After the 2021 public biotech market shakeup, life science investment dollars may be shifting. The past few years have seen a crowded investment market, with both veteran life science investors and new opportunistic investors getting in on the groundswell, especially in the case of IPOs.
In 2021, many of these transient investors cleared out when the bottom ﬁnally dropped out. While this investor exodus has been tough for pre-clinical and Phase I startups hoping to go public, steadfast VCs and other biotech investors have the ﬂexibility and wherewithal to weather the froth coming of the IPO market . Comparing 1Q22 to a year earlier is revealing: only nine came in the ﬁrst three months of 2022 versus 33 IPOs in 1Q21.
So, how will investors wield this new-found freedom? Some signs point to early-stage opportunities as a good destination for their dollars.
Demand for biotech IPOs still weak
One factor pushing investors away from later stage biotech is compressed exit opportunity – either through acquisition or IPO. The fervor for biotech investment carried over from 2020 drove the overvaluation of biotechs going public at all technology stages, leading to a poor post-IPO performance from 2021’s public crop. This trend has shaken conﬁdence in the ability of biotech IPOs to yield returns and has caused all except dyed-in-the wool biotech VC investors and strategics to hang back. While there
is a continued supply of biotechs at the age and stage to go public (approximately 75 companies have SEC registrations ready), there is simply not enough demand for those IPOs currently.
While companies considering an IPO do not all necessarily boast technologies in advanced clinical trials, there is certainly a correlation between technology maturity and propensity for IPO. As a result, those in late-stage clinical work with technologies closer to market may feel the pressure of a slumped IPO market more acutely than less mature ﬁrms, primarily because of their cost structure.
With the XBI still leveling out at about half its highwater mark of a year ago, investor conﬁdence in the biotech market will take time to recover. So, it may be a while before capital ﬂows back into public biotech markets to enable the consistent exit environment of last year.
Though the valuations won’t be as lofty as in 3Q21 without the “crossover” or pre-IPO investors, late-stage biotechs can nonetheless seek ﬁnancing from seasoned VCs, eager to put their money into more reasonably priced deals, and fund the signiﬁcant
C-rounds needed to support these larger, more mature biotech ﬁrms.
Late-stage acquisitions few and far between
The other exit path for late stage biotechs, acquisition by big biopharma, is showing very little activity currently. At the J.P. Morgan Healthcare Conference in January 2022, big pharma such as BMS, Novartis, Pfizer, and Roche indicated their preference for smaller, ‘bolt-on’ deals with small- to mid-size companies rather than large, capital-intensive M&A deals. Smaller deals allow big biopharma to leverage the target’s unique expertise, whereas value added from large, late-stage biotech acquisitions may be not as substantial because of acquirer overlap with the target’s skills.
Moreover, the hawkish tone of the FTC since 2021 has indicated that the coming years could see increased scrutiny on large deals. While the Pfizer completed the acquisition of Arena Pharmaceuticals, the waters of large-scale acquisitions remain untested. These factors may make the ‘exit via merger’ route harder to come by for a large share of later stage companies..
Could VCs and strategic investors shift focus upstream to earlier-stage biotech?
Given biopharma’s currently small appetite for late-stage acquisitions, the focus on earlier-stage biotech is coming from both strategic investors and life science VCs. And that’s not a bad thing, as it will avoid putting more pressure on the large number of biotechs that went public in 2021 whose shares trade below their IPO price. An investor shift toward earlier-stage, private-market opportunities where those companies remain private longer will give public biotech markets time to recover. Meanwhile, companies spending time to create real, milestone-based value, will be in a position for an exit either via industry acquisition or through a solid, facts-based IPO story.
Moreover, looking backwards to early-stage companies could help investors ﬁnd more potent contenders to face the now-crowded startup scene. The IPO enthusiasm of 2021 weakened the winnowing process for biotechs and led to an environment with too many companies, with similar, poorly differentiated technologies. Backtracking to earlier stage opportunities could help investors ﬁnd technologies with the potential to leapfrog the current generation rather than ones providing only incremental improvements.
Rising interest rates could interfere
While a new focus on earlier stage companies seems to be a natural shift, factors like current events and high inﬂation, which add uncertainty to the market, may intercede. Investors expect the Fed to push interest up rates several times over the coming months to ﬁght inﬂation, projecting interest rates six more times over the year. These higher interest rates work against longer term, riskier investments while pushing investors into safer markets. However, the magnitude of this effect on current markets is unclear as of yet.
Takeaways: Early stage biotechs could be the winners of 2022
Despite the difﬁculties of 2021, life science investors are fueled up and ready for
another round. Already in the ﬁrst quarter of 2022, VC funding reached almost $8 billion, which is higher than all of the last three quarters of 2021. Many of these funds are explicitly set for new venture creation or early stage technologies, such as Atlas Venture’s recent $450 fund geared toward generating new biotechs from existing and new creators. Other players are also making their plays in the early-stage biotech market – including corporate VC such as Fujiﬁlm, which has set up a small new fund of $60 million explicitly for early-stage companies and in modalities like cell therapy.
With the intensity of the current market downturn, factors pushing investors towards earlier stage companies are also strong. Namely, the lack of exit opportunities for later stage companies, either by IPO or acquisition, could cause capital to shuttle rapidly up pipeline. The recently churned market may yield exciting opportunities to a fresh generation of early-stage tech in 2022.