After biotech sector pullback, venture capital turns to safer bets: 'flat is up'

In 2010, Agios Pharmaceuticals urgently needed funding. Like many biotech startups at the time, Agios was struggling to survive in the aftermath of the global economic recession.

At that time, venture capital was contracting, and emerging companies had few financing options. Initial public offerings (IPOs), a primary source of funding, were not going well, especially for biotech companies like Agios that had not yet begun drug development.

"Public market investors at that time wouldn't invest in private companies," recalled David Schenkein, Agios's long-time CEO and now a general partner at venture firm GV. "We knew funding sources would be limited."

But in April of that year, Agios struck a unique deal with Celgene, agreeing to give up some equity and rights related to what later became two approved cancer drugs. In return, Agios received $130 million in funding, which allowed it to keep operating until the public markets reopened to biotech in 2013.

"In difficult times, you need to focus on how to advance your science," Schenkein said.

More than a decade later, emerging biotech companies face similar tough choices. Concerns about an economic downturn are intensifying. A widely watched biotech stock index hit a five-year low in May, and although it has recovered somewhat over the past month, it is still down more than a third since last year. Demand for biotech IPOs is scarce. Meanwhile, private fundraising has become more difficult as some investors steer clear of the biotech sector.

According to six biotech private investors interviewed by BioPharma Dive, the result is a readjustment. Although venture firms hold as much cash as in previous years, they have become more selective due to anticipating a long road ahead for the startups they back. Budgets are being closely monitored, and company structures are more cautious. Biotech companies are also being pushed to the negotiating table earlier.

"This will separate great ideas from bad ones, great teams from bad ones, and well-managed companies from poorly managed ones," said Stephen Berenson, managing partner at Flagship Pioneering.

'Flat is the new up'

The biotech downturn that began last year can be divided into two phases: first a "proper correction," then an "overcorrection," according to Christiana Bardon, co-managing partner of BioImpact Capital and portfolio manager at MPM Capital.

The first phase ended nearly a decade of boom that spawned hundreds of biotech companies and drove many public. Biotech companies were founded, privately funded, and then quickly moved to IPOs at increasingly higher valuations. According to BioPharma Dive data, in 2020 and 2021—both record years for new biotech issuance—182 companies collectively raised nearly $30 billion. Nearly two-thirds of them were in preclinical or early clinical testing at the time of their IPOs.

"There was a lack of discipline in valuations," Bardon said, and "possibly too much enthusiasm about the realities of drug development."

That situation ended in 2021. Stock prices began to plummet, and by year-end, nearly 90% of newly listed biotech companies were trading below their offering prices. In 2022, the downturn accelerated as the effects of Russia's war in Ukraine hit economies already facing rising inflation. The retail investors who had supported the biotech sector fled to safe-haven assets, and IPOs stalled. Dozens of public companies cut costs to conserve cash.

"What happened in 2022 had nothing to do with biotech," Bardon argued. "We are now overcorrecting due to external factors."

Although the impacts vary, the effects have reached emerging biotech companies.

Multiple investors told BioPharma Dive that while the rate of new company formation is roughly the same, many companies are being built with cost control in mind. Venture firms now expect to keep their portfolio companies private longer, as the "crossover" investors that helped drive biotech companies public have retreated. Some say that funds raised now may therefore yield lower returns.

"We used to call large Series B rounds crossover rounds," said Sean Harper, founding managing director of Westlake Village BioPartners. "We don't use that term as much now."

Venture financing is also trending downward. Although a report last week from Silicon Valley Bank (SVB) found that total funding in the first half of the year exceeded the same period last year, those numbers were driven mainly by Series A rounds—primarily the massive $3 billion raise by anti-aging startup Altos Labs. Funding fell by a third in the second quarter quarter-over-quarter.

According to the report, cash raised for companies "potentially heading to IPO" halved in the first six months of this year, seen as an indicator of investor interest in taking biotech companies public.

SVB expects this slowdown to continue into next year. Biotech companies that raise funds during this period may need to bring in new investors in their next round or complete "inside rounds" to extend their cash runway, the report said. In the current environment, investors say, this often means selling shares at the same or lower prices than before.

"'Flat is the new up' is the joke these days," Bardon added.

