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Risky Business

Biotech is an industry with great promise — and great risk. Reaping the benefits of a promising new drug while sidestepping the quicksand of expensive, super-sized failures is no easy feat. In recent years, with a string of high-profile, late-stage drug failures, many venture capitalists jumped ship for safer waters.

No one understands this better than HealthCap, a family of multi-stage venture capital funds, investing globally in life sciences. With committed capital exceeding € 900 million, HealthCap is one of the largest specialized providers of venture capital within life sciences in Europe, based in Sweden and Switzerland. The first five funds have financed 91 companies. Approximately 30 of the companies were startups and several have successfully completed their Initial Public Offerings.

High-profile failures

But success doesn’t come to everyone, as the headlines for two Swedish companies testified this past spring and summer. In May, Diamyd Medical’s vaccine for diabetes failed in a European phase III trial. The vaccine represented four-fifths of the group’s market capitalization (more than $450 million). In August, Active Biotech’s Laquinimod, for treatment of muscular sclerosis (MS), failed to meets its primary endpoint of reducing relapses in MS patients in phase III, despite showing great promise just a few months earlier.
These high-profile failures have an impact, says HealthCap founding partner Björn Odlander, but they don’t tell the whole story. “We have had a decade behind us where many investors viewed the risk in biotech as too high and avoided the space. But in this decade, a lot of progress has been made with commercial impact, and those investors active in the field have been rewarded.”
Such confidence is sorely needed. According to Ernst & Young, the R&D investment by the biotechnology industry declined by over 20% in 2010. While the number of alliances between small biotech and big pharma increased, the trend was for milestone payments. The market conditions for start-ups to raise funds remain daunting.

Risk appetite varies over time; investment tends to be cyclical, with interest rising and waning when a particular sector shows value. Other industries are not without risk, but it is “more of an incremental commercial risk,” explains Odlander, rather than the all-or-nothing risk faced by many biotech firms.


We try to avoid very early biological risk

“In other industries, you bring out a new technology based on an already quite proven technology. It is possible to do this in biotech as well, but you need to have a certain skill set to control the risk,” he adds. “Of course, there is an inherent biological risk that you cannot totally avoid and therefore we try to avoid very early biological risk. Before we invest, we want proof of concept that this has a great chance to work. We are quite choosy about which companies we invest in based on this criteria.”
Of al the tools HealthCap employs to mitigate the risk associated with biotech, diversification is key.
“It’s not wrong to take the ‘big bets,’ but you need to diversify to minimize the risk,” says Odlander. “You can also control risk by avoiding areas where it is difficult to show efficacy, or the more speculative types of development. If a company embarks on product development on a recently developed biology where the implications are not fully understood, it is exposed to a higher level of risk than a company developing the next-generation product in a field already well understood.”
It’s also important to know your stuff, he adds. “The risks associated with biotech are possible to mitigate to some extent but you need to know what you’re doing; otherwise, you expose yourself to a random outcome that is uncontrollable. This is an area where your knowledge base has great impact on the outcome.
“The more we learn the more we can control risk,” he continues. “Modern biology, with a better understanding of underlying causes of disease, and the advent of personalized medicine, enables us to find more targeted treatments with better efficacy, thereby avoiding some of the random risks in biotech.”

It would be unfortunate if high-profile failures overshadowed the important work of many biotech firms, he adds.

“The increased understanding of biology allows for development of specific and very effective therapies which obviously bring value to patients, to society and to payors who can actually save money with more modern and efficient therapy and avoid other cost components like hospitalization, etc. There are strong reasons to invest in biotech.”

Still, Odlander doesn’t predict a major upswing in the near term. “I don’t think we will see a huge return to biotech at a time when Greece might blow up the next day. A big financial crisis won’t encourage investors to look at biotech at this very moment. But where there are proven commercial models, those companies represent safe havens at times of financial turmoil. Companies with proven products, improving financial situations based on product sales, and a successful track record in product development, might benefit from a situation where risks in other industrial sectors might be more apparent.”
In the economic downturn, industries that are cyclical are more vulnerable, and that’s good news for pharma and biotech, he points out.
“People get sick whether or not the economy is booming or boosting, so from that perspective, heath care remains a very attractive sector.”