Venture Round: And now the bad news

It’s popular to suggest that the venture capital world is somewhat insulated by the turbulence on the public markets, but let’s get real. That’s not the case.

Last week, we offered a potential "bright side" scenario. The likelihood that boutique investment banks will finally get the sunlight and the attention to grow large enough to support a small, revenue-poor industry like life sciences.

But such a development, while positive, will take a while. Until then, we’re looking at a number of potential negative impacts, many of which we’ll explore in our upcoming magazines.



Fundraising: Three words. Forget about it. If you’re not a top-quartile, blue-chip fund you’re going to have a terrible time trying to raise a new fund.

And those firms that have raised new funds aren’t off the hook. One venture firm with AIG as an limited partner still hasn’t heard whether or not the insurance giant's commitment will be honored.

Even those firms with limited partners not being bailed out by the government could face some problems down the road as they begin to call down portions of the fund. Some LPs may simply say, no, sorry we don’t have the cash—or even the appetite—any longer.

This might lead to fund reductions, similar to what we saw after the technology boom busted. But in this case, GPs won’t be giving capital back for lack of investment opportunities. They’d be doing it because of lack of support from LPs. (In fact, one professorial type told PE Hub that VCs should be nice and give some of their money back. We're not really buying that one.)

Early-stage investing: Big funds probably won’t be doing it. Why should they when they can have their pick of later-stage companies that will be hungry for capital. As for the angels, well, they’ll obviously be a little risk averse given the current situation. But they too will have the option of investing in “later” early-stage companies, the kind of companies that VCs backed until now. We’re not sure if angels can provide enough of the capital those more established start-ups need, but they’ll be given the opportunity to invest.

Mid-stage investing: So you have a product about to start clinical trials, which puts it on track for commercialization in five or six years, maybe, after some serious infusion of cash? Good luck with that.

Late-stage investing: This could be a blood bath. VCs with capital will be obligated to find bargains in this market. At this point, no one is willing to admit this, but we’re expecting some serious hammering on existing investors. To be sure, VCs can’t be too cutthroat since they too have companies that will require outside capital, but if they can get a late-stage company at early-stage prices then they have to do it. And look for more and more PIPEs. (BTW, we ass-U-ME-d incorrectly last week. The Angiotech deal involving Ares and New Leaf Ventures is not dead yet. We're told something may indeed happen.)

Exits: It’s been said that we’ve been through IPO droughts before, and that’s true. But this isn’t just a drought. Somebody blew up the pipeline and poisoned what's left in the reservoir. As for the corporate buyers, yes, pharma and medical device companies SHOULD be buying. But will they? And if they do what sort of prices will they be seeking. Just as venture firms have to answer to LPs, corporates have shareholders who demand value when it’s available.

In fact, VentureWire Lifescience released some sobering statistics today. We’re back to 2003.

Health care companies have created $3.01 billion this year through IPOs and M&As, down from $8 billion at this point in 2007, a 62.2% drop. That's the worst nine-month performance in five years. Through September 2003, life sciences companies had produced $1.33 billion in M&A and IPO liquidity.

It’s worth pointing out that health care accounts for most of the liquidity activity since the entire venture industry generated $4.3 billion from sales and IPOs in the first three quarters of this year. PriceWaterhouseCoopers Money Tree report offers a similarly glum outlook.

Readers of START-UP already know our take on the acquisition of privately held biopharma companies. Colleagues Ellen Licking and Chris Morrison supplied an exhaustive study in the current issue.

So yes, we’re not dead yet. (We're keeping with the Monty Python theme.) But keep an eye out for the cart hauling dead folks. Oh that reminds us, we see one more significant development.

The Rise of Secondary Buyers: We already reported on their rise in our July START-UP. But, whether it's portfolio companies or stakes in general partners that LPs no longer want, secondary buyers likely will have an easy time finding bargains. Firms like Saints Capital will prosper.

Are we missing any?

Orion to Cover Both Sides of the Atlantic

In most venture circles, talk around forming an international strategy generally leads to VCs staging fact-finding missions to China and India. But a great deal of opportunities still lie in the Old World as VCs grapple with how they might do a better job at investing in Europe where the industry is maturing but the capital can sometimes be scarce.

A new firm is in the market to raise a fund that will target this particular problem. Orion Healthcare Equity Partners, founded by Mark Carthy, who has left Oxford Bioscience Partners, and Joël Besse, formerly of Atlas Venture, is seeking a $250 million fund to invest in both sides of the Atlantic, according to people familiar with the effort.

The new firm will maintain offices in London and Boston and expects to bring aboard additional partners later this month or early next. Orion apparently will pursue clinical-stage companies or assets in the U.S. and Europe. It’s unclear whether the firm would attempt relocate assets from one continent to the other, but that seems to be a possibility.

