Early Investors Remain Bullish On Biotech-- With Reservations

In 1980, biotech was a fledgling industry with only 20 companies and no reported revenue. It has become a $2 billion-a-year industry with 1,000 companies. Now, industry analysts conservatively project revenues to grow to $20 billion a year by the end of the decade, while a report on national biotechnology policy released in February by the President's Council on Competitiveness predicts revenues will shoot to $50 billion by 2000. "The venture capital industry is undergoing very dramatic changes and has very significant pressures on it," says Jim Bochnowski, a general partner in Delphi BioVentures of Menlo Park, Calif., which has $43 million invested in biomedical companies. "Returns on investment in the venture capital industry have been disappointing and, as a consequence, it's become far more difficult to raise money for venture capital partnerships in general. This puts a somewhat less ebullient and optimistic cast on venture capitalists as they look at subsequent financings." The disappointing market also discouraged other general investors who "dabbled" from time to time in biotech ventures, Bochnowski says. As a result, the final year of the boom decade--1989--saw a significant decline in the amount of money being invested in biotech. That drop was cited in a recent article prepared by G. Steven Burrill, national director of manufacturing and high technology industry services in the San Francisco office of international accounting firm Ernst & Young, in a report published by Venture Economics Inc. The article, entitled "Technology Focus Yields to Sound Business Sense," showed that capitalists invested $251 million in 1989, or 7.7 percent of all venture dollars, in biotech firms, a decrease of 20 percent from 1988's record $312 million. The biotech investment stampede of the '80s seemed to be turning. A recent survey on biotech investment entitled What Do Venture Capitalists Think About Biotechnology? attempted to assess the impact of the shrinking investment pool on biotech startups. Coopers & Lybrand, the giant accounting and management consulting firm based in New York, interviewed 88 venture capitalists who had indicated a willingness to invest in biotech, to determine, among other things, if they were following the general trend in the speculative market to move away from early-stage technology investments toward more developed proposals with shorter payback periods. The study found that while other technology investors might now be taking the safer route of later-stage investing, 55 percent of venture capitalists interested in funding biotech startups said they expect to continue funding the very early-stage biotechnology startups--those companies with little or no expense history, products, or revenues. With less capital, fewer may get funded, investors say, but a good proposal will get the same amount of financial support as it might have in the early '80s. Only 25 percent of those surveyed said they would be interested in later-stage proposals that are already receiving product revenues. On the other hand, 2 percent said they are looking for very, very early-stage proposals. "The only thing that might have changed in the past couple of years, in bowing to the trends of the industry," says Lacob, who specializes in biotech investment, "is that we look for more deals where there is revenue earlier on." The "good deals" that investors look for nowadays are those likely to develop and market specific devices or services, they say. The others being funded, at the very least, have moved away from general research programs on core technologies, such as immune response, into the development of more narrowly defined areas aimed at the development, for example, of drugs and diagnostics for specific immune disorders like AIDS, allergies, or diabetes, Lacob says. "It's preferable for a startup to be offering a strong core technology with several end-product potentials," says Matt Plum, a general partner with Copley Venture Partners in Boston, whose investment portfolio is one-third biotech. Promising research areas targeted for investment, venture capitalists say, include cell therapy and cell manipulation to develop therapeutic and diagnostic devices using cell separation technology; complex carbohydrates and glycoconjugates for use as human therapeutics; genetics and genetics testing; nervous system diseases; cardiovascular disorders; and immunological systems (see story on page 8). Although the venture capital industry's major focus is on pharmaceuticals, some investments are also being made in biotechnology research on crops, pesticides, energy alternatives, and environmental cleanup technologies. Since the payback in these areas is uncertain and much less lucrative than from drug development, the financial interest has been conservative, investors say. "I've been amazed at the number of little organizations working on local environmental problems," Lopez says. "If we ever get real money in this country to clean up our environment, which we don't now have, and if biotech solutions turn out to be better than digging up the contaminated dirt and moving it somewhere there could be big wins in this area too, but right now we just don't have the funding." In whatever field of research being pursued in a startup, entrepreneurs say that raw science alone isn't always enough anymore to attract the big money they need to get a business started. Venture capitalists, seasoned by more than a decade of experience in biotech, say they now look for a polished business plan with a solid management team in place. In reality, they still more often see the scientist who shows up with little more than an exciting new theory, they say. The Coopers & Lybrand study found that a third of all of the investors surveyed cited "weak management team" as the primary reason for declining an investment proposal. Of those who had experience in biotech investments, 52 percent said they view weak management as the primary reason for turning down a plan. Other reasons included a longer-than-desired payback period, the lack of focus on a potential market, and unpatentability (see chart on page 23). "We try to look for serious, seasoned management," Sprout's Lopez says. "There are a whole bunch of biotech managers out there on their third or fourth company. Somebody has already paid for their learning curve." Lacob agrees but adds that "in this industry, a strong management team [at the earliest stages] doesn't often exist." "When you tend to invest in a very early stage and in a biotech company, in particular," says Bochnowski, "that very often means all you have to go on is the science." In these cases, Bochnowski says, if the promising company doesn't have the infrastructure, the venture capital operation may supply it itself. This could mean, he says, not only seating someone on the company's board of directors, which usually is the case in startup investments, but also being very active in recruiting the chief executive officer and the rest of the management team, in developing strategy, and in finding additional funding or corporate partners. But investors aren't looking for total control of the operation, they say. "We are typical lead investors," Bochnowski says. "But that does not involve control of the company. If that happens, it's a good way to kill it." Lopez says she sees her role as "more of a caboose than an engine." "If a company starts listening to me about how to run it, I know I've made a mistake. While we share with them our financial expertise, a company has to have leadership that tells you where it plans to go." Lacob says his company has often stepped in to manage a biotech startup when an exciting, yet undeveloped, idea turns up. He himself spent a year as president of Cellpro Inc., which develops therapeutic, diagnostic, and research devices, in Seattle in 1988 and 1989, in its earliest, pre-financing stage. The company was suggested by two scientists who came to him with a concept for separating cells. "I knew from my background that the manipulation and handling of cells was going to be important in the '90s," says Lacob, who had worked in the mid-1980s as marketing director and a project manager at Cetus Corp. in Emeryville, Calif. "This is an unusual situation, with one of us [venture capitalists] being so directly involved," Lacob says. "We do about one of these a year." Entrepreneurs looking for that kind of special attention--and funding--from venture capitalists should learn how to stand out from the thousands of others who submit biotech business plans each year. "Except for those people with absolutely impeccable credentials who may catch our attention," says Bochnowski, "I think they [scientists with a business idea] would be well served to get help developing a sound business plan before approaching a venture capitalist." But Lacob contends it's the people and not the plan that makes or breaks a proposal: "The ideas and technology have to be great, but it comes down to how well known or accomplished a scientist is in a field. We're looking for credibility." He says he reads all of the hundreds of unsolicited biotech business plans his office gets a year, starting first with the executive summary. Then, he says, "I flip back to the people section and read who the players are, and usually I don't get past that. "If I do, I might go back and look at revenue predictions before reading the actual plan itself. It's basically that we're investing in people, and it's important to have other people who I trust think it's a good idea." To that end, Lacob urges would-be entrepreneurs to make contacts with scientists already getting investment money, sell them on their idea, and ask them for a referral to a venture capitalist. "Never just send a plan out willy-nilly," he says. "It almost never gets funded that way."

Early Investors Remain Bullish On Biotech-- With Reservations

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