VCs Get on a Health Kick

In the wake of the dot-com downturn, investors are betting big on life-sciences startups, from biotechs to medical devices

By Julie Fields Business Week Online

No one has to tell Paul Lavoie how tough the venture-capital trail can be. For 18 months, the 53-year-old entrepreneur pitched his fledgling medical-device company, Xoft microTube, to two-dozen VC firms and 40 other investor groups. "They told us we were either too early or they didn’t have the money or — and this was my favorite line — ‘We don’t believe in the market,’" recalls Lavoie, who scraped together $500,000 in loans to hold together his 16-person staff.

This fall, Lavoie finally hit pay dirt: $13 million in venture capital — enough to produce and begin testing the Santa Clara (Calif.) company’s main product, a tiny X-ray catheter aimed at preventing arteries from closing after balloon angioplasty.

There’s no question the hunt for money is taxing. But for entrepreneurs in the life-sciences industry — a broad category including biotech, medical devices, pharmaceuticals and other health-care services — investor interest has risen markedly from a year ago. Attracted by technological advances and repelled by the dot-com downturn, venture capitalists are pouring money into life-sciences companies after avoiding the sector for much of the late 1990s.

While still just a fraction of all VC funding, investments in health-related companies soared to $1.7 billion in the third quarter of 2000 — almost double that of a year ago and a 38% jump over the second quarter, according to a PricewaterhouseCoopers Money Tree survey released Nov. 13.

So where, exactly, is all the cash going? Biotech and medical-device companies captured the lion’s share of third-quarter cash, taking in $708.2 million and $530.5 million, respectively. The two sectors also saw the biggest increases over the second quarter — 67% for biotech and 58% for medical devices, by PWC’s measure. Those increases are due, in part, to a greater number of later-stage investments in companies waiting for better market conditions before going public. In the third quarter, for instance, nine biotech companies received funding rounds over $30 million, compared with just three in the second quarter.

ILL-INFORMED INVESTORS? What’s driving the surge in private equity funding? The same thing that sent biotech stocks soaring earlier this year: excitement over the mapping of human DNA and the promise that research holds. While profits from the so-called genomics revolution remain elusive, VCs are nonetheless giddy at the prospect of gene-based drugs and therapies that may someday regenerate tissue and cure life-threatening diseases. "We’re really entering a golden decade," gushes Kurt C. Wheeler, a general partner with MPM Capital, which has $830 million under management, all of it invested in biotech and health-related ventures. "We’re going to see tremendous discoveries and tremendous value built for investors."

Yet for all the true believers, some VCs are also chasing the latest sector to get hot after the fall of the dot-coms. "A lot of it is money that’s not particularly informed," says Brenda Gavin, a general partner with SR One, SmithKline Beecham’s venture-capital arm. Murray Alter, a tax specialist with PricewaterhouseCoopers’ venture-capital and high-tech practice, agrees. While it’s hard to pinpoint just how much money is being redirected from e-commerce companies that didn’t pan out, Alter says, "that money has got to find a home where the greatest perceived opportunities are."

Still, investors shouldn’t expect an easy ride. Such ventures remain "incredibly risky," says Wheeler, a former life-sciences entrepreneur himself. "You can lose a lot of money — or you can make a lot of money, depending on the patents," he adds.

While the market for biotech IPOs has improved over the past year, there’s no guarantee of a quick exit strategy. And many of the venture-backed companies, like Lavoie’s Xoft microTube, haven’t even brought a product to market yet. Other potential problems: A company might fail to get Food & Drug Administration approval for a new drug or therapy. Even worse, a drug could be recalled, or a treatment banned, because of dangerous side effects.

REGULATORY RUMBLINGS. There’s also public opinion to consider. The spread of genetically modified crops has sparked protests in Europe and the U.S. And many people remain skittish about technologies such as cloning and the use of stem cells in research. Those attitudes can strike a chord with elected leaders, as happened in March, when President Clinton and British Prime Minister Tony Blair issued a joint statement on genetic patents. Investors perceived a threat to genomics companies and started a furious sell-off of biotech stocks.

Despite the risks, VCs insist they have good reasons to bet on health-related startups these days — the biggest being the enormous leaps made in the understanding of human genes, proteins, and antibodies. Those advances are leading to new drugs and therapies. The biotech pipeline now has over 280 products being tested in clinical trials, according to a recent industry report by Ernst & Young. "A lot of these companies are finally being rewarded for a lot of years of hard work" when private equity funding was far more scarce, says Gavin. Still, for entrepreneurs, getting the cash is only the beginning.

By Julie Fields
Edited by Robin J. Phillips

http://www.businessweek.com/smallbiz/content/nov2000/sb20001121_026.htm