Platforms vs. products

The types of companies receiving venture backing may also be shifting.

Over the past decade, platform companies—drugmakers built around technologies designed to support multiple medicines—attracted significant attention. The most notable is perhaps COVID-19 vaccine maker Moderna, which privately raised billions on the promise of messenger RNA technology before pricing a record $604 million IPO in 2018.

The idea behind drug platforms is to ensure a company's fate does not depend on the success or failure of a single drug. If a drug from the platform succeeds, the company's value will immediately exceed that of the drug itself. If it fails, the company can rely on another program.

However, platform companies are expensive and time-consuming to build. Some sought IPOs before selecting a lead candidate, extending the time it takes to reach the kind of success that boosts stock prices.

"They spent too much money," said Adam Koppel, managing director of Bain Capital Life Sciences, referring to platform-based biotech companies. "If you haven't used your balance sheet to create value between financings, call it value-dilutive," he added. "That is, you haven't created any value, yet you've diluted your lead new investors from the previous round."

Koppel and others describe a shift among investors from technology platforms toward biotech companies more focused on specific products.

A recent analysis by biotech consulting and research firm Bay Bridge Bio suggests the stock market performance is also reversing. Bay Bridge found that among more than 500 biotech companies that have gone public since 2010, 7 of the 10 worst performers were platform companies.

"The excitement around platforms over the past few years was an exception in biotech, not the norm," Bay Bridge wrote.

An example of a product-focused biotech receiving strong backing occurred earlier this month, when a group led by Bain invested $350 million in Areteia Therapeutics, a biotech testing a previously failed amyotrophic lateral sclerosis (ALS) drug as a treatment for asthma. The drug's mechanism of action is similar to an approved injectable biologic, and it has already been tested in humans. "That reduces risk," Koppel said.

Even Flagship Pioneering, Moderna's founding investor and known for building platform biotechs, acknowledges the shift. "The trend is very clear," Berenson said. "It's another way of expressing a higher degree of risk aversion."

For investors like Flagship, this means "we need to think about this very carefully when financing private companies," Berenson said. It also means these companies must lower expenses, do more rounds of private financing, and focus on programs that can enter human trials within a few years of a Series A round, he said.

"It's not that there are no investors interested and excited about participating in the underlying investment in new product platforms," he said. "Just fewer."

"Given the increased cost of capital, everyone is thinking harder about how to build and at what pace," added Jason Rhodes, partner at Atlas Venture.

Trade-offs

Biotech startups are typically years away from generating any revenue, so they must give something up to raise funds. In financing rounds, they trade equity for cash. In partnership negotiations, they give up rights to drugs.

Take Agios, for example. The alliance with Celgene allowed the company to go public, grow, and develop three now-approved drugs. But it limited Agios's financial upside. More than a decade later, the company is still not profitable and recently sold its cancer drugs to focus on rare diseases. Its stock price is roughly where it was in 2013.

"I don't believe in the word 'non-dilutive' when you do a deal with another pharma partner," said Schenkein, the former Agios CEO, "because you're giving up commercial rights."

When equity financing was easily available, biotech companies could more easily retain those rights. Now it's harder. Investors note that partnership discussions are starting earlier as biotech companies become more willing to trade economic interests for cash and engage in deal negotiations. Schenkein and others have reported an increase in such activity. "There are many similarities between the current environment and the 2007-2009 recession," he said.

Perhaps in response, M&A activity is showing signs of heating up. According to BioPharma Dive data, there were 13 biotech acquisitions of at least $50 million between April and June, with 4 more in July. Some of these deals involved companies like Epizyme and Radius Health, whose stocks were at or near all-time lows, indicating biotech companies are willing to accept lower valuations. Most acquisitions targeted private drugmakers, with the largest being GSK's $2.1 billion acquisition of vaccine developer Affinivax.

Berenson said large drugmakers are also more interested in discussing partnerships, and the process is becoming competitive as pharmaceutical companies are "flooded" with calls from smaller biotechs seeking "capital." Other biotechs have turned to unusual financing deals, a trend some investors believe will continue.

"Given the difficulty of the market," said MPM's Bardon, "a lot of companies might say, 'Yeah, we might as well take the opportunity in front of us.'"