By Alistair Blair
The Biotech industry, involving the use of living systems to make products, has become an investment safe-haven during the last 18 months. This is namely due to its record innovation, given advancements in technology, and the handling of the COVID-19 crisis. The industry’s investment opportunities can offer astronomical short-term returns; however, given the primarily loss-making nature of these companies, the potential for losses is certainly a point of consideration. Another key caveat in devoting funding to this industry is the nature of how success is determined: data. Scientific and clinical trial data are the rate limiting factors that determine the success of investor endeavors – this can be a risky factor to play with given the stringent procedures that therapeutics must undergo before going to market.
When considering biotech, is it clear that there are very few industries that have successfully emerged from the storm that is the COVID-19 crisis, but this sector is one of the anomalies. With the S&P500 as a benchmark, the average share price of US and European biotech companies has increased two-fold, and Chinese biotech performed more than six times better than the benchmark. Specifically, VC focused biotech activity grew by 45% in the year to 2021, totaling at $36.6 billion.
(Image from: Biotech is riding a wave of growth in funding. What’s next? | McKinsey)
Logistically, the pandemic brought no hinderance to the development of VC-backed biotech deals. Jonathon Norris, managing director of the Silicon Valley Bank, explains that “most early-stage deals back a known serial entrepreneur or management team.” Therefore, the nature of online dealings has not been a setback for these deals. In addition, deal sizes have increased significantly over the past year with median early-stage rounds collecting 36% more in funding compared to the previous year.
Emerging from the last 18 months, there in uncertainty as to why we have seen an increasing shift towards VC-backed biotech activity, leaving investors with varied standpoints on this topic. Since the pandemic hit, some investors think that the industry has matured, making it a more attractive venture even at a small market capitalization stage. VC-backed biotech firms are filing for IPOs earlier in the drug development process, which gives them access to large volumes of capital available in the equities market from both institutional and retail investors.
A second explanation for this shift is that some investors believe this sector has suffered from underinvestment in the past. The emerging importance of vaccine development and drug discovery have purely opened our eyes to the investment opportunities that the sector can present. In any case, another subset of investors note that the acceleration in VC activity in the sector is partly driven by the need to diversify VC portfolios. VC analysts will be looking to learn from their mistakes of the last 18 months and target industries that are more resilient to the types of shocks that impact growth stocks.
It also should be considered if this acceleration in VC-backed biotech activity is sustainable. Looking at the science alone indicates that this boom could be sustained well into the future; with the advances in biological science, spanning both our theoretical understanding and developments in artificial intelligence, the sector is set to achieve unprecedented levels of innovation.
Coupled with a growing understanding and appreciation for life sciences due to the COVID-19 crisis, the very nature of the biotech sector is set to aid in the continued growth of this VC-backed biotech boom. Data is the driver behind the progress and value of biotech ventures, contrary to normal company growth metrics. Therefore, when typical business models are impacted by changes to consumer demand and swings in unemployment, the biotech sector by-passes the conventional aches that firms experience during economic hardship. Further, there are myriad of unmet patient needs with the potential to have meaningful impact on human lives. This suggests that this biotech boom has the potential to accelerate further once the COVID-19 pandemic becomes a distant memory.
That is not to say, however, that VC-backed interest in this sector is riding purely off the back of COVID-19. A major theme for this boom in biotech has been the current global landscape that has shed light on the importance of drug development and how the bounds of innovation can be achieved with focus on a common goal. As such, funding has not only been poured into biotech firms looking to solve the coronavirus crisis: the sector has seen unprecedented funding thrown at firms developing therapeutics for Alzheimer’s, cancer and other rare illnesses. Therefore, upon closer examination it appears that this boom in VC-backed biotech is being driven by a handful of auspicious factors.
We can also potentially attribute this increase in funding to a changing M&A landscape in accordance with evolving financial strategies involving specially purposed acquisition companies (SPACs). A potential driver behind this sustained growth is the dependence on M&A activity from large-cap pharmaceutical companies that have a constant need to update and diversify their medicinal portfolios. Since the 2000s, large-cap pharmaceutical companies have moved away from astronomical R&D budgets to using small-cap firms as outsourced generators of innovative drug pipelines – in 2020, 64% of late-stage therapeutics in development followed this trend. Therefore, VCs are playing an increasingly significant role in providing the necessary funding to kick-start the drug development process, acting as catalysts in the first step towards mass drug rollout.
Despite the complexities that come with the outlook for VC-backed biotech firms, particularly the uncertainties that come with data-driven quantification of success, it seems clear that the COVID-19 pandemic was not the be-all and end-all for the sector. In a world that values social freedoms, we now turn to science to ensure that the events of the past 18 months will not be easily repeated. Are VC backed biotech firms a potential starting point?
The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.