Trends, Opportunities, and Drivers in Early-Stage Life Sciences Investing

It’s a great time to be an early-stage life sciences company. Significant funding continues to roll into this sector, driven by legacy venture capital (VC) funds bringing in new dollars, new players that are out-raising their targets, and active corporate venture capital players. Despite trade wars and economic shifts in China and the EU, early-stage investing in life sciences, particularly in the biotechnology and medical devices sectors, remained strong in Q1 2019, improving quarter over quarter with more than $2.8 billion invested into the space. The confluence of funding and an innovation-friendly regulatory environment provide early-stage life sciences companies with ample opportunity to bring their solutions to market. This article explores the factors driving opportunity in this investment space, as well as how investors and companies can position themselves as attractive partners.

Getting Innovation to Market and Subsectors to Watch
Recent actions by the U.S. Congress and leadership at the U.S. Food and Drug Administration (FDA) have demonstrated regulatory support for innovative life sciences solutions. Numerous programs, such as the FDA’s Breakthrough Designation Program for medical devices and the Digital Health Precertification Program, among others, have allowed companies to work more closely with regulators, communicate with them prior to approval submissions, and bring products to market more rapidly, while still maintaining patient safety. These programs, which require fewer data submissions at the outset in exchange for increased post-market study and surveillance obligations, can allow companies with smaller budgets to get their product to market earlier.

Coinciding with the shift in focus from treatment to cure, from status quo to innovation, the first generation of gene cell therapies have arrived, along with a new wave of digital health applications that employ artificial intelligence (AI) and machine learning (ML). New tools, diagnostics, and devices are reshaping the way patients receive treatment across the spectrum of care. These exciting breakthroughs are accelerating discovery and creating a better understanding of the mechanism of action—which, in turn, gives better insight into clinical outcomes, giving investors a more predictable return. Particularly ripe subsectors for investment as indicated by Q1 2019 performance and regulatory attention include:

• AI and ML: From diagnosing tumors to matching patients to clinical trials, the staggering amount of data collected in the life sciences space presents numerous use cases for AI and ML solutions. While implementation challenges remain, a recent FDA white paper on its efforts to develop a framework for regulating AI products, along with two AI-based devices approved by the agency in 2018, are promising for investors and developers alike. Investors and analysts have taken note, with AI in the life sciences space valued at $902.1 million (forecasted 2019-2024).
• Medical Devices: Funding for medical devices saw a 7 percent quarter over quarter increase to $701 million in Q1 2019. The FDA’s Breakthrough Device Program, which has granted 112 Breakthrough Designation Requests as of January 2019, is one example of the supportive regulatory environment and a contributing factor to the funding increases seen in this life sciences subsector.

Transformation-Driven Partnerships: Evaluating and Attracting Targets
Within this dynamic landscape, early-stage life sciences companies and investors are forming mutually profitable partnerships to bring transformative products to market faster and more efficiently. Life sciences companies can take strategic steps to enhance their value as a potential investment target. When evaluating targets, investors often look for the following elements:

• Innovation and unmet need. Novel products, therapies, or approaches that address an unmet need in the market are good candidates for investment.
• The right team. It is often easier to find good technology than good managers, according to some investors. A life sciences company with a well-run team and strong leadership in place makes for a more attractive investment partner. Effective leaders who can clearly articulate the path to commercialization and the cost to do so will attract investment dollars.
• Cross-border application. More than ever, investors are looking for products that can enter multiple markets, including Europe and Asia Pacific, because an expanded geographic approach can increase returns. Devices and other products that have application to China’s burgeoning market are a particularly hot focus for investors.
• Opportunities to add value. Many investors seek out targets that present compelling and quantifiable propositions to drive significant costs out of the healthcare system while improving health outcomes. Investors are not seeking opportunities for marginal savings, but rather transformative “move the needle” innovation.

To set the stage for an effective investment partnership, life sciences companies should reach out early and often to potential investors, well before they are actually looking to raise capital. Attending industry and well-orchestrated partnering events like Life Science Nation’s RESI series can be a good opportunity to connect and develop relationships with a host of potential investors. Investors don’t just invest in a product—they invest in a team—so face-to-face interaction can lay valuable groundwork for a potential partnership. Curating those contacts through counsel, an accountant, and/or banker can reap dividends over time.

In addition to evaluating whether a partnership is a good fit from a leadership and culture perspective, investors will often consider the following questions when evaluating a potential target—being prepared to speak directly and clearly to these points, as well as to specific goals for the partnership, will allow for a much more fruitful conversation with a potential investor.

• What is the regulatory risk? What will it take to get the company through the next regulatory milestones in all relevant jurisdictions? Is it reasonable to expect the device or product to be approved globally at the same time, or will there be regulatory lag? What level of investment will it take to get the product into a clinic and generate the necessary clinical data? Investors today are increasingly conditioning funding on these regulatory milestones.
• What is the reimbursement pathway? With regulatory approval achieved, revenue can only be achieved by executing a reimbursement strategy that addresses coverage, coding, and payment. After satisfying investors on the ability to secure coverage determination and coding, investors will focus on the pricing of a product to assess the sales potential.
• Does the company have a clear inflection point it is trying to reach? If a life sciences company can’t articulate a specific, discrete strategy for how it will use the funding to develop or commercialize the product, investors may pass on the opportunity.
• What is the competitive landscape? How big is the market opportunity in various jurisdictions? This evaluation should take into account not just the general consumer or patient pool, but also specific practicalities, such as the number of patients willing to pay a given price for the product, or the treatment paradigms that come into play. Having a good grasp of these specifics can improve conversations with potential investors, because it reduces the amount of uncertainty they will have to devote time and resources to address.
• What is the exit opportunity? We often counsel our early-stage clients to “begin with the end in mind.” Life sciences investors will want to hear a clearly articulated vision of the exit. Will the company be seeking to access the capital markets in an initial public offering, looking for an exit through an acquisition, or seek to out-license the technology? In the case of an M&A exit or an out-license, companies should identify each of the potential suitors with whom they envision they will one day conduct a deal.

Changing economic and political environments aside, the life sciences market presents exciting opportunities for early-stage life sciences companies and the investors who believe and invest in them. Early-stage firms with defined strategic goals, an innovative product addressing unmet need and a compelling value proposition, effective leadership, and above all, an exit strategy that enables investors to achieve the returns they are seeking, can position themselves to attract the right investors to bring their solutions to market. 

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Byron S. Kalogerou is the founder of the McDermott Will & Emery’s Life Science Industry Group and the senior attorney in the Boston Corporate Practice. He focuses his practice on domestic and cross-border mergers and acquisitions, finance, and joint ventures and alliances. He has substantial on-the-ground experience structuring mergers, acquisitions, divestitures, and joint ventures on six continents. Byron has extensive industry background in the life sciences, industrial, and manufacturing sectors. He also acts as outside general counsel to a number of companies.