In the life science space it’s becoming increasingly clear that funds today need to differentiate themselves, be this by creating pure play funds or offering something different. Tom Allchorne looks at what the VCs are up to and whether LPs are really interested.
The last 18 months have seen a whole raft of biotech venture funds come to the market following three years or so in the wilderness. Biotech was big back in the dot.com days, and while obviously not as popular as its high tech and Internet-based cousins, VCs everywhere saw their enthusiasm for biotechnology shared by LPs. According to Thomson Venture Economics, 2001 (in the midst of human genome project fever) saw 12 dedicated funds raised, accumulating over €2bn.
The inevitable drop-off followed, both in terms of money raised and funds closed, but it was a sector never far away from the lips of European VCs as the next big thing, even in the darkest days of the industry. LPs are now beginning to turn their gaze to the sector as money comes flowing back, with Sofinnova the biggest beneficiary in this change of mood.
Sofinnova’s fifth fund, which won EVCJ’s Venture fundraising of the Year award for 2005, saw €385m raised for investing in start-up and early stage life science and information technology companies, primarily in France but also in other European countries. The largest fund since the end of the bubble days, the fund closed after around five months of being launched, and topped its initial target of €350m. Investors in the fund include a government fund from Asia, AlpInvest Partners, BP Pension Fund, CDC Entreprise, CPR PE (Credit Agricole Group), European Investment Fund, HarbourVest Partners LLC, JPMorgan Fleming Asset Management, LGT Capital Partners, Partners Group and The Wellcome Trust.
Index Ventures also scored high in 2005 raising €300m. Like Sofinnova’s vehicle, Index Ventures III’s focus will be split between technology and biotechnology, the diversification an appealing aspect to investors. LPs in this instance include Adams Street Partners, AlpInvest Partners, BP Pension Fund, Horsley Bridge International, all new investors, and HarbourVest Partners, LGT Capital Partners, Partners Group and Schroders.
Ventizz Capital Fund II received €60m in January 2005, five years on from its maiden fund. The strategy for the second alters from its predecessor in that it will explicitly target later stage high tech and biotech companies, rather than the more early stage-driven strategy of Ventizz I. Ventizz at least deserves some marks for honesty here as most VCs are focusing on later stage investments while still giving the impression they cover the whole spectrum of venture capital.
The pressures of fund raising and the consequent need to show LPs returns is what has driven VCs further along the pipeline. With a large number of funds raised in 1999, 2000 and 2001, the fund raising cycle is upon us, yet with so few exit opportunities the firms have struggled to have anything to justify to existing investors to re-invest, let alone attract new ones. The last half decade has been largely spent looking after portfolios, but this doesn’t show up on the accounting side.
“Some VCs,” says Iain Wilcock, head of life sciences and healthcare at Quester, “appear to be foused on generating exits in the shortest timeframes rather than focusing on reaching key value inflection points. Some of these ‘exits’ are not liquidity events. However, given the increase in the average length of early stage technology investments over recent years, VCs are finding it increasingly difficult to continue to support these portfolio companies. These ‘exit’ transactions can modify the risk profile and particularly reduce the funding risk associated with their portfolio.”
One thing which links Index and Sofinnova’s latest funds, apart from their size, is the fact that they are both members of an ever-shrinking breed, that of the generalist fund. This is an approach that is no doubt attractive to investors, seeing as putting all their eggs in one basket in 2000 and 2001 didn’t work out too well for them. But there has been a growing trend in favour of specialisation.
TVM, now TVM Capital, raised €240m last year for its Life Science Ventures VI fund. Down from the preceding fund, which managed to get €336m in 2001, it received investments from over 20 LPs, mainly from Europe, with additional commitments from Asian funds and two US biotech companies. NeoMed Management managed to get €104m for its fourth fund, which closed in December 2005 and is based in Jersey, received its money primarily from Europe with one contribution from Saudi Arabia. Merlin Biosciences raised €141m the year before, while GIMV raised €26m for Biotech Fonds Vlaanderen, a government-backed fund focused on biotech companies in the Flemish region.
TVM used to have a mixed fund approach, the last one being TVM IV, which closed in 2000 on €300m. Sofinnova has no such plans. “It is very important to us”, says Sofinnova’s managing partner and CFO Monique Saulnier of a generalist venture fund. “There are cycles in the market in this business and having a mixed fund is just a way of risk management. We have a better chance of coping with a downturn in one of our sectors.”
