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Biotechnology startups struggle as venture capitalists seek quick hits

When biotechnology companies and venture capitalists meet these days, they talk about the changing landscape of financing. Early-stage innovative companies are struggling to get venture capital, despite the seeming end of the economic downturn.

At the recent BayBio 2011 biotechnology conference in Burlingame, venture capitalists painted a somewhat grim picture of the future and called for new approaches to funding, including corporate partnerships and reaching out to Big Pharma.

“These are not cyclical changes,” said Jonathan MacQuitty, partner at Abingworth Management, a venture capital company. “We're never going to do business the way we used to do,” he said.

Angel investor Robert Behl said that big funds have been investing throughout the recession. The change he sees now is that the angels and early-stage investors are being excluded from deals as mid-range funds that have been inactive are re-entering the game.

“We're starting to see a surge of investment from these mid-range funds but they're looking for quick pops, things that can turn around rapidly,” Behl said. “They need quick hits to pump up their returns.”

Major roadblocks stand in the way of quick returns. MacQuitty said initial public offerings no longer work for biotechnology companies as a source of investment equity.

“It is impossible to overestimate how much the IPO market sucks,” MacQuitty said. “The pricing is atrocious and the aftermarket performance is worse.”

Venture capitalists also see the U.S. Food and Drug Administration as another big problem. In addition to being bureaucratic and risk-averse, MacQuitty said that the FDA doesn't know how to properly regulate things. “They can no longer answer the question 'what should I do to get regulated'.”

The extensive clinical trials the FDA wants companies to do are partly to blame for the third problem, reimbursement – or the lack of it. Getting a possible return of investment in 17 years doesn't make investors flock to small biotech companies.

The investors pointed out that the FDA is not alone to blame. According to them, some politicians believe that by impeding drug development, rapidly rising healthcare costs can somehow be reduced.

“We can complain about the FDA but in the end they're serving their Congressional masters,” MacQuitty said. “There is no amount of slowing down the process that Congress is currently going to object to, and the FDA is well aware of that.”

Venture capitalists are trying to get their message across on Capitol Hill by, for example, referring to companies – and jobs – that have moved to Europe in search of less rigid regulation.

Funding for a biotechnology startup can come in other ways, for example corporate partnerships and teaming with big pharmaceutical companies. Big Pharma is fighting a lack of innovation, declining earnings per share and rising costs of clinical trials. They are trying to get research expenses off their balance sheets by cutting their own research and externalizing it to small and innovative companies.

Shauna Farr-Jones, academic coordinator from the University of California, San Francisco, reminded the companies of a variety of government grants that are available to startups. Companies working on infectious diseases or treating issues that soldiers face have an especially good chance of getting funding without diluting their ownership. One example of such a startup is Menlo Park-based Cantimer that developed its dehydration meter with government grants.

Farr-Jones said that a startup company that receives government grants doesn't need a commercialization plan, as venture capitalists expect. They just need to address a recognized medical need. “You should be able to raise money to make yourself more interesting to an angel or a venture capitalist.”

Indeed, startups must differentiate themselves from the rest of the pack. MacQuitty said that his company gets 900–1,000 offers yearly. This year they'll proceed with nine or 10.

And that's a lot – usually the number is five.