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Thursday, May 17, 2012
Special Report: June 2008
Biotech Hubba Hubba
Life science attracts venture capital in Northern California
Story by Mark Larson
Claire Pomeroy has a vision for a robust life sciences industry in Sacramento and along the Interstate 80 corridor connecting to the Bay Area.
Pomeroy, vice chancellor for human health sciences at UC Davis and dean of the School of Medicine, sees a huge potential to convert life science research into local companies producing marketable medical products.
But there’s a critical ingredient: “Venture capital must play a role in investing to make this a success.”
The region already has the other needed ingredients, she says: brainpower, public and private funding, scientists, venture capitalists and industry leaders. To move this vision forward, Pomeroy sees a need for local leaders in these arenas to consistently huddle up and talk. “All those people need to be constantly in touch in an increasingly coordinated way,” she says.
From the Bay Area’s perspective, the notion of a booming I-80 corridor seems like a stretch. Nola Masterson chairs BayBio, a South San Francisco nonprofit dedicated to the life science industry. She notes the majority of bioscience activity in Northern California sits in the Bay Area and not along the I-80 corridor. Genome and medical device companies, she says, are in Emeryville, Berkeley and Silicon Valley, where they enjoy “more [venture] money than they’ve ever had.”
Masterson says the I-80 corridor — in spots such as Vacaville — could be a biotech-manufacturing zone for companies like Genentech, because of its cheap land and an educated labor pool from which to hire.
Pomeroy concedes there’s a long road ahead to build out this vision. “Right now,” she says, “it is very much at a fledgling stage.” But on the venture side, conversations are starting to happen.
“The potential is huge,” Pomeroy says. “The I-80 corridor as an extension of the Bay Area and Silicon Valley is a very logical place to come together. It’s a potential for economic stimulus and potential to refine the definition of who we are in this region.”
UC Davis, Masterson says, is primarily a source of agriculture-related research, as opposed to drug and medical device innovations. However, biotech and life science research are gaining a higher profile. In the 2007 fiscal year, UC Davis received $532 million in research funding. Top schools benefiting from the funding were the School of Medicine with $147.68 million, followed by the College of Agriculture and Environmental Sciences with $85.4 million.
Ilan Zipkin, a partner in Palo Alto-based med-tech venture capital firm Prospect Venture Partners, says he sees the I-80 corridor’s challenges as an incubator zone for health science companies as similar to those of similar startup companies north of San Diego on Highway 101.
“Companies along 101 need to move to San Diego, the nearby biotech hub, to recruit management and [scientific] talent,” Zipkin says. “I-80 is similar. The Bay Area is such a biotech hub, locating in Davis might be difficult because of all the talent available in the Bay Area.”
The Solano Economic Development Corp. has identified more than 60 biotech companies along the I-80 corridor from San Francisco to Sacramento. Many of the companies clustered around UC Davis are based in agriculture. This is just a sliver of the nearly 1,380 biotech companies recently identified by BayBio in Northern California.
John Steuart, managing director of Claremont Creek Ventures in Oakland, says he’s seen the amount of venture capital funneled toward health science companies increase over the past five years, with most of the money going to medical device and med-tech companies. In Silicon Valley, medical devices and equipment was the third-hottest venture investment in the first quarter 2008, snagging $341 million in 29 deals, roughly 13 percent of venture invested in the region, according to the MoneyTree Report.
Hot areas for funding, Steuart says, are medical devices, which he estimates garners about 85 percent of life science venture funding, and bioinformatics, which studies how a person’s DNA can be better decoded for more effective medical treatments. That area gets about 10 to 15 percent of venture capital, Steuart estimates.
But he is bullish about the I-80 corridor as a place for health science startups, and notes the Oakland location of his venture firm keeps the area clearly in its sights.
“It’s still small in comparison to Silicon Valley,” he says. “The trend is it has a nice mix of pharmaceutical and medical device companies. The great thing about the region is that it is so close to the Silicon Valley, companies are able to access startup capital more easily than in other areas. We think there is a lot of really interesting technology out of UC Berkeley and UC Davis.”
Dinesh Patel, president and CEO of Arete Therapeutics Inc. in Hayward, has seen success attracting venture capital. In 2005, his startup secured $51 million in series-A venture funding, to develop a new treatment for hypertension.
Although funding has spiked for life sciences, Patel says, the emphasis seems to be on funding companies developing future market products rather than those aimed at current markets. “It’s very similar to the clean-tech sector,” he says, “where the real payoff may be 20 years from now.”
