Corporate Venture Capital – An Alternative Route To Finance?

By Suzanne Elvidge

The buzz around the biopharma industry is that the traditional venture capital (VC) companies are withdrawing from funding new pharma and biotech start-ups in favor of supporting their existing portfolio companies. Coupling this with the lack of IPOs during 2008 and 2009, this leaves a large funding void at the early-stage part of the industry.

Start-up companies are vital to the industry because they provide innovation and early-stage leads and clinical candidates for the large pharmaceutical companies, many of which are noticing their pipelines drying up as their blockbuster molecules come off patent. Most start-up companies have little or no income stream, and previously relied on traditional VCs to provide funding.

The growth of corporate VCs provides a solution to both of these issues by supporting the cash-strapped start-ups and providing the large biopharma companies with a route to access the early stage products they need so much.

“Innovation is clearly a bottleneck within large biopharma companies,” says Graeme Martin, Ph.D., president and CEO of Takeda Research Investment (TRI). “Part of the problem is that the drug discovery process is now so information-rich that the expertise and infrastructure required to mine it effectively is increasingly difficult to assemble under one roof. Academic institutions and biotech start-ups are generally much more applied in their research, bringing a focus that benefits from years of intellectual and financial investment. These academic and biotech centers of excellence provide us with important access to skills, experience, and innovation.”

Corporate vs. Traditional VC
VCs provide funding for start-up companies, generally in return for an equity stake in the company. Corporate VC differs from traditional VC in that the corporate VC generally has a strategic interest in the portfolio company, rather than just simply a financial interest. The financial return is still important, at the very least to provide a pool of money for future investments. The advantage to the portfolio companies of working with corporate VCs rather than traditional VCs is that they can provide access to pharmaceutical expertise. They also understand the process of drug development and the issues that might arise. However, issues can arise when the strategic needs of the corporate VC do not align with the financial needs of the traditional VC.

Corporate VCs are more likely to invest in early-stage companies than traditional VCs, since the early-stage companies may require additional investments, and the investment is likely to take longer to come to fruition. “Corporate VCs are generally not looking for as high returns as traditional VCs, so they are happy to accept the higher risk and longer-term involvement,” says Martin.

According to Maggie Flanagan LeFlore, Ph.D., one of the managing directors of the corporate VC arm of the AstraZeneca/MedImmune group of companies, MedImmune Ventures, “We usually invest in early-stage companies, but like most traditional VCs, we look for products that are at most 12-18 months from the clinic. We align our goals closely with those of traditional VCs, including expectations for financial return, and this gives us the opportunity to play with everyone. However, if it is the right project for us, we are prepared to invest in projects that are further from proof-of-concept, though we would balance the higher risk with the expectation of a higher reward.”

Roland Kozlowski, Ph.D., CEO, of Lectus Therapeutics, a recipient of TRI funding, says, “The involvement of a corporate VC provided early endorsement for us as a company and for our technology and a reassurance for the other investors.”

Behind The Corporate VC
The corporate VC has been a part of the industry for more than 35 years. Created in 1973, the Johnson & Johnson Development Corporation (JJDC) is one of the oldest corporate VCs in the healthcare and pharmaceuticals industry. Despite the current economic climate, healthcare and biopharma companies are still setting up new corporate VCs. For example, Merck Serono created Merck Serono Ventures, with a fund of 40 million euros, as recently as March 2009.

Most corporate VCs have been created to help large biopharma companies identify strategic opportunities to expand their businesses and provide a competitive advantage.

“Some corporate VCs are more integrated into the parent biopharma company than others, with more of a focus on strategic rather than financial,” says Will West, Ph.D., CEO, CellCentric, another recipient of TRI funding. “Even those that say the relationship is purely financial generally have at least some level of strategic involvement.”

