‘Flat is the new up’: After biotech correction, venture investors turn to safer bets

Agios Pharmaceuticals needed money. It was 2010 and Agios, like many other biotechnology startups then, was trying to survive following a global recession.

Venture capital was contracting, leaving emerging companies with fewer financing options. Initial public offerings, a main source of funding, weren’t readily available, especially to biotechs like Agios that hadn’t begun working on a drug.

“Public investors back then didn’t invest in private companies,” said David Schenkein, Agios’ longtime CEO and now a general partner at the venture firm GV. “We knew there would be limited sources of capital.”

But in April of that year, Agios struck a unique deal with Celgene, agreeing to part with stock and rights to what would become two approved cancer drugs. In return, it got a $130 million check, which kept the company alive until public markets warmed to biotech in 2013.

“When there are difficult times, you need to focus on what you need to do to bring your science forward,” Schenkein said.

More than a decade later, emerging biotechs face similarly tough decisions. Fears of a recession are rising. A widely followed biotech stock index hit a five-year low in May and, while its value has begun to climb in the last month, remains down by more than a third since last year. There is little demand for biotech IPOs. Private financings, meanwhile, are harder to come by as some investors turn away from biotech.

The result is a realignment, according to half a dozen private biotech investors interviewed by BioPharma Dive. Though venture firms are armed with as much cash as they have had in years, they’ve become selective as they foresee a longer road ahead for the startups they back. Budgets are being closely watched, and companies built more cautiously. Biotechs are being pushed toward the negotiating table earlier, too.

“This is going to separate the great ideas from the bad ideas, the great teams from the bad teams, and the well-run companies from the poorly run companies,” said Stephen Berenson, a managing partner at Flagship Pioneering.

‘Flat is the new up’

The biotech downturn that began last year had two phases: an “appropriate correction” followed by an “overcorrection,” according to Christiana Bardon, co-managing partner of BioImpact Capital and portfolio manager at MPM Capital.

The first phase brought to a close a near-decade long run that birthed hundreds of biotech companies and led many to go public. Biotechs formed, raised money privately and quickly pivoted to IPO at higher and higher values. In 2020 and 2021 — both record years for new biotech offerings — 182 companies raised nearly $30 billion combined, according to data from BioPharma Dive. Nearly two-thirds were in preclinical or early clinical testing at the time of their IPO.

“There was a lack of discipline with regard to valuations,” Bardon said, and “probably excess enthusiasm for the reality of drug development.”

That ended in 2021. Stock prices began to tumble and by year’s end, nearly 90% of newly public biotechs traded below their offering price. The downturn accelerated in 2022 as the impact of Russia’s war in Ukraine hit economies already dealing with rising inflation. Generalist investors, who had helped prop up the biotech sector, looked for safe havens, while IPOs ground to a halt. Dozens of publicly traded companies cut costs to save cash.

“What is happening in 2022 is not related to biotech,” Bardon argued. “We are now overcorrecting due to external factors.”

Though the impact varies, the effects have trickled down to emerging biotechs.

While new companies are still being formed at a similar pace, many are being built in a cost-controlled manner, multiple investors told BioPharma Dive. Venture firms now expect to keep their companies private for longer, as “crossover” backers, which help pull biotechs to the public markets, have retreated. Funds raised now could have lower return rates as a result, some said.

“We used to call large Series B rounds crossover rounds,” said Sean Harper, a founding managing director of Westlake Village BioPartners. “We don’t use that term much anymore.”

Venture financings are trending down as well. While a report last week from SVB found funding totals in the first half were ahead of last year, those numbers were driven by Series A rounds — chiefly a $3 billion raise for anti-aging startup Altos Labs. Funding declined by a third between the first and second quarter.

Cash raised for companies “likely to IPO” — a proxy for investors’ interest in taking biotechs public — fell by half over the first six months of the year, according to the report.

SVB expects the slowdown to continue through next year. Biotechs raising funds in the meantime will likely need to add new investors to their last round or complete “insider financings” to extend their runway, the report said. In the current climate, that often means they’re selling shares at the same or lower value than they did previously, investors said.

“‘Flat is the new up’ is the joke these days,’” Bardon added.

Platform versus product

The types of companies getting venture backing may also be shifting.