To speed up federal approval and time to market, he says, some drug startups develop new applications for drugs already approved. Or they may come up with ways to improve drugs already in the market.
Meanwhile, big pharmaceutical companies haven’t enjoyed notable increases in stock value in recent years, Patel says. Federal drug review has become “pretty tough,” with much more scrutiny than in past years. And finally, the big drug companies have drug patents that are expiring, Patel says, so they are losing revenue to generic drugs.
As a result, over the past three years big pharmaceuticals have been in the hunt for novel drugs to sell. And that has turned the venture capitalists’ attention to companies like Arete, which have an inside track on a novel drug for a potentially big market.
And because companies like Arete are likely to be acquired by a bigger company, venture investors don’t have to wait 10 years for a payoff. They’re likely to get rewarded in three to five years, when the startups are going through a second phase of clinical trials.
“That’s the optimum time for a big pharma company to do a [buyout or partnership] deal,” Patel says.
That trend of biotech product development and big player buyout will continue, he says, until the public markets turn around and begin valuing small to midsize biotech companies enough to fund public offerings.
In the Bay Area, Patel says, that has led to many empty buildings that once housed small, but full-tilt, biotech companies. “It saddens me to see it,” he says. “The challenge is how to reinvent that kind of energy.”
Matt Gardner, president of BayBio, says that after a peak of life science venture funding in 2007, the activity has fallen sharply so far this year.
In April, BioWorld reported first quarter totals on biotech funding nationwide. Its tally showed $479.6 million funding 33 deals, versus $1.5 billion funding 29 deals in first quarter 2007. This year’s first quarter saw a 20 percent drop in median sized deals for series-A, BioWorld found, along with a 35 percent drop in series-B and a 78 percent drop in higher rounds.
Hedge fund and institutional investors are pulling back and “sitting on the sidelines,” says Gardner, noting these days there’s more venture capital than ever. While 10 years ago there were funds with $100 million to $200 million to invest, that number is now $1 billion to $2 billion. And that has made individual investments — like Arete’s $51 million deal — a lot bigger than they used to be.
But most investments are late-stage deals, when a company’s promise to make a big payday through an acquisition by a much bigger company is within reach. Still, the less common early-stage life science venture investments are also bigger than they used to be.
Gardner notes that there’s no shortage of activity in the life sciences startup space in Northern California, where there is a new company formed every 10 to 14 days. “There hasn’t been a slowdown in new ideas [for life science products],” Gardner says. “The thirst for capital is up, and that’s creating an interesting phenomenon. Early-stage investments have been cut in half in the past five years. It’s drying up.”
One factor Gardner points to is California tax law, which is tougher on investors than similar laws in other states. Prior to 1994 in California, venture investors could carry forward net operating losses incurred by an investment for 20 years after the investment. The typical bioscience company takes 15 years to generate the revenue needed to make those tax credits achievable.
But since 1994, that loss write-off window has been 10 years, making a needed minimum 15-year tax loss carry forward all but impossible. The federal government and 28 other states allow a 20-year tax loss carry forward. That, Gardner says, has negatively affected venture capital investment patterns in California, putting it at a competitive disadvantage with other states with bioscience clusters.
“The [venture capitalists] look at that, and they realize that will make them pay more in taxes [on investments] here than other places,” Gardner says.
He’s lobbying in Sacramento to get the law changed back to a 20-year allowance. The current tax law sets up long-term problems for the life science industry in the state, he says. It will continue to decrease the number of startups that land venture capital. “Five years down the road, we’ll notice it,” says Gardner, by way of fewer products in the pipeline.
For medical device companies in Northern California, Gardner says, “there continues to be massive amounts of investment in research. Those companies are mostly under the radar.”
And the investments are producing results. Every year for the past four years there have been 200 new, approved medical devices emerging from Northern California research schools: UC Davis, Stanford, UC San Francisco and UC Berkeley.
Looking ahead, Gardner sees advancements in genetic diagnostics as creating a “brand new industry” in California over the next five to 10 years. “The amount of capital to move this forward is growing, rather than shrinking,” he says.
But Northern California has so many life science products in the pipeline today, Gardner says, that they will require an estimated $50 billion to $100 billion to advance, which remains a problem.
Despite those industry challenges to bioscience development in the state, UC Davis’ Pomeroy says the industry can take root in flourish in Sacramento and the I-80 corridor.
She says someday it can have a national identity for bioscience the way the Bay Area, Seattle, San Diego and other markets across the country do. “It can happen,” she says. “We’re at that critical defining moment.”
