among experts is that the use of AI within life sciences will be a game-changer, attracting investors once more. This could be especially true after recent developments, in which AI helped to discover a new antibiotic, and the first fully AI-generated drug entered clinical trials in humans. 

And, according to both Zmudze and Jakimov, quality will always shine through in the end: “A startup with the right team, good clinical data, and a robust roadmap will always get funded.”

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