Funds-on-Tap is passé & Drip-Funding is the new reality.

It’s probably been true for IT/ ITES (particularly for e-commerce and social media & app-developers) much longer, but for the drug discovery start-ups hitherto unaccustomed to expecting anything under a mio given their rather pricey research, the writing on the wall is abundantly clear - Funds-on-Tap is a pipe dream & Drip-Funding is the new reality.

Over the past year, more and more VCs have started to unveil & employ their own versions of a ‘return-maximizing, risk-mitigated investment model’ that typically involves multiplying the early-stage portfolio & bringing down the average-size of seed-investment while maintaining the overall seed-stage investment at no greater levels than earlier - A case-in-study being the recent Seed-class of Atlas Ventures & equally demonstrated by Index Ventures developing its proprietary version of MonteCarlo simulation for optimally distributing precious funds across its portfolio of biotechs' with assets across different phases of clinic.

This holds largely true for the increasingly active Pharma CVCs too that not only are mimicking the VCs in increasing their early-asset portfolio, but have taken derisking a notch higher with their joining forces* with other CVCs (competing pharma) in funding rounds, quite apparently compromising on the eventual ownership of the commercial potential &/or IP generated in the bargain.

* OPSONA (Novartis, Roche, Baxter among other VCs) AILERON (Novartis, Roche & Lilly among other VCs); MERUS (Novartis, J&J & Pfizer among other VCs)

While this may sound like life sciences venture funding is slowly turning into a mere statistical exercise (venture-farming…?), a la the stock market, knowing what it takes to separate wheat from the chaff in the complex world of drug discovery, the users of these models will surely need a lot more than a practical knowledge of the probability theory – which even a cursory read of the above posts again will make it very evident. Just may be, a biotech VC can still showcase ‘proprietary deal-flow’ as a core-strength while making a pitch to the LPs.

Now how does this lean-funding scenario impact the development strategy of the start-up? – while a few indicators of change are already out there like the CROs being encouraged (~arm-twisted) to share risk with the biotech while providing services, I believe this'll trigger bigger changes & hopefully nudge the drug-discovery towards an innovation pathway that’s a lot more rational & predictable – but then this is something Drug Baron should talk about.

Deal-Flow : Value-addition :: Silicon-rapids : Organic back-waters

Reacting to the rather weird scenario wherein some VCs are trashing their own brotherhood, Bruce Booth wonders in his latest article if this is an outcome of a Lake Wobegon-like illusion or if it is the Dunning-Kruger effect in action.

In my comment against this post, I offered my own little suggestion for this apparent case self-deprecation (OR is it not) and more....

My comment:

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If I go by what Mahendra Ramsinghani said here on LPs bothering more about deal sourcing capability than value-add by VCs, Khosla’s indictment of ‘95% zero-value add VCs’ shouldn’t really rock the boat more than the supposed shake-up caused by the AngelLists’ & Kickstarters’ of the world – The ‘80% negative-value-add’ rhetoric though is way below the belt & confounding.

Perhaps these intriguing proclamations are a manifestation of nervous energy of the PE biggies that are ‘but-of-course rattled too’ by the progressive warming of the PE globe and thus eager to reaffirm their value-add alternate asset investor status to the larger LP universe.

Can’t help but note again that a lot of the above paradigms, shake-ups, prophesies & reactions are all still relevant mostly to the 'silicon-rapids' (IT et al) and much less to the 'organic-back-waters' (~biotech) – taking a cue from what you said about the CEO, I’d think the loneliest job in the world at present probably is that of a biotech venture capitalist :-)

Isn't re-coding the organizational DNA viable only for smaller set-ups?

Bruce Booth makes some really radical suggestions to altering the way a big-pharma R&D set-up could work, primarily by way of re-coding the organizational DNA - the optimist in me loves the game-changing propositions, but the cynic in me fears a big-pharma is way too big to present itself to re-coding..... 

My comment:

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However long-term, I feel the inversion of periphery into core is something that sounds too Utopian for any block-buster-strapped-big-pharma-headed-by-a-recently-appointed-turnaround-artiste to consider doing - Laying off scientists & shutting down sites, though a lot messier, is much quicker and in corporate speak, efficient!