Carthy and Besse certainly have expertise in straddling the Atlantic. While at Oxford, Carthy served on the board of UK-based Solexa Ltd., the genomic sequencing company that would be acquired by Illumina Inc. He also represented Oxford in its investment in another UK company, PowderMed Ltd., which Pfizer would acquire after several Trans-Atlantic transactions.

Meanwhile, Besse managed many of Atlas’ European investments from its London office. He was among the founding investors in publicly traded Actelion Pharmaceuticals Ltd. and Novuspharma S.p.A.

Clearly, Orion will have some homegrown competition (or co-investors depending upon how you want to perceive things). We've been writing about VCs and VC investments in the UK, France, Germany and Spain. But a little more capital certainly wouldn't hurt.

What will be interesting to see how institutional investors view a trans-Atlantic fund. In years past, firms with strategies that covered both sides of the Atlantic had to work hard to sell their plans to limited partners. But times have changed. The investment climate does show some positive signs of life, and the world is a considerably smaller place than it was four or five years ago.

A New VC On The Block. Finally!

News of Third Rock Ventures closing on its new $378 million fund got us thinking. It’s been a long, long time since a new potentially top-tier venture firm has hit the scene.

No offense to firms like Clarus Ventures or New Leaf Ventures. True, both raised their first funds over the past few years and both will try to raise follow on funds over the next few months. (Clarus will go out later this year. New Leaf is out, according to VentureWire LifeScience.)

But neither of those firms presented new stories. Clarus split from MPM Capital. New Leaf Ventures was an off-shoot of Sprout Group. Their teams and strategies were largely the same.

So IN VIVO blog is more than a little excited at the formation of Third Rock for a few reasons. First, the name is cool (kudos to partner Robert Tepper). Second, the strategy is unique and very ambitious. Third, limited partners lined up quickly behind a concept story that is has a fair chance for success given the team but is by no means a slam dunk. A new life sciences venture firm hasn't generated this much buzz since Care Capital in 2000.

It's worth noting that Third Rock’s success comes amid some bad news in the venture industry overall. Venture capital fund-raising, according to VentureOne, is way down. Venture capital firms raised $6.3 billion over the first six months of the year. If that pace continues—and second halves don’t typically exceed first halves—the $13 billion total would be the second or third lowest total in the past 10 years, matching the 2002 tally. Only 2003 stands out as the worst year with $9.9 billion raised. More recently, limited partners over the past two years have committed $25.3 billion and $24.7 billion in 2005 and 2006, respectively. So a $13 billion finish would be an enormous disappointment.

Also, there's been particular bit of bad news for many venture funds--namely, they don't exist any more. Check out this analysis by OVP Venture Partners. It suggests that there are half the VC firms around today than there was in 2000. Not really suprising, but an interesting study.

But the life sciences have largely been immune to this bad news. We haven't had any signficant blow up of venture firms, except the break up that created Clarus and MPM. But no significant firms are dissolving, giving back money or even falling on hard times.

Check out the fund-raising for the past few years. Our industry's top tier firms have done exceptionally well in fund-raising: Alta Partners, Clarus ($500 million), MPM ($550 million), SV Life Sciences ($572 million), Abingworth($587 million) Essex Woodlands Health Ventures ($600 million) and, of course, Domain Associates ($700 million.)

The good times should continue to roll for the industry's blue-chip. Clarus and New Leaf will get their capital. Meanwhile, IN VIVO Blog was told that Frazier Health Care Ventures shouldn't have much trouble securing the $600 million it'll be seeking for its new fund. And can Versant Ventures and Prospect Venture Partners be far behind? Both last raised their funds in 2004, so if they're not out this year expect them to be raising money in 2008 (probably along with Delphi Ventures as well.)

Meanwhile, we're anxious to see what Third Rock Ventures will be able to do.

Third Rock Ready To Roll

Look around the newswires today and you’ll see Third Rock Ventures wrapped up $378 million for its debut venture capital fund. Great news, no doubt, but we have to ask: Can Third Rock Ventures really, as it intends, resurrect early-stage life-science VC?

As we reported back in May (Third Rock exceeded its $300 million target), the Boston-based venture firm started by a team of former Millennium Pharmaceuticals Inc. executives is intent upon performing “true venture capital.” You know, the kind of roll-up-your-sleeves, get-your-hands-dirty, or fill-in-any-other-tired-venture-capital cliché to describe the investing that you don’t see a great deal of any more from life sciences VCs, a number of whom seem quite comfortable putting millions into companies with late-stage clinical products.

The principals at Third Rock Ventures want to operate much further upstream. Their aim is to build “product engine companies” capable of employing a novel technique or technology—be it biological, chemical, intellectual or whatever—to develop multiple products and to target multiple diseases. In short, Third Rock wants to build the next Sepracor, Millennium, Alnylam, GlycoFi, Momenta, you name the big-picture company.