LeFlore explains, “MedImmune set up MedImmune Ventures in 2002 to provide us with access to new technology and new product concepts, and on MedImmune’s acquisition by AstraZeneca, MedImmune Ventures expanded its focus to seek out investment opportunities for both AstraZeneca and MedImmune. We look for potential portfolio companies at investor meetings and in biotech business publications, and we get business plans directly from the companies themselves and via other traditional and corporate VCs. We see about 400 companies a year and believe that the process of reviewing new technologies, even those we don’t invest in, is an opportunity to expose the company to a wide range of innovative approaches. We expect to make four new investments a year, typically $5-10 million in the first round. We are looking for a good strategic fit with a company whose management team has a track record of success.”

Strategic Fit
Because corporate VCs are looking for companies to enhance their own position, they will seek companies with an obvious therapeutic strategic fit, explains Martin. “We also look for clear evidence that the management team can execute their business plan.”
Start-up companies have to be able to prove themselves in order to attract VC funding, whether corporate or traditional. “We were originally funded by management and SULIS [now Wyvern], a small VC group, and this gave us enough money for the preliminary studies, which then enabled us to attract an investment from TRI, following a meeting at an investor conference,” says Kozlowski. “Our technology to identify ion channel therapeutics for pain had potential to put Takeda ahead of the curve, so there was a strategic reason for TRI to invest a seven-figure amount in us. Start to finish, this took about four months.”

The Portfolio Perspective
As of June 2009, there have been no IPOs since November 2007, according to Reuters, and while these will begin again at some point in the future, this is not expected in the short term. In this case, the exit strategy for most portfolio companies will be an outright acquisition, a structured acquisition involving an up-front and milestone payments, or an option to acquire the company at a set price. Investment by a corporate VC can help tailor the start-up to acquisition by a large biopharma company or make it a more attractive partner if acquisition is not on the cards. It also raises a start-up’s profile and demonstrates validation of the business and management team, providing an early endorsement of the technology and pipeline from key biopharma companies.

“Portfolio companies do gain a lot from investment by a corporate VC, because it provides the perspective of a major biopharma company. This is useful because most start-ups are looking to large biopharma companies as customers, in the form of a licensing partner or trade sale,” says LeFlore.

Ongoing Involvement
The ongoing involvement varies from corporate VC to corporate VC and agreement to agreement, with some choosing to take a seat on the board of directors, either in a strategic or observer role, and others maintaining a more “hands-off” relationship.

“We only take an observer role on a company’s board, which allows us to participate in strategically relevant discussions, without involving us in any commercial discussions that could cause a conflict of interest,” says Martin. “It has the added bonus of providing us with networking opportunities with other nonexecutive members.” Kozlowski confirms this: “The TRI representative on our board does not see any privileged commercial information, especially about deals, so this will not affect any future collaborations.”

For an investment agreement to work long term involves commitment and negotiation from both parties. “The key to setting up an agreement is getting the terms right, especially ensuring that the agreement does not preclude relationships with other corporate VCs,” says West. “We have made a conscious decision to mitigate risk by seeking a number of funding streams and have negotiated funding that did not involve having someone on the board or giving away access to sensitive information, as we felt that could compromise future collaborations or acquisition.” Kozlowski adds, “Our agreement with TRI granted Takeda low-level rights in our technology, but we didn’t give too much away.”

The Economic Downturn And Venture Capital
Corporate VCs generally invest alongside traditional VCs as part of a syndicate, however, since 2008, this became harder as traditional VCs are pulling back from investing in early stage companies and moving towards the lower-risk late stage companies.

“Traditional VCs and finance houses definitely seem to be leaving the sector as a result of the economic downturn, leaving an investment void that will make things difficult for the industry in the short term. However, in the medium to long term, I think the outlook is bright for biotechnology companies, with corporate VCs beginning to fill the funding gap, and the industry moving more towards outsourcing more of its research,” says Kozlowski. “While there is more of a focus on it at the moment as a result of the withdrawal of some traditional VCs, corporate VC is more than just a gap-filler. It is part of the mix, and I believe it is here for the long term,” adds West.