Coming of Age
The biotech industry in Germany and Europe can now claim a history of more than two decades. Looking back at the life cycle of this industry, we can certainly identify some shifts and milestones that triggered major change.
In the early days of investment in biotechnology and life sciences – at least in Germany – federal programmes were set up to support acadaemia with promising biotech projects. To facilitate the development of an ‘entrepreneurial spirit’ within these circles, the role of investors, especially venture capital investors, focused on building well-functioning companies around the idea of an entrepreneur. The necessary capital and network of expertise was provided, and syndicates of investors financed within several rounds to finally IPO the company at one of the relevant stock exchanges. The IPO usually was a form of exit and financed the commercialization of at least one product candidate. Risk mitigation was handled on company level; they were to build a broad, multi-stage product pipeline that ensured the development and growth on a long-term scale.
Venture capitalists had to get disruptive
The year 2008 was a memorable year for the global economy at large and inevitably for the biotech industry and all players in the industry – namely venture capital providers. However, the meltdown of the financial markets in late 2008, although it had its well-known implications on all of us, was not the start of a phase of rethinking the finance model in the industry. That started even earlier. The “pharmaceutical ecosystem” was already transforming. Emerging markets were gaining significance, while the established pharmaceutical markets of Western Europe and the U.S. grew more slowly. The pharmaceutical business underwent major reconstruction and demanded higher capital efficiency. Undoubtedly, the biotech sector also experienced major pressure from private and public capital markets, and the sector was not rewarded for the years of work that management teams and their investors had put into the development of broad pipelines. Therefore, IPOs, if they happened at all, were valued often only slightly above the last private financing round and became financing transactions rather than being an exit. Less money from private and public investors was flowing into the sector. The biotech industry – and above all the venture capital firms – needed to develop new models to finance early-stage development assets. Their limited partners were not willing to accept the overall risks connected to drug development any longer and wanted to see higher capital efficiency, as well as decreased holding periods. TVM Capital Life Science and others started to think about new models of financing life sciences innovation, finding ways of managing drug development in a significantly more cost-effective development setup and governing the necessary development steps in a very different setting. This idea was fuelled by a growing perception on the part of the big pharmaceutical players that their in-house capacity for innovation was not increasing fast enough to fill a widening gap in their products pipelines related to an upcoming patent cliff which significantly would affect overall sales.
The investment case in biotech as of today
Global health care expenditures are projected to reach US$8.7tn by 2020, from US$7tn in 2015. Growth is driven by improving treatments in key therapeutic areas coupled with rising labour costs and an increased life expectancy. North America, Western Europe, China, and Japan continue to be the largest healthcare markets. As populations age, healthcare will take an ever-larger share of GDP. Urgent unmet medical needs, the need of pharma and big biotech to diversify pipelines through acquiring external innovation, and the promise for high rewards generated by successful drug development projects have the potential to generate good return for all stakeholders: investors, founders, industry, and patients.
Although pharma companies continue to deal with the repercussions of patent expiries and payers’ cost control efforts, the growing acceptance of innovative drugs that are either first-in- class or best-in-class, offering clear clinical benefits, are expected to drive sales growth for the next several years. Sales are expected to grow at an average of 4.4% annually to total projected US$1.2tn in 2020. Sales from the top 10 pharmaceutical companies account for ~35% of the global pharma market today. Scientific progress, general increased levels of education, and a more empowered patient population are driving changes in healthcare towards a more personalized experience that demands meaningful health outcomes as the core metric. However, despite the anticipation for steady and long-term growth, the industry faces several inherited challenges.
R&D spending grew from US$0.5bn per new drug approval in the mid-1990s to up to US$2.5bn today (this includes the cost of the pipeline products that failed). National reimbursement and insurance policies are increasingly incentivizing the prescription of less costly generic drugs after patent expiration. Pharma is also aiming at a rather narrow set of indications driven by blockbuster economics (>US$1bn in annual revenues). This is in stark contrast with the actual industry average for pharma products of US$522m five years post launch. Within the next five years, until 2022, current annual sales of approximately US$160bn will be at risk due to patent expirations. The industry will face mounting price pressure driven by governments seeking to control healthcare costs.
A new mode of action to successfully finance innovation in biotech
of action of investing in early-stage drug development – as well as later-stage platform and medical technology companies – was installed to handle the above-mentioned requirements and challenges. The company invests in early-stage drug development projects and chaperons them to Proof-of-Concept (PoC) with a team of serial entrepreneurs and advisors and external providers for full-service R&D, specializing in lean development to PoC. This approach ensures reduced timelines and cost while providing big pharma quality for the produced clinical data. We offer our early-stage investees a majority stake outlining a clear path to exit. The management teams, founders, or originators of such projects will benefit from a reliable in-going and out-going equity participation as the capital required to exit is committed upfront and does not depend on future financing rounds with unpredictable dilutive effects. Ensuring exit at reach of PoC requires a highly skilled investment team with expert knowledge of the pharmaceutical industry‘s future demands. Also, the mitigation of investment risks in this setting is happening within the respective fund, not within the investee company as was the case in the early days of biotech investing. This shift required a new thinking and a new skillset in the investment team; the firm also built up an experienced operational team that can meet the challenges and is very deeply integrated into the global pharmaceutical industry. Now, after a couple of years, the investment firm prides itself on the smooth transition into this new mode of action. The company's recent exit of AurKa Pharma to Eli Lilly is a rewarding proof of the investment rationale.
However, it is important to say that this mode of action is not applicable to companies developing a platform technology, or companies offering innovation within the segments of medical technology or e-health. TVM Capital Life Science continues to invest in promising companies in these segments but will apply a later-stage, minority investment approach in these cases. Again, from the experience of the company‘s current investment activities, it is felt that this two-pronged investment strategy currently is the path of success for a life sciences dedicated venture capital firm like TVM – the emphasis being on ‘currently.’