And when we say Third Rock wants to build these companies that’s exactly what they intend to do. The six general partners—including former Millennium CEO Mark Levin—expect to hold key management positions at these start-ups during the first year or so. They’ll negotiate the deals, set up the shop, do the hiring, etc., etc. to assure these companies get off to the right start. “We’ll be the start-up team,” says Kevin Starr, the former chief operating officer and chief financial officer at Millennium. The partners will serve CEOs, heads of science, whatever is necessary “to make sure these companies are built the right way, have the right cultures, hire the right people, and do the right partnerships. We are going to get involved in a hands-on way.”

Starr says Third Rock’s approach is “quite different than what is currently out there” in venture firms, and he’s right. No doubt, a handful of venture firms still start companies from raw research (See our recent visit with Polaris Ventures) but it’s usually just part of their portfolio, a small part. Starr expect 75% percent of Third Rock's portfolio to be “product engines” built by the firm's partners' own hands. The remainder will be less complex therapeutics companies developing new drugs or devices. Starr says Third Rock should invest the fund in 12-15 companies in three to four years.

That means Third Rock is providing considerably more than just the sweat equity of Starr, Levin and fellow partners Nick Leschly, Lou Tartaglia and Robert Tepper (they’ve all played big roles in Millennium and other companies, please go here for their full and impressive backgrounds). The firm will be positioned to invest up to $30 million into a single company, which, if the firm executes as it hopes, should provide significant stakes in these companies.

This capital plays into the second-part of Third Rock’s bid for “old school” venture capital—get bigger returns by creating companies that require less capital. The math is fairly simple. Venture investors pouring $100 million to $150 million into a company better hope to see the company’s value hit $500 million to $700 million at some time or another, or else they’re not going to see a venture-style return.

Third Rock’s answer: Max out venture investments at $50 million; get pharmaceutical companies to step in with the capital and infrastructure necessary to perform late-stage clinical trials. “It doesn’t make lots of sense to build large clinical groups in early-stage companies,” Starr says. “It doesn’t make sense to build large regulatory groups. Those are things that pharma does very well. We are going to do that collaboratively with pharmaceutical companies.”

All this sounds simple yet very, very ambitious even for a team accomplished as this one. It's the rare start-up that can, in its first few deals, demonstrate enough value to a partner to justify a major-dollar deal. On average, biotechs raise about $100 million in equity before they're ready to go public; most of the more significant acquisitions raise well north of $50 million before the buyer bites (e.g., NovaCardia had raised $88 million by the time Merck bought it for $350 million--a way-above-average return). For Third Rock Ventures to pull off its strategy, it will need to do...well... a Millennium: the company that managed, while Levin was CEO, to raise, via breathtakingly expensive discovery deals, more partnering capital per equity dollar than any other biotech, carving up the diagnostic and product rights to its technologies like a netsuke master.

Now you can quibble with what happened to Millennium--none of its pharma discovery deals drove value to its partners (for lots of reasons, not all of them Millennium's fault)--see, among our other commentaries, here and here. And largely because the discovery-partnership market dried up, and its discovery engine itself produced less than required, Millennium ended up developing precisely the kind of infrastructure Third Rock's partners say their portfolio investments will eschew.

But it's a new day. Discovery is back in fashion; so is the concept that biotech can make plenty of money providing high-value early-stage material for Pharma (and that Pharma might just as well ratchet way back on its own internal discovery spending). And Mark Levin is preternaturally capable of seizing, and commercializing, a trend. In any event, the new fund's limiteds have faith: the company reached its hard cap after less two months or so on the capital-raising trail. IN VIVO Blog certainly looks forward to watching and we would not bet against these guys. But we’ll tell you more, lessons learned from the Millennium experience, and what others have to say, in the upcoming issue of START-UP. Feel free to offer a comment.

Third Rock's a Charm

It’s one of the oldest stories out there. Successful management team, a few years removed from running their own successful biopharmaceutical company, decide to get back into the business by raising their own venture fund.

In the past, such an effort might elicit some snickers. But this is likely to be a story with a happy ending. Third Rock Ventures—a venture firm started by four former Millennium Pharmaceutical executives—is out raising $300 million for a first-time venture firm, an effort one institutional investor already has deemed a “hot commodity.”

The team includes former Millennium CEO Mark Levin, who actually is returning to his venture capital roots. Levin was a partner at Mayfield when he started Millennium and left in 1994 to run the company.

Levin joins Robert Tepper, Millennium’s former head of research and development at Millennium, Kevin Starr, Millennium’s former CFO, and Nick Leschly, who had been the project leader for Velcade. (Nick is the third Leschly to become a VC, joining father, Jan of Care Capital, and brother, Mark, who is with Rho Capital.)

No details yet on the strategy, but some expect Third Rock to look at early-stage, product-focused companies. "True venture capital," in the words of one IN VIVO Blog source.