Venture Capital and Laboratories: A Lingering Question Mark

Despite the vastness of the health care industry, the laboratory sector is one business branch with minimal leverage. Despite its ubiquity - what patient hasn't undergone a lab test? - it still only counts for about 2 percent of total health care spend. As a result, the lack of leverage has exposed the lab to payment cuts other segments have not had to experience. And it has also made it a little less attractive for firms with deep pockets to wade into the market. One of the most notable illustrations of this was the $250 million Warburg Pincus invested in Regional Diagnostic Laboratories to acquire properties. Primarily because of the business climate, the company has not executed a single deal to date. The company's website says it is being redesigned. There are some signs that may be changing. At the close of 2014 and early into this month, there were four significant infusions of capital into esoteric labs. None of the deals were particularly large on their own, but it may be indicating a loosening up of venture capital going into the lab market. However, there are some provisos: The recent capitalizations were mostly to already existing labs that offer products, as opposed to startup firms. And in some of the instances the labs took the private equity money in lieu of making public stock offerings. The biggest deal of the three involved California-based CardioDx, which develops tests focused on detecting cardiac anomalies. It raised $35 million from the Canadian investment firm Alberta Investment Management Corporation, or AIMCo. The proceeds will be used to better promote its primary test, the Corus CAD, which helps detect coronary artery disease. The company recently performed its 100,000th test, but given the pathology of heart disease in the United States, has barely penetrated its potential market. It had previously raised $21 million earlier in the year from a variety of funders. The investments apparently took CardioDx onto a different course. Less than a week after receiving the funding, the company withdrew its plan to make an initial public offering that would have raised as much as $92 million. According to its December 23 filing with the Securities and Exchange Commission, "the terms currently obtainable in the public marketplace are not sufficiently attractive to the registrant to warrant proceeding with the public offering." A spokesperson for CardioDx did not respond to a request seeking comment. The second-largest transaction was the only one that included a startup firm. Sera Prognostics, a Salt Lake City-based lab, raised $20 million in second-round financing to develop prenatal tests for conditions such as pre-term births and preeclampsia. European-based Chione, Ltd. led the round. Previous investors such as Investors Domain Associates, InterWest Partners and Catalyst Health Ventures, also participated. era is currently conducting clinical trials involving more than 5,500 patients. Vermillion, an Austin, Texas-based laboratory that focuses on women's health and gynecologic diseases, closed a $10.5 million investment from a couple of funds, Oracle Investment Management, Birchview Fund LLC and several of the company's directors. The proceeds will be used for working capital and general purposes. Unlike CardioDx, Vermillion is publicly-traded, and it is struggling. For the third quarter ending September 30, it reported a loss of $5.6 million on revenue of $323,000. In the year-ago quarter, it lost $2.3 million on revenue of $330,000. The buy-in also includes an option to purchase another $8.3 million in equity. "We are pleased with the success of this capital raise. It will provide the funds necessary to propel our commercial transition," said Vermillion Chief Executive Officer James LaFrance in a statement. Simultaneously, the company suspended its at-the-market offering of additional stock. A Vermillion spokesperson did not respond to a request seeking comment. The third lab that received funding, Massachusetts-based Interleukin Genetics, raised $5 million from New Enterprise Associates and Bay City Capital. The company also secured $5 million in debt financing from Horizon Technology Finance Corporation. Interleukin intends to use the proceeds to continue promoting its oral health assays. An official with New Enterprise Associates did not respond to a request seeking comment. Tight-Lipped Indeed, it was difficult to locate anybody with venture capital experience who was willing to discuss the current trending in private equity in the laboratory sector. The overall trend in terms of numbers has been uneven at best. For the third quarter of 2014, the most recent data available, there were only eight deals consummated, according to the MoneyTree Report, a list of such transactions compiled by PricewaterhouseCoopers and the National Venture Capital Association. They ranged in size from the $21 million CardioDx raised to just around $1 million. However, the second quarter of 2014 was a different story. The sector (which also included medical devices for categorization purposes) reached $649 million, up 8 percent from the second quarter of 2013. Deals included Proteus Digital Health raising $120 million from a variety of individual investors, and Integrated Diagnostics, which raised nearly $32 million. Overall, biotech and medical devices are among of the hottest areas of venture capital - according to the MoneyTree Report, the two areas combined represented 18 percent of all the money that flowed into companies through the first nine months of 2014. However, published reports say that many firms are still skittish about investing in diagnostics companies. That's primarily because of uncertainty in reimbursement - think the sequester - the huge cut in the technical component of CPT 88305 for pathology services and the ongoing decision-making among both governmental and private payers as to how molecular diagnostics will be reimbursed. Bruce Booth, a partner in Atlas Venture, remarked on his blog that "venture-backed diagnostics have been a painful sub-sector to invest in." Among the reasons: Diagnostics are no less risky than the pharmaceutical sector, which requires a product that actually delivers and regulatory approval. Meanwhile, the exit point for diagnostics is usually commercialization - a viable product. "There are a number of solid private companies with launched Dx products that have consumed (more than) $100 million in equity capital: CardioDx, XDx, Tethys, Crescendo, to name a few. These will need to be very large exits to generate a venture return." Whether any of the venture capital firms have a big exit this year - or head for the exits instead - remains to be seen.

Lab Name	Sum Invested	Investor(s)
Proteus Digital Health	$120 Million	Undisclosed
Precision Therapeutic	$60 Million	HealthCare Royalty Partner
CardioDx	$56 Million	AIMCo., Artiman Ventures LP, Asset Management Ventures, Longitude Capital Management
Integrated Diagnostics*	$31.7 Million	Baird Capital, InterWest Partner
Guardant Health	$31.5 Million	Khosla Ventures, Sequoia Capital, Pejman Mar Venture
Acutus Medical	$26.2 Million	Undisclosed
Sera Prognostics**	$20 Million	Chione, Ltd., Investors Domain Associates, InterWest Partners, Catalyst Health Venture
Daktari Diagnostic	$13 Million	Global Healthcare Innovation Fund, Norwich Ventures, Partners Innovation Fund
Vermillion	$10.5 Million	Oracle Investment Management, Birchview Fund LLC
Interleukin Genetic	$10 Million*	New Enterprise Associates, Bay City Capital
* Included debt financing
** Announced in 2015
Sources: MoneyTree Report, FierceDiagnostic

  Takeaway: The prognosis for venture capital into lab ventures continues to be unclear.