Corporate Venture Funding Expected to Play Larger Role in Supporting Diagnostics Innovation

With healthy balance sheets and cash to deploy to expand access to innovation, corporate venture arms are becoming an increasingly sizable portion of the venture capital world. While the technology sector has been highly visible with active venture arms such as Google Ventures and Intel Capital, health-related corporate venture has been stepping up its presence in biotech over the past several years and is expected to increasingly invest in diagnostic startups in the coming years. Corporate venture capital stepped into the life sciences to fill a void left a few years ago as traditional venture capital firms began to shy away from early-stage startups. In a report titled “Strong Momentum in Healthcare: Trends in Mergers and Acquisitions Dollars,” Silicon Valley Bank (SVB) highlights this void. Dating back to 2002, venture-backed device and biotech companies represent about a quarter of all venture dollars invested on a yearly basis. However, the report explains that that pace of investment (roughly $6.6 billion a year) is not sustainable given both the decline in venture capital fund-raising overall and a potential decline in the percentage of total venture dollars allocated to the health care sector. “We believe that dollars invested into health care venture-backed companies will come down to the $5 billion to $5.5 billion level in the next few years, leading to a smaller percentage of overall venture investment into health care—likely 18 percent to 20 percent of total venture investment,” writes Jonathan Norris, managing director of SVB, in the report. Over the past few years, investment in health care-related companies has mostly been “follow-on activity” from older funds supporting existing portfolio companies, often in later stages of development with the need for additional time and capital to achieve clinical or commercial milestones. According to the SVB report, for biotech companies there was a decline in the number of companies raising at least $2 million in Series A funding—from 66 companies raising a total of $915 million in 2005 to 47 companies raising $605 million in 2012. Device companies (which includes diagnostics companies in the report) similarly experienced a decline in Series A financing from 60 companies raising $403 million in 2005 to 25 companies raising $155 million in 2012. This decline in venture firms’ funding of early-stage companies has been partially offset by corporate venture. According to CB Insights, over one-third of the most active corporate venture capital arms are health care-focused, including the venture arms of Novartis, GlaxoSmithKline, Merck, Johnson & Johnson, and Kaiser Permanente. SVB estimates that corporate venture capital accounts for 15 percent to 20 percent of all investments in health care venture-backed companies, although the funds have not invested equally across the biotech and device industries. “If you look at big biotech companies, the Street wants a pipeline of products from preclinical to phase 2. For a strong pipeline they turn to partnerships and early-stage acquisitions,” Norris tells DTET. “In biotech 40 percent to 45 percent of V.C.-backed company exits are in preclinical or phase 1.” So three years ago, as venture capital firms began to focus on later-stage companies, corporate venture arms began to step in—filling the funding void and ensuring continued access to early biotech innovation, thereby plugging the “innovation gap.” One in three venture-backed biotech companies has a corporate investor, some of which are strategically focused while some are strictly financially driven, SVB found. But on the device side of the business, the picture is very different. Because device company exits aren’t occurring until after U.S. Food and Drug Administration approval, companies have figured out the reimbursement strategy and really have traction, Norris says. Big device companies have “dragged their feet a bit and held back on early-stage acquisitions,” thus propagating a cycle in which early-stage device companies are finding it even more challenging to raise early-round funding since their exits are deferred longer than their biotech counterparts’. From 2005 to 2013 there was an increase in corporate investments in venture-backed biotech companies from 9 percent to 30 percent, while device companies saw a decrease over the same period of time. “This is really a little shortsighted [on the part of big device companies] because they can only grow so much through geographical expansion. At some point they need new products . . . and if nobody fills the [funding] gap, new companies will never get there,” says Norris. “We believe that device acquirers are aware of the innovation gap that has been created in their world, and we predict over the next few years that the big players will step up their activity in the innovation economy through early investment, earlier mergers and acquisitions (M&A), and unique licensing/option deals that will look similar to corporate pharma and biotech activity today,” concludes Norris in the report. While the news of declining investments may be construed as negative news, Norris says in the long run the trend may be in the best interest of the industry. “Companies receiving Series A investment today are poised to be a very attractive crop of companies . . . as these companies will have overcome a very high hurdle for investment,” Norris says. “Fewer overall early-stage, venture-backed device companies will create a scarcity of innovative technologies for big markets that should drive better and hopefully earlier M&A, as acquirers continue to reduce research and development and look to venture-backed companies to fill the Street’s requirement for innovation.” Takeaway: With a growing scarcity of investment funds for early-stage diagnostic companies, corporate venture arms are expected to step in and partially fill the gap, as has been the case in the biotech industry over the past several years. However, with limited capital, a smaller number of companies will be created in the coming years, possibly driving higher valuations.