Biotech notches another $2B VC quarter, but can it last?

Biotech venture capital investments remain on pace for a record year after racking up another $2 billion in the third quarter, but some current shakiness in the public markets could change the outlook for early-stage drug developers looking to fill their coffers in the future.

The industry's third-quarter haul came from 121 total deals, according to the latest MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association, based on data from Thomson Reuters. The cash and deal tallies stayed about flat compared with the second quarter, according to the report, but the repeat sum brings 2015's biotech VC haul to $5.8 billion, on track to well exceed last year's record $6 billion.

But the climate has shifted since the third quarter, with the compounding forces of drug pricing scrutiny and investor skittishness dragging down the valuations of publicly traded biotechs. And softness on Wall Street has contributed to some underperforming IPOs, reversing a now years-long hot streak for drug developers going public.

Canaan Partners' Wende Hutton

That's a trend that could eventually impact how well early-stage biotech companies can rally VCs, Canaan Partners' Wende Hutton said, as the recent wide-open IPO window has helped bring more and more investors to the table amid the industry's recent boom.

If things stay as they are, the first domino to fall will likely be so-called mezzanine rounds, she said, in which investors pile in to finance a biotech in the run-up to its planned IPO. Such deals have become ever more popular, especially with non-traditional backers, because the cheery reception for biotech on Wall Street had long promised a quick--and often huge--return on investment. If the public markets continue to sour on the industry, massive crossover financings may become a thing of the past, Hutton said.

And the possible departure of investor groups that are relatively new to biotech could dampen enthusiasm for the record-breaking Series A's 2015 has seen. Earlier this year, Denali Therapeutics emerged with a $217 million round with big ambitions of building a whole pipeline of first-in-class therapies, and Stemcentrx came out of stealth with a $250 million fundraise that gave it a reported $5 billion valuation. Deals like that will be harder to put together if going public becomes a less likely option, Hutton said, and nontraditional biotech backers--like the Alaska Permanent Fund and billionaire Peter Thiel--are often the first to head for the exit when things start to go south.

But what hasn't changed is Big Pharma's appetite for M&A, she said. The world's largest drugmakers still have big holes in their pipelines and bigger billfolds with which to fill them, and Canaan, like many well-heeled VCs, believes the the demand for new projects of clinical merit is unlikely to waver.

In the meantime, Hutton said Canaan still remembers well the lessons of 2008, when money all but dried up in biotech and success depended on austerity. Like most VCs that survived the downturn, Canaan learned the virtue of putting together lean, focused companies with clear goals and milestones, she said. And those principles apply in any funding climate.

"Management teams and venture syndicates are much more focused on a capital-efficient model, where instead of building out a full management team and hiring an employee in every functional area, you offload maybe toxicology outside and keeping a permanent team that's very high-quality and lean and using a lot of outside resources to advance a drug candidate," Hutton said.

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