Genome Mapping, Stem Cell Therapy and Foundering Funding: Biotech Comes of Age

Biotechnology, in some form or another, has existed virtually since the dawn of civilization. Ancient Egyptians made wine and bread through fermentation (the process yielded more than 50 different kinds of baked delicacies) and they healed wounds with raw honey, one of nature’s more powerful antimicrobials. Before the onset of Anno Domini, the Chinese treated boils with moldy soybean curds and Ukrainian peasants armed themselves with moldy cheese to kill bacteria and prevent infection. But it took more than half a millennia for those artisanal skills to become a true science, thanks in part to the 1675 discovery of bacteria, a 1797 experimental smallpox inoculation, Charles Darwin’s renowned theory of evolution, and Gregor Mendel’s revolutionary work in genetics during the mid-1800s.

Despite such breakthroughs, biotechnology remained on the outskirts of conventional science until the genetic engineering of bacteria and the sequencing of deoxyribonucleic acid (DNA) more than 40 years ago. Since then, the milestones—particularly in health—have arrived at warp speed: Genome mapping, recombinant molecules, cloned sheep, gene sequencing, embryonic stem cell therapy, pharmacogenetics and tailor-made drugs all have helped nourish a growing global industry that is expected to exceed $450 billion by 2016. The number of corporate tillers has grown exponentially over that same time, likely buoyed by the 1980 U.S. Supreme Court decision that allowed the patenting of genetically altered life forms. The 2,175 biotechnology companies currently operating in the United States generated $63.7 billion in revenue in 2012 (the latest year for which data is available), nearly an eight-fold increase from the $8 billion such firms earned in 1992 and a 63.3 percent rise from the $39 million they made in 2003. The industry, in fact, has grown by leaps and bounds over the last decade—total U.S. financings (including debt, venture, initial public offerings [IPOs] and follow-ons) practically tripled, going from $8.6 billion in 2002 to $23.2 billion last year; market capitalization (the total value of publicly traded biotech firms) swelled 16 percent to $360.3 billion; workers’ wages grew 13.1 percent, far outpacing the 4.4 percent increase among all other industries; and the number of U.S. Food and Drug Administration approvals has risen to Clinton Administration-era levels.

But the decade also spawned its fair share of challenges, too. The Great Recession drained venture capital from every sector of the global healthcare industry, forcing startups and mid-stage biotechnology firms to forage for financing from angel investors, government sources and non-profit organizations. Funding fell 33 percent to $875 million during the first three months of 2013 as less capital-intensive industries (software, particularly) attracted a greater share of available dollars, according to a PricewaterhouseCoopers LLP/National Venture Capital Association MoneyTree Report based on data from Thomson Reuters. The amount of funding raised during the first quarter tumbled 34 percent from the comparable period in 2012 and represented the slowest three-month period for venture capital fundraising since Q3 2003, the report notes.

“The bubble mentality, where every good idea gets funding, is over,” Elias Zerhouni, research and development chief at French drug giant Sanofi SA, told The Wall Street Journal last spring.

Indeed, the days of free-flowing funding ended long ago, quite possibly for good. After rising precipitously through the early and mid-1990s—capital, ironically, peaked at $1.5 billion in Q4 2007 as the recession began—investments fell back to earth in 2009 and have seesawed ever since, vacillating between lows of $726 million-$843 million and highs of $1.33 billion-$1.46 billion, historical data from MoneyTree Report show.

While the recession certainly contributed to biotech’s current cash crunch, the industry also has been impacted by poor investment returns over the last decade. A meager 1 percent internal rate of return has prompted many limited partners to pare down their venture teams or abandon the sector altogether; since 2011, Frazier Healthcare Ventures, CMEA Capital, New Leaf Venture Partners, and Skyline Ventures all have lost team members, and OVP Venture Partners is operating its last $250 million fund (a message on the company’s website states, “We are not currently accepting business plans.”)

Venture capital (VC) firms still loyal to the sector, however, have had to ditch their traditional investment strategies. Partners that once bankrolled high-risk startup companies with possibly “game-changing” early-stage technology now are backing later-stage innovations with acquisition potential.

Mergers and acquisitions (M&A) have become a key exit strategy in recent years as the IPO market foundered (public offerings of venture-backed biotech companies plummeted 58 percent between 2007 and 2011.) As a result, VCs increasingly are funding biotech companies that develop products for diseases that fall within established portfolio strategies and helping their beneficiaries develop products that eventually will attract potential buyers. Some even are aligning themselves with large biopharmaceutical companies to design critical development-stage studies.

Despite such funding challenges, demand for the innovation produced by biotech firms remains strong. Large life science companies continue to look to startups for promising new technologies that can bolster product pipelines and offer the potential for higher revenue growth. Accordingly, 2012 M&A activity remained on par with the robust levels seen in 2010, and Nasdaq healthcare and biotech stocks significantly outperformed the broader market indexes. As G. Steven Burrill, CEO of global financial services firm Burrill & Co. noted, “We are faced with great challenges, but the biotech industry is forging answers.”