Mounir Guen, MVision’s CEO, says it all depends on the particular investor as to their attitude towards a fund’s investment strategy: “LPs can sway either way on dedicated or mixed funds. Sofinnova has a 30-year track record as a venture investor, but with Wellington, the LPs were very supportive behind their decision to split their technology and life science teams into separate funds.”
Wellington decided in the summer of 2004 to split life sciences and technology into two separate funds. Dr Rainer Strohmenger, a general partner at German VC Wellington Partners, says: “There were several reasons behind the move. The first was that we identified there is a market trend towards specialisation. Also, the life science team wanted to have detailed discussions with clinical experts and management teams of potential portfolio companies, and you don’t need software experts in the same meeting, and vice versa. Another reason was that we wanted to give the LPs the choice over how they allocate their funds.”
Strohmenger points to the closing of the technology fund in July 2005 on €150m as proof that the new strategy is a success and welcomed by investors. The fund’s target was €120m and the amount finally reached was actually the hard-cap. A life sciences fund is currently being raised, and expects to close by the end of the summer on €100m.
An adviser close to the market thinks the time of the mixed fund is coming to an end. “The cycles are so different between life sciences and technology that it makes the timing virtually impossible. Also the healthcare sector in Europe is far more clustered than technology. It is easy to build a team and target tech companies in the US because the companies are clustered. In Europe, they are all over the place, there are tonnes of little shops. Germany has over 100 software companies alone. It’s not like this in European biotech.”
BioMedinvestor is currently still investing from its 2003 fund, BioMedinvest, a €64m fund. While it is a dedicated fund, it does have quite a broad investment remit, covering not only biotech but also healthcare and medical technology. Dr Gerhard Ries, co-founder and managing partner of BioMedinvest, believes LPs are increasingly opting to invest with these types of vehicles: “Investors are more and more professional, by which I mean they are now sophisticated enough to invest in dedicated funds, and I think the direction the market is going in will see more dedicated funds emerge and become more popular.”
The issue of diversification is particularly pertinent for VCs looking to fund raise in an environment where most LPs have difficulty looking beyond buyout funds. Hanns-Peter Wiese, partner at Global Life Science Ventures (GLSV), says: “There is a growing concern among LPs about pouring billions and billions into buyouts, which is not what people believe is the best mix when it comes to asset allocation.” One issue, which he takes exception to, is the lack of distinction made by investors when it comes to looking at the industry. “LPs put things into certain categories and don’t distinguish between venture capital and private equity. I was reading a magazine article where they compared private equity to other asset classes such as the public markets and hedge funds. There was no distinction between buyouts or venture capital, or early stage and late stage, or between US venture and European venture. It’s just all classed as private equity. It shows the market is not very sophisticated on the investor side to some extent.”
This is touching on a separate debate as to whether private equity, as in buyouts etc, is in fact a separate asset class to venture capital, but Wiese admits the situation can look quite opaque to investors, especially when you throw dedicated biotech funds and mixed funds into the mix. For its part, GLSV is preparing to raise a new fund, following on from its 2002 GLSV II. The new fund is expected to launch shortly, and will be aiming for between €150m to €200m. The second fund was raised in a particularly tough climate, immediately following the bursting of the bubble, but still managed to raise €143m, more than double the size of its predecessor. The fund was unable to get any backing from US investors though, which is something Wiese hopes will change when the firm hits the road with its latest offering.
Abingworth has thrown a new vehicle into the mix with the launch of its €44m BioEquities Fund (ABE), the first of its seven life science funds targeting quoted companies. Dr Joe Anderson, the Abingworth partner charged with heading the fund, said: “Many development stage companies in life sciences have outstanding growth potential but their shares are often mispriced due to increasing stock market volatility, diminishing coverage of earlier stage companies by equity analysts and the pressure on public mutual funds to satisfy short-term oriented performance benchmarks.”
“ABE has been structured to approach these stocks with a venture mindset and allow for a longer-term investment view. Demand for new medicines is increasing steadily as populations age and pharmaceutical companies seek to fill their product pipelines. Abingworth is well placed to find those public life science companies with the potential to perform strongly against this background.”