Having said that, I do believe this inversion is indeed happening in some fashion as the disruptive model of shutting down big-pharma R&D sites does release hell a lot of under-utilized scientific talent that in many cases ends-up getting far more productive by reinventing themselves as 'Out-sourced drug developer' and/ or 'Spin-off Biotech' each class of enterprise working in synergy with the other.

Just as genetically engineering a large mammal vis-a-vis' a single cell organism is a completely different devil, re-coding organizational DNA works only for smaller set-ups and hence the only way innovation has to change in big-pharma is through a disruptive shake-up that allows cloistered talent-islands to drift-apart and reassemble in mutually cohesive clusters.

Finally, it's surprising just how long its taking pharma to make that elusive paradigm shift in its approach to innovation.... here's a link wherein a lot of heated discussion happened way back in 2008 & nothing much is still different as on date.

A start-up messed up at its foundation OUGHT TO be fixed!

The celebrated venture investment guru Peter Thiel postulated a law that says "a start-up messed up at its foundation cannot be fixed" - Bruce Booth attempted a commentary of this law in the context of Biotech ventures through his blog post titled 'Foundings Matter: Thiel’s Law Applied To Biotech' - While Bruce's application of Thiel's law is based on a tacit agreement of the postulation, I believe this can be argued differently, as indicated by some campus talk here...

Below is my comment against the article by Bruce Booth, wherein I agreed and disagreed with the author in two independent contexts....

My comment:
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It bugs me no end just how little the VC & PE literati out there ever attempts to explain all those lurid, smart theories in the context of biotech enterprises instead of solely building case-studies out of super-achieving IT start-ups that brought-in bags of cash to the VCs very early into its life cycle. This peculiar penchant among the authors for avoidance of anything called biotech enterprise I feel is owing to a general investor impatience for acknowledging the veracity of any investment that can’t be cashed out profitably within 3-5 years & thereby not showcased as a text-book case of intelligent investing. While otherwise is a decently thought-provoking & stimulating book, “Venture Capitalists at Work: How VCs identify and build billion dollar successes” by Tarang Shah is one such recent addition to my list of disappointing treatise.

Peter Thiel too probably isn’t greatly different after all, since a lot of the wisdom he’s been postulating is validated only within the narrow context of IT start-ups - Your effort Bruce, at ‘pharmifying’ the ‘Thiel’s law’ is thus a very welcome diversion.

None of the mess-ups you listed right from ‘un-reproducible science’ to ‘inappropriate capitalization’ can be contested as inconsequential in any which way & together these six make a great check-list for the entrepreneur on how not to go wrong initially & for a full-fledged due diligence by the VC either at the initial funding or an informal, abbreviated review prior to subsequent funding rounds. I however am struggling a little bit to accept that the DNA can’t ever be repaired once messed up – isn't disruptive innovation, which inherently amounts to re-coding the DNA of the enterprise /or enterprise's innovation/ business model, an accepted strategy now?

In the June 2013 issue of HBR, Rita Gunther McGrath (Author of “The End of Competitive Advantage”) talks on how the current day enterprise scenario is all about moving away from the conventional ‘Sustainable competitive advantage’ model and instead moving towards “Transient competitive advantage’ – Biotechs' that operate within an ever evolving, dynamic clinical scenario I believe can’t really base their strategy on sustainable competitive advantage & have to necessarily adapt, quickly & efficiently to the transient competitive advantage model & this may necessitate periodic re-coding of the enterprise DNA - What I quote here is what pretty much you and others said earlier regarding the need of emergence of ‘lean-start-ups’.

So instead of trying overtly to ensure all loose ends are tied-up upfront (…including the phantom scenarios!) & showcase a supposedly fine-tuned enterprise DNA to the VCs, the start-up would do good to expand the scope of the business plan to incorporate a well thought through set of situation-appropriate pivots & an alternate disruptive innovation model or two.

