Starting Up: What's Attractive To Biotech Investors?

Industry observers maintain that capital is available for companies that have the right formula for success With almost-daily headlines chronicling funding and scientific setbacks to the biotechnology industry, the challenges for scientist- entrepreneurs contemplating making a go of their idea seem daunting, even insurmountable. Yet biotech analysts, officials, researchers, and other observers insist that, despite the depressed financial climate in the industry and investor wariness, capital should be available in 1995 for startups with the right formula for success. At the core of this mixture, they say, are sound ideas with high product potential, backed by a solid business plan and a management team that combines scientific savvy with entrepreneurial skills. "The outlook for startups is surprisingly positive_the terms may be difficult when actually making a deal, but there's a lot more [start-up activity] going on than you would think," maintains Kenneth B. Lee, the national director of the life sciences industry services division of Ernst and Young, a management-consulting firm headquartered in San Francisco. Lee was one of the coauthors of "Biotech '95: Reform, Restructure, Renewal," the ninth annual report surveying the industry, released last September (F. Hoke, The Scientist, Oct. 31, 1994, page 1). In addition, they say, the biotech startups that yet attract venture capital and investment support from larger companies are distinguished by their novel research and ability to fill a void in the market. "Although many venture capitalists say that they are less interested in 'typical' biotech companies, there are still as many startups as there ever were," asserts Lee. Not everyone agrees with Lee's analysis of the state of the industry, especially the prospects for start-up firms. "I do not think that there are as many [start-up] companies as there were before," contends Rajiv Datar, a biochemical engineer and entrepreneur in Plainsboro N.J. He incorporated his firm, 3i Systems Inc., in 1993, but has found investment hard to come by. "If the outlook is as positive as they [Ernst and Young] claim, why would the industry be in need of 'reform' and 'restructuring,' as they state in the report's title? "This time last year, the average biotechnology company had enough funds to sustain them through a three-year cycle_now their supplies are down to two years," he notes. "Biotech took an incredible readjustment in the last two years_and a lot of companies are not going to make it," predicts Mike Egan, a partner in the venture capital firm of Sanderling Ventures in Menlo Park, Calif. "A lot of money went into the biotechnology industry in the late '80s and early '90s. [Now] there is less money to go around, which lowers the valuation on deals." "Venture capitalists are less willing to fund startups these days," says Richard Beleson, a biotechnology investment executive with Capital Research Co. in San Francisco. "In terms of financing, the major sources for new companies are the large pharmaceutical firms and more established biotech firms like Genentech [Inc. in South San Francisco, Calif.] and Chiron Corp. [of Emeryville, Calif.]." On a more optimistic note, however, he adds that "this is the golden age of molecular biology_science has never been better." Ernst and Young maintains that the numbers show a more hospitable climate for biotech startups than is readily apparent. "The biotech market is cyclical, following a two- to three-year pattern since the 1980s," contends Keith Brownlie, regional director for the life sciences industry services division of Ernst and Young in Princeton, N.J. "When companies go public, the venture capitalists cash out and therefore have more money for new projects." In fact, he adds, "The biotechnology industry raised more capital for startups last year 1993-94 than ever before." Mike Egan recounts that during the past year Sanderling was presented with some 200 business plans and portfolios for start-up companies. The venture capital firm provided financial backing for initiating just three of these ideas. So, what attracts the venture capitalist today? With the deluge of scientists with an idea for a "magic fix" to one medical problem or another, who are the lucky few who manage to convince potential investors of the value of their particular innovation or approach? The importance of the right people_with an appropriate mix of scientific, managerial, and entrepreneurial experience_to the success of a start-up venture is underscored by everyone involved. "Scientists are not necessarily businessmen," declares Ned Israel-sen, a patent attorney specializing in the biotech arena and a partner in the San Diego-based law firm of Knobbe, Martens, Olson, and Bear. "It helps [a startup] to have a person with good management abilities and reasonable expectations with respect to time and returns." "Good [investable] ideas entail more than a discovery in a lab," agrees Egan. San Diego-based Desmos Inc., one of the few startups to procure funding from Sanderling, is an example of the importance of this symbiosis of science and management. The company was founded in 1993, based on a discovery made by two scientists Vito Quaranta, an associate member of the department of cell biology at the Scripps Research Institute, La Jolla, Calif.; and Jonathan C.R. Jones, an associate professor of cell and molecular biology at Northwestern University working on the pheno- menon of cellular adherence in epithelial cells and the relationship of this attachment to cell shape and function. As a result of their collaboration, the scientists were able to find the protein that acts as the "glue" between epithelial cells and underlying tissue and to identify a cultured cell line that acts as a "factory" for a soluble