Pathfinders Podcast | Investment Banking

When to Call it Quits: VCs Making Tough Decisions in a Tough Market

RBC’s Noël Brown, Head of US Biotechnology Investment Banking, recently held an Endpoints roundtable with Jerel Davis, Managing Director at Versant Ventures, Otello Stampacchia, Founder & Managing Director at Omega Funds, and Simeon George, CEO & Managing Partner at SR One to discuss the hallmarks of portfolio companies that will succeed or fail in today’s challenging markets, and when it makes sense to ‘call it’ or divest.

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Key Points

  • Structural issues in the public markets have led to shift in the biotech funding ecosystem and companies are increasingly looking beyond traditional IPO routes.
  • Winning biotechs will have management teams that are able to deploy capital and resources to drive value-creating research towards capital efficient, validated, clinical outcomes.
  • A notable shift in VC investing from company creation to later-stage investments raises concerns regarding the availability of capital for earlier stage, high science pre-clinical companies.
  • In this constrained funding landscape, VCs offer guidance on grants, early-stage collaborations, and partnerships when early stage biotechs are not yet quite ready for public market investment.

Challenging conditions within the funding ecosystem are creating new dynamics for biotech firms and investors. In today’s world, it’s not uncommon for VCs to have distressed biotech companies in their portfolios.

No-one is immune to the impact of a shift from a period of abundant cash and easy public offerings to a more challenging financing environment that has seen a dramatic reduction in IPOs, constrained access to capital, and stricter investment criteria, as Otello Stampacchia, Founder of Omega Funds explains.

“Looking at today's public markets, I think we’re seeing a shift back to the type of clinical stage companies with relatively near-term milestones that attracted public investors five or six years ago,” says Stampacchia. “Those type of companies are still seeing successful public offerings and demand from public investors. But public markets are very reflexive to shorter-term macro trends. Private markets operate on a different timeline, with longer investment horizons. Most venture capital funds have a lifespan of 10 years or more, allowing them to deploy capital over a longer period.”

“Historically, this longer-term approach has made the capital invested in private markets relatively more stable,” continues Stampacchia. “But the biotech sector has also experienced an influx of capital from ‘tourist’ investors who did not have that longer-term lens on the industry. That led to a number of immature companies going public too early. The eco-system has to be blamed for having good companies that were too early-stage for the public markets becoming distressed because they had no news flow for public investors who were distracted by market volatility.”

A private capital renaissance

While the public biotech markets remain volatile, VCs continue to raise new funds. Are we witnessing a renaissance in the private capital markets? "It's important to note that both public and private investors are adopting a more cautious approach in today’s climate," says Jerel Davis, Managing Director of Versant Ventures, “but it’s true that there is more capital available within funds than ever before.”

“Additionally, the pending loss of exclusivity in the pharmaceutical industry is already driving mergers and acquisitions, and creating a tremendous appetite for innovation from pharma companies. We also have a thriving eco-system of small to mid-sized biotech firms, all offering a multitude of opportunities. I do think this era could mark a renaissance for the private markets, where we surpass past ideas and achievements.”

Despite major innovations and untapped potential, large parts of the biotech industry are trading today at discounted levels. What will happen to the most distressed firms? “The stark reality is that we now live in a different world of higher interest rates, ranging closer to 6% compared to near-zero rates of just two years ago,” says Simeon George, CEO and Managing Partner of SR One. “That has changed the landscape for entrepreneurs, start-ups, and venture firms. It necessitates a reassessment of business models and how we approach accessing capital and managing costs.”

“Management teams must operate within their means, without relying on unrealistic investor expectations for a pot of gold. Understanding available capital and maximizing its potential is critical for success. Regardless of background, business acumen is essential for running a company.” George continues.

“Unfortunately, this aspect has been taken for granted. As venture capitalists, we also have a responsibility to assess management teams' capabilities in executing their scientific and operational strategies. We need to redefine our role in scaling businesses, going beyond our previous approaches. Disengaged investors impede productive problem-solving – we all need to prioritize financial discipline and active involvement to navigate the company's challenges effectively.”

Separating winners from losers

So what are the hallmarks of companies that will and won’t make it? “Three fundamental questions will determine the companies that will prevail,” says Davis. “One, is the company fundamentally a valuable business with an eye towards competition? Two, is the management team able to deploy capital and resources against the most value creating elements of that company? Three, do the capital needs of the plan align with its financeability?”

“That’s what has changed so radically,” continues Davis. “When equity markets pull back as firmly and quickly as they have, it puts that question of financeability in disarray for many companies. We’re already seeing what happens as a result. We’re seeing more and more dissolutions, reverse mergers and combinations every day.”

Fresh from the pipeline

Science doesn’t stop because there is a down market, but funding is clearly going to be harder to get this year for many biotechs. What therapeutic areas and modalities should investors be most interested in right now?

“In the past five years, there has been a notable shift in the therapeutic areas driving value,” says Davis. “Obesity, cardiovascular health, and incretin mimetics have emerged as highly valuable and promising areas. Additionally, we've witnessed advancements in CNS and Alzheimer's disease treatments, as well as immunology.”

“However, precision oncology and immuno-oncology have faced challenges in achieving similar success. Investors have redirected their focus away from oncology in both public and private markets, favoring other sectors where pharmaceutical companies are reaping the rewards. A glance at the market cap leaderboard highlights the remarkable changes in the landscape.”

Venture capital meets venture creation

One other aspect of the venture financing world has been a considerable amount of new company creation. Will the funding for new biotech company formation still be there in the current climate? “In recent years, we have witnessed a significant rise in VC firms venturing into company creation, even those that traditionally did not engage in it,” says Davis.

“However, the trend is now shifting towards a return to later-stage investments, reflecting a broader trend in the private markets. This raises an important question regarding the support for preclinical platform companies. It is crucial to identify which entities will back these companies at the early stage. While some firms may exit the space, many will persist but with revised strategies. It becomes necessary to understand the evolving focus of early-stage company creation firms. The primary concern lies in the availability of capital for high-science early-stage preclinical companies. Rather than an excess of company creation by VC firms, the potential scarcity of capital in this area is a greater concern."

New challenges facing biotech start-ups

How can biotech start-ups that are still in the early stages of development attract investment when investors are primarily interested in companies with more mature assets and clinical data?

“We work hard to provide clear explanations when start-ups are not yet ready for investment,” explains Stampacchia, “and to also outline the milestones they need to achieve. It's challenging because we encounter passionate entrepreneurs, founders, scientists, and academics who require our resources to progress. While there isn't always a simple solution, we can offer guidance on grants, early-stage collaborations, and partnerships.”

“As capital allocators, we have a fiduciary duty to our investors, which is crucial for the success of our fund,” continues Stampacchia. “But building relationships within the ecosystem is also critically important, as long-term connections often yield the most rewarding opportunities. It's important to choose your battles wisely, seek mentors, and remember that we may be there for each other in the future, even if the timing for investment isn't right at the moment.

A new funding landscape

“Fundamentally, we need to support the entire ecosystem, from start to finish,” concludes George. “We require skilled early-stage company creators who excel in this role. We need venture capital investors who can effectively navigate institutional rounds. We also depend on later-stage investors to facilitate public offerings. Currently, we're witnessing some disorder in the ecosystem due to the prevailing market backdrop. But that end-to-end capability is essential, whether within a single firm or across multiple organizations.”

View audio transcript

Featured Guests:

Otello Stampaccia

Otello Stampaccia
Managing Director, Omega Funds

Jerel Davis

Jerel Davis
Managing Director, Versant Ventures

Simeon George

Simeon George
CEO and Managing Partner, SR One

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