This need to differentiate, and Abingworth is not the only example of a VC offering something unique, is in direct response to a criticism levelled at European venture by investors. LPs obviously still have a whole raft of reservations about investing in European venture capital, be it biotech or not. Europe is still struggling to compete with the US on the return track record, although Europe outperformed US biotech on the IPO front in 2005. One particular problem Mounir Guen identified was the lack of VCs operating in Europe. “Investors want to see a large group of very high quality VCs but in Europe it’s quite concentrated. There aren’t enough good quality VCs, around and so a lot of them work together on many of the same deals. The LPs see this and so don’t see any point in investing in more than one or two of them.”
One adviser says it is becoming harder and harder to differentiate between funds. He says: “Increasingly you have a realisation that these funds have to have more than just money. There is a feeling that many funds are too large and are chasing the same deals and so are pushing the deals into valuation ball-parks that are unsustainable.”
He has particular praise for Abingworth: “They have really taken on the message than it is about more than just cash.” In September last year the firm hired David Pinniger, an analyst from Morgan Stanley, to advise on new and existing investment opportunities. In April 2004 they appointed a head hunter in the shape of Sarah Shackelton to seek out the best managers for Abingworth’s portfolio companies. Two months prior to this they hired a funding and re-financing expert Michelle Doig who, for among others, had worked for JPMorgan and Morgan Stanley. “They also hired a bunch of ex-investment bankers,” he says, “to help portfolio companies when they IPO. This has been a problem with a lot of VCs in that they don’t know how to IPO properly, and often send out information memorandum which either tell the investors more than they need to know, often giving away competitive information to rivals, or not enough.”
There are plenty of stats out there to paint a pretty picture for European biotech. Five of the world’s largest pharma companies are headquartered in Europe. There are more patented drugs here than in the US, roughly the same number of researchers and publications, even more private biotech companies (1,500 compared to the US’s 1,200).
“We have much less money in
the market in Europe,” says Strohmenger, “about one third of the amount in the US. We have a much lower number of active VCs. This is all reflected in the lower pre-money valuations that we have to pay in Europe. Over the last five years the median pre-money value of a biotech company in the US was 2.5 to 3x higher than in Europe.”
Strohmenger says in 2000 the average European company was not as advanced, in terms of product development, as its average US counterpart. Today, it is the European ones that have the edge, “so you pay less for more advanced companies,” he argues.
In terms of exits, the Europeans also have the advantage he says: “A trade buyer does not care if the company is located in Basel or Boston. They are interested in the products and the data. If you look at the public markets, there were 17 biotech IPOs in the US last year, there were 22 in Europe. The US ones raised US$800m, Europeans raised US$900m. At the moment the US companies’ share price is, on average, 10% lower than its IPO price. In Europe it is 14% higher. This means the European market is even more liquid than in the US.”
Whether the LPs are convinced is another matter. The amount of money raised last year would suggest there is some degree of interest among investors for the biotech sector. However, the success, or more importantly the size of Index and Sofinnova’s funds, should be viewed in the context that both are brand names with a long track record, both are mixed funds, and both, because of their size, are forced further down the series chain to the later letters. Also, Index is more focused on technology than life sciences.
MVision’s Guen says: “There is a cautious appetite among LPs. There aren’t that many who have an active programme for venture investing and those that do already have a relationship with the VCs. Most of the European investors are predominantly buyouts focused. There are some, but venture is not being give top priority by most LPs.”
Quester’s Wilcox is of a similar persuasion: “Not surprisingly, some generalist LPs say that making a healthy return from life sciences, or indeed more generally early stage technology in Europe, isn’t possible. Fortunately there are some more experienced LPs who understand the cycles and the profile of investing and these are the type of investors tha life science VCs will already have in their fund or be seeking to attract into future funds.”
The make-up of LPs has changed recently too. One estimate reckons about one-third of LPs investing in new funds are existing investors. The Middle East is beginning to release some money, one example being the Saudi Arabian investor in NeoMed’s latest fund. There is also increasing interest from pharma companies, with TVM’s last offering receiving commitments from pharmaceutical services giant Quintiles Transnational, and US biotech companies Genzyme and Biogen Idec.
If the traditional sources of funds are forthcoming, the gap may well be filled by more organisations like these. While there is obviously a degree of conflict of interest, it hasn’t bothered anyone so far, and the vast majority of VCs are in no position to turn down money. The forthcoming 12 to 18 months will see even more money being raised in the field of life sciences, and if the appetite among old school investors is cautious at best, expect to see more unusual names cropping up on fund closing press releases.