form of this glue. "This protein called desmosin had the ability to attach epithelial cells to several different surfaces, where the cells could grow and maintain their original characteristics," Quaranta explains (M. Langhofer et al., Journal of Cell Science, 105:753-64, 1993). Since epithelial cells grown by conventional tissue culture techniques quickly lose their original properties, desmosin's property of sustaining cells with their original forms and functions spawned ideas for many possible applications and really began their entry into the biotech market, he adds. "Suddenly, this was no longer basic research; we had ideas for applications that were best pursued by forming a company," recounts Quaranta. In 1992, he enlisted the support of Raymond Kahn, who had recently retired from Scripps, where he had served in various scientific administration and technology- transfer capacities for more 10 years. Kahn was immediately attracted by the potential uses of desmosin and teamed up with the two scientists. Early in 1993, the three men hired an attorney to file for a patent on their discovery and by April were incorporated as Desmos Inc., with Kahn as president. "We then prepared a business plan, which we began presenting to various venture capitalists in January 1994," recalls Kahn, who originally trained as an anatomist. Soon thereafter, Desmos obtained financial backing from Sanderling, as well as the venture capital firm of Burr, Egan, Deleage, and Co. of San Francisco, and they were in business. One of the firm's partners, Jean Deleage, now serves as the chairman of the board at Desmos. Kahn attributes a portion of Desmos' success in attracting two major sources of funding to the fact that "there were not too many people looking to apply substances like desmosin_a soluble form of extracellular matrix in the area of tissue engineering and regeneration. We created a new niche in the biotechnology market." Indeed, the significance of novelty_and creating niches_is em- phasized by participants throughout the industry and by officials of the large drug firms that, in many cases, come to serve as the outlets for the products of biotechnology. For instance, says Mary Graves, di-rector of biotechnology at Hoffmann-La Roche Inc. in Nutley, N.J., the company is always surveying the biotechnology market for products to fill the gaps in its own pipeline or to enhance its current research. Analysts and others stress that a start-up idea that fulfills such a need would be the most likely one to attract investors. As is the case in the larger drug companies, ideas for "me- too" products are not viable, they say. "Two very difficult areas to finance right now are the diagnostics business and anything having to do with HIV," Isra offers as an example of this trend. "Most diagnostics are based on monoclonal antibody technologies_no longer considered as revolutionary as in the past_which yield very low profits. In the case of HIV, the whole field is very highly competitive, with very few promising results." However, "an investable idea would be a new human therapeutic," he says. "Potential cures for heart disease, high blood pressure, glaucoma, cancer, and diabetes are good candidates." "Areas that would interest investors include new technologies based on gene sequencing, gene therapy, and combinatorial chemistry_using mathematical means to predict the structures of drugs," observes Ernst and Young analyst Lee. "The anti- infectives area and ideas involving prostate cancer also have good prospects for getting seed money." A case in point is IntraBiotics Pharmaceuticals Inc., a new firm in Menlo Park, Calif., which last month announced its success in raising $4 million in venture-capital funds. The company will be developing anti-infective compounds_products for the prevention or treatment of various infections. The company's focus, according to president and chief executive officer Kenneth Kelley, will be on using substances produced by humans and other mammals to develop a new class of drugs against pathogens that have developed resistance against the currently used drugs. "I first got the idea for starting the company based on insights that a market opportunity would emerge in the area of drug-resistant bacteria," says Kelley, who has a background in molecular biology. The resultant company was named IntraBiotics for its projected product line_a new class of antimicrobial agents derived from protective substances produced by, for example, cells lining the gut and lung. Unlike the antibody and cell-mediated responses of the immune system, which are specifically mounted against each new patho-gen, these innate substances act to prevent various infections. Since they are a new source of antimicrobials with a mechanism of action as yet not fully understood but probably different from conventional antibiotics, Kelley anticipates that they would be free of the problems of microbial resistance. Incorporated last January, the firm was able to raise an initial $250,000 as seed money, with which Kelley bought rights to and licensed "intrabiotic" technologies from researchers at various universities. He then put together a three-man "SWAT team" and developed a business plan that appealed to a group of investors, led by the Sprout Group in Menlo Park. Kelley maintains that the idea attracted the necessary money because it "offered an elegant technical solution for an unmet medical need." In addition, he says, "we had an extremely capital-efficient business plan." Kelley, who has worked as a management consultant and venture capitalist in biotechnology, attributes this success to his prior experience and resulting contacts with investors "who were knowledgeable in the field" of biotech.

Starting Up: What's Attractive To Biotech Investors?

Interested in reading more?

Become a Member of