Editor's Note: Even if you don’t agree that U.S. tech firms are overvalued, you can’t argue that billion-dollar valuations are increasingly common. This article is part of a series examining signs of a bubble.
These companies all operate in the biotech industry, which for decades has been second only to the mainstream technology sector in terms of attracting investment dollars. Whereas technology has a lot of signs pointing toward investor overreach and a potential bubble, including overhyped valuations and high-flying stocks, the same can't be said of biotech.
True, investments in biotech are increasing to pre-recession levels. But the nature of the industry, with its extremely long and costly research and development cycles, acts as an anchor to keep the industry more grounded. At the same time, venture capital firms, which act as the early investors in such companies, are relying increasingly on access to public markets to tap larger pools of finance to ensure their companies' expensive research, development, and marketing bear fruit.
"The reopening of the public markets has had a dramatic impact on the ability to fund innovation and keep these companies moving along," says David Mott, general partner of New Enterprise Assoicates, of Menlo Park, California.
NEA, with about $13 billion of assets under management, is one of the biggest investors in biotech in the U.S. It typically allocates 30 percent to 40 percent of its funds to such companies each year since 2000, says Mott.
In technology, dozens of venture capital companies compete for investment in hot, promising startups, driving up valuations. But the same cannot be said of biotech. A much smaller number of companies, including Delphi Ventures of Palo Alto, Third Rock Ventures of Boston, and Pappas Ventures of Durham, North Carolina, compete in biotech--but they also collaborate with each other to bring innovations to market.
"Our business is much more capital-intensive, and there really are only a handful of firms that have the scale of capital to do drug development," Mott says. "It's a small club and we all need each other."
About $3 billion in 236 biotech deals was transacted for the first half of 2014, according to the National Venture Capital Association. That's quite a bit smaller than the $10 billion for 877 software deals over the same time period, but if the pace continues for the remainder of the year, biotech firms could pull in about $1 billion more than they did in 2013. That would put things back to the pre-Recession levels of 2007, when biotech firms pulled in about $6 billion for 543 deals.
It can often take a decade or more, and billions of dollars for research, development, and marketing, for a biotech firm to successfully bring its products to market. So it's increasingly important for such firms to be able to access public markets for the extra financing, venture capitalists says.
While that window closed pretty firmly during the financial crisis, it now appears to be open. Biotech companies have led the pack for new IPOs in 2014, with 51 occuring so far, according to IPO fund manager Renaissance Capital. That's 10 more than in technology. Proceeds from the biotech offerings do tend to be smaller: They yielded $3.3 billion so far this year, half of what tech pulled in, and less than a third of financial company offerings. Still, that's more than biotech offerings have yielded for the last 15 years, says Greg Leffert, a research analyst for Renaissance.
Venture capital firms aren't alone in their interest in biotech companies; they've got competition from Big Pharma. Some of the small companies working on Ebola cures are now owned by large pharmaceutical companies. Last year, for example, GlaxoSmithKlein purchased the Swiss-based Ebola vaccine developer Okairos for $335 million. Now GSK is collaborating with the National Institute of Health to further develop the company's product.
The reason for such an alignment is not all that different from the rise in the number of corporate venture funds in recent years, reported on by Inc. last week. Specifically, the pharmaceutical industry is highly subject to the "patent cliff" phenomenon, says NEA's Mott. Big companies spend billions of dollars to research, develop, and market medicines under brand names; once those become generic, they lose huge amounts of revenue. So it's often cheaper for them to acquire, or partner with VCs to fund, smaller companies already doing research on promising drugs and treatments.
One other thing to bear in mind--pharmaceutical companies and VCs alike are typically most interested in acquiring or funding companies whose treatments are for chronic diseases that afflict millions of people, such as cancer or diabetes. Virulent as Ebola is, the outbreak so far has affected about 2,000 people. In that regard, it's not that different from other sporadic outbreaks of illnesses like the flu and Severe Acute Respiratory Syndrome (SARS), when responses tend to be more limited.
Of course, it remains to be seen how limited the Ebola outbreak remains. And even if this one becomes more contained, VCs and big pharmaceutical companies are becoming increasingly interested in more specialized biotech treatments.
"Over the last few years, given the difficulty of financing later-stage trials, the VC sector and entrepreneurial sector have moved to try to invest in what we call rare disesases," says Art Pappas, founder and managing partner of Pappas Ventures, which is dedicated to life sciences investment. "The small patient populations and targeted use of the drugs allows small companies to take the products into the clinic."