Over the last decade, platform companies — drugmakers built around technology that’s meant to support several medicines — attracted significant interest. Perhaps the most well-known is COVID-19 maker Moderna, which raised billions of dollars privately on the promise of a messenger RNA technology before pricing a record $604 million IPO in 2018.

The idea behind a drug platform is to ensure a company’s fate isn’t tied to the success or failure of a single drug. If a medicine that comes from a platform succeeds, the company is instantly worth more than that one drug. If it fails, that company can fall back on another project.

Yet platform companies are expensive and time-consuming to build. Some have sought IPOs before selecting drug candidates, lengthening the time until they could reach the kind of success that boosts shares.

“They were spending too much money,” said Adam Koppel, a managing director at Bain Capital Life Sciences, of platform-based biotechs. “If you don’t create value with a balance sheet in between capital raising efforts, that’s called valueless dilution,” he added, “where you didn’t create any value, but you diluted the key new investors in your last round.”

Koppel and others described a shift among investors away from technology platforms and toward biotechs that are focused more narrowly on specific products.

A recent analysis from biotech consulting and research firm Bay Bridge Bio indicates stock market performance is reversing as well. Among the more than 500 biotechs that went public since 2010, seven of the top 10 underperformers were platform companies, Bay Bridge found.

“The excitement around platforms over the last few years is the exception in biotech, not the rule,” Bay Bridge wrote.

One example of a product-focused biotech getting substantial support came earlier this month, when a group led by Bain put $350 million into Areteia Therapeutics, a biotech that’s testing a once-failed ALS drug as an asthma treatment. The drug works similarly to an approved, injectable biologic and has already been tested in humans. “It derisks things,” Koppel said.

Even Moderna’s founding investor Flagship Pioneering, which is known for building platform biotechs, acknowledges the shift. “The trend is crystal clear,” said Berenson. “It’s another way of expressing a higher degree of risk aversion.”

For investors like Flagship, that means “we need to think about that quite carefully when we’re financing our private companies,” Berenson said. It also means those companies have to lower their expenses, raise more rounds privately and focus on programs that can reach human trials within a few years of a Series A, he said.

“It’s not like there aren’t investors interested and excited by the prospect of getting in on the ground floor of a new product platform,” he said. “Just not as many.”

“Given the increased cost of capital, everyone is thinking much harder about how they build and how quickly they build,” added Jason Rhodes, a partner with Atlas Venture.

Give and take

Biotech startups are often many years away from earning any revenue, so they have to give up something to raise funds. In financing rounds, they trade stock for cash. In partnering talks, they forfeit rights to their drugs.

Take Agios. The Celgene alliance enabled the company to go public, grow and develop three drugs that are now approved. But it limited Agios’s financial upside. More than a decade later, the company still isn’t profitable and recently sold off its cancer drugs to focus on rare diseases. Shares are worth about as much as they were in 2013.

“I don’t believe in the term ‘non-dilutive’ when you’re doing a deal with another pharma partner,” former Agios CEO Schenkein said, “because you’re giving away commercial rights.”

Biotechs can more easily hold on to those rights when equity financing is easy to come by. That’s harder now. Investors note that partnering talks are starting up earlier, as biotechs are more willing to trade economics for cash and engage in deal negotiations. Schenkein and others already report seeing an increase in such activity. “There are a lot of parallels” between the current environment and the 2007 to 2009 recession, he said.

Perhaps in response, M&A is showing signs of heating up. There were 13 biotech buyouts worth at least $50 million between April and June and another four in July, according to BioPharma Dive data. Some of those deals were for companies like Epizyme and Radius Health that were trading at or near all-time lows, suggesting biotechs are willing to accept lower valuations. A majority of the acquisitions were for privately held drugmakers, led by GSK’s $2.1 billion purchase of vaccine developer Affinivax.

Berenson said there’s stronger interest among big drugmakers to discuss collaborations, too, a process that’s becoming competitive as pharmaceutical companies are “inundated” with calls from smaller biotechs “looking for capital. ”Other biotechs have turned to unusual financing deals instead, a trend that some investors believe will continue.

“Given the difficulty of the market,” said MPM’s Bardon, “a lot of companies may say, ‘yeah, let’s just take the bird in hand.’”

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