My two Rappen*

*on a business trip in Switzerland at the time of posting this article

Confessions of a VC on a Total Write-off

In a very candid entry on his blog, Bruce booth postulates on what could've gone wrong with the once highly promising Dx dream-venture, On-Q-ity - a must read!

http://lifescivc.com/2013/04/on-q-ity-a-cancer-diagnostic-company-r-i-p/

Below's the comment I posted on the above entry;

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Murali Apparaju•2 hours ago

It's always painful to see a promise not living up to the faith of those who believed....

I'm not exactly sure, but what you said about recapitalization sounded like 'despite the value of the combined capital raised by the two merging ventures prior to 2009 was USD 31mio, the merged entity (On-Q-Ity) prior to investment was valued at USD5mio', To me this initial valuation (& disregard of capital) is where the deal started going wrong?? - wasn't this one of the risks flagged in 2009?

While not tranching the investment does look like the most probable reason for the VCs losing out on the return, I'm wondering what promise of return led to the VCs risking a USD 21mio investment upfront into a company wherein a cumulative capital of USD 31mio only resulted in a USD 5mio valuation? - probably there was something prophetic about the then CEO using a term "diagnostic blackhole" back in 2010..... (different context ofcourse..)

PS:

It'd be interesting to understand why the exit-route expectations involved "oncology focused Pharma M&A"?, consdiring Dual Capture OnQChip techonology wasn't really being worked on as a customizable companion diagnostic platform? OR was it?

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What could VCs learn from the recent pharma deals involving biotechs with very early-assets?

My response on the blog post "Preclinical Biotech Structured Deals: Reflections on 2013′s Solid Start" by Bruce Booth - posted on 01/Mar/2013
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The news of structured-deals/ buy-outs of ‘tight/ single-EARLY-asset’ biotechs both pleases & scares me… pleases, as I feel this will trigger a healthy change in the way start-ups choose their programs & scary because I (CRO/ CMO) will now start losing clients/ programs much before the conventional PIIA - read-on…..

While I totally agree with the points you’ve raised & the surmises made, I’d like to add the following;

• This in some fashion is an endorsement of the importance of early venture seeding by the very same stakeholders that typically enable the high value exits for VCs, viz., the mid-sized/ big pharma companies.
• As you say, there seems to be a promise of reward for innovative organizations that know their science – however I’m not sure if there’s any message about preference for a single asset/ tight set of assets, It is rather a niche focus/ platform & this aspect I’d think always mattered to the investors.
• Do I also see some de-risking in the form of going in for companies who’s lead/ pipeline candidates are inherently safer (recombinant proteins; antimicrobials et al) & hence highly likely to breeze through Phase-I
• Interestingly, though the indications are rare/ orphan, the therapies themselves seem to be more maintenance than curative & hence more attractive to the investing company
• This lure of an early alliance/ deal may now encourage the new enterprises to come up with more compelling technologies rather than me-toos… & thus help put drug discovery enterprise model on a correction course
• Is this the emerging new avatar of the CVC? - CVC 2.0? (Perdona, Baron.... :-))

Now, having seen a lot of my clients getting lapped up by mid/ big pharma & their programs either killed, shelved in favour of the larger companies competing pipeline, I would be a little cynical till I see the next instalment is released/ option executed.

Finally I would like to ask if there is a message in here for the VCs? – towards an opportunity, a need to structure the initial funding deals differently so that they could still keep an option to enhance their share whenever such early alliances crop-up eliminating  avenue of series-B funding?

Post Thought:

Quite a coincidence that I was just reading an article in HBR (Mar 2013) titled “How Competition Strengthens Start-ups” by Andrew Burke and Stephanie Hussels of Cranfield University.  The authors postulate that exposure to competition in the early stages of a firm’s life increases its long-term survival prospects – competition in this context including competing against a lean-funding scenario & hence learning to stay creative, efficient & productive – Since for all four companies here the early pressure is almost eliminated of by the reasonable/ comfortable funds received (upfront instalment OR buy-out), I was wondering if that makes these companies less long-term in light of the above study.

Of course I do understand that it’d be foolhardy to apply an academic study arbitrarily to any context, particularly in life sciences, where the author’s themselves have made a provision indirectly through their statement “Of course, early competition has a downside: Some new businesses fail before they have time to build up the immunity we describe” which sure sounds like the business of designing drugs.