Nooman_Haque_2015_editThe latest ‘Trends in Healthcare Investments and Exits’ report from Silicon Valley Bank was recently published. Following last year’s guest blogs, Nooman Haque, Director of Life Sciences & Healthcare, Silicon Valley Bank UK, once again provides us with an overview of the key data, with a focus on the UK.

Recently, Silicon Valley Bank produced a ‘Trends in Healthcare Investments and Exits’ report that exposed fascinating findings – you can read the full report here. In this short blog, I’ll focus on the aspects most relevant for the UK market along with other key data for the healthcare sector.

Investment and fundraising boosted by crossovers

Both of these variables showed significant increases over the year. Investments in 2014 stood at $8.6bn, up 30% on 2013, and at the highest level since 2008. Biopharma attracted over two-thirds of this amount. On the back of buoyant M&A and IPO market activity, venture firms increased fundraising by a staggering 56% to stand at just over $6bn.

Last year, we predicted that investment activity would fall because non-VC investors – or crossovers – would not keep pace with the level of company creation. Yet crossovers, boosted by strong returns, continued to have a healthy appetite. They have been attracted to the sector partly because of the macro environment and there are signs that Europe’s big institutional investors are realising that to deliver promised returns they must also bet on the sector. Even though Woodford Investment Management’s fundraise for its Patient Capital Trust inflows into a number of venture funds, there is still a significant gap in dollars demanded by the sector versus dollars supplied.

Companies targeted by crossovers enjoy superior valuations and post-IPO performance

The 15 most active crossover investors made 57 unique investments over 2013 to 2014 and as of February 2015, 25 of those had achieved an exit – creating an exceptional exit rate of 44% within two years.

The 25 companies that achieved an exit enjoyed pre-money valuations that were almost 52% higher than their peers and raised around 48% more. In addition, 6 months following their IPO, these companies had a median value 20% higher than their IPO price and their average valuation was 70% higher than their peers.

Whilst the stats don’t reveal cause and effect relationships, talking to investors and companies it’s clear there’s a pattern whereby genuinely innovative science is backed by strong VC’s who in turn are able to count on support from strong crossover investors. The very tentative emergence of a crossover sector in the UK and very selective US investors may boost required returns critical to fundraising.

UK enjoys highest ex-US investment activity from US investors

US VC’s concentrated their biopharma investments at home with Massachusetts accounting for just over 40 deals and Northern and Southern California having 35 and 25 respectively. Next in line was the UK with 10 investments, followed by Switzerland with 7, and France and Germany each with 6.

The UK is the fourth most important destination for US investors because of a traditionally strong science base and the desire of venture firms to leverage offshore cash held by big pharma companies for M&A and partnerships.

Innovation is key to attracting capital

A statement from BioCentury’s European Iceberg survey underlines the point: “companies at phase II that had first and second in class molecules were able to raise on average 3 times as much money; achieving 10 times as much upfront in partner deals and achieving 5 times as much in M&A upfronts.”

Sensible valuations at IPO?

Despite 2014 easily exceeding the previous year for IPO’s, median pre-money valuations continue to trend down at $141mn compared to $174mn in 2013. This is in part driven by the proportionately large increase in pre-clinical and phase I companies listing, with statistics showing that 9 pre-clinical companies listed in 2014 compared to 1 in each of 2012 and 2013. It is also likely a factor of the quality of companies coming out as it is clear that the sustained secular demand for biotech equities from generalists is allowing companies of lower quality to go out.  Even still, the market is discerning – something that may be hard to believe as the index creeps ever higher.

Capital efficiency is key to exit success

The most surprising conclusion, and noted by Bruce Booth in his own blog, is the importance of capital efficiency. SVB’s research showed an inverse relationship between equity dollars invested and exit multiples achieved. Top quartile exits, an 8x minimum, had just over a third of the capital invested of the next quartile.

It’s clear from this that, unless a company is building to access a market directly, large investments do not translate into big exits. Companies in the top quartile were judicious in their use of partnerships, grants and other non-dilutive funding including debt.

What does this mean for the UK?

Funding continues to be challenging in the UK, especially for phase II companies. However, from a simple demand and supply analysis, one might conclude that there’s too much biotech for the money available.
This is a controversial conclusion, but one should consider that genuine innovation is the most important driver of a successful investments and exits. Might it be better to allocate scarce funds towards those truly outstanding companies who could use the extra cash and leverage other sources of funding – not to create mega A rounds –  but to be securely funded through key development stages and to have sufficient firepower to open up additional value-adding pathways to innovation. These successful companies in turn are likely to provide their investors with better returns and this leads to a much improved fundraising environment.

Consider also that although the US is the undoubted leader as a source of investment, highly reputed US VC’s do look to the UK and when they do they’re looking for highly innovative companies. The UK’s strong position in NGS and Synthetic biology are a case in point and noted by Jon as well.

There’s a balance of course. Innovation requires a diversity of ideas to compete in the marketplace and a degree of collaboration between them. We are thankfully far from the days of drip-feeding a large number of very early-stage companies. However, the funding environment will not change dramatically in the short-term and we might require this strategy to help the UK move away from being considered an early-stage biotech factory and towards creating truly independent companies. Large recent fundraisings like Kymab, CellMedica and Silence Therapeutics perhaps point the way.

Click on the links to view Nooman’s previous BIA guest blogs, written following the release of the 2014 report: Part One and Part Two