In the Jiu-Jitsu Match of Biotech Risk, a Reminder of Other Paths

Xconomy National — 

Risk makes for great headlines. I’m guilty as charged. My first column for Xconomy questioned whether biotech venture capitalists were losing relevance, running away from risk in an inherently risky business.

Heading full steam into the new year, there will be plenty of headlines and stories from us and our peers about the brave and the few taking big risks on bold ideas. But only a handful of venture firms can be catalysts of what I like to call “bigfoot” companies: those crazy bets in the tens, even hundreds of millions of dollars on cutting-edge ideas like Moderna Therapeutics’ scheme to inject synthetic RNA into patients so that they produce their own therapeutic proteins.

So let’s emerge from the la-la-land of J.P. Morgan conference week with a reality check. Plenty of other firms are doing just fine, thanks, acknowledging risk and, like jiu-jitsu practitioners, bending and flexing with it. I had conversations with two well-known investors who are staying away from the temptation of the bigfoot and carving their own path through biotech’s ever-present thicket of risk.

The first is Avalon Ventures of San Diego. The second is Canaan Partners of Westport, Connecticut, with a big San Francisco Bay Area biotech presence.

Both have been around for decades and are investing from their tenth funds. Both are diversified, which means they like having tech and biotech under one roof sharing a pot of cash. (That’s not always the case, as the Lightstone Venture and Atlas Venture folks can attest.)

Let’s start with Avalon first.

Most biotech VCs try to whittle down risk by investing in later-stage assets that have made it at least part way through the clinical trial gauntlet. Avalon has gone in the opposite direction. Half of its biotech allotment is dedicated to finding new ideas bubbling out of research labs—most often “an academic with a paper and a patent,” said Jay Lichter, Avalon’s top biotech partner—and forming tiny companies around them. That’s usually about as risky as it gets in biotech.

But Avalon has given the international drug firm GlaxoSmithKline (NYSE: GSK) an option to buy those companies when they choose a clinical candidate—that is, when the company has nominated a drug to move forward as its main product. It’s a very early milestone, and it fetches modest returns. IPOs are definitely not part of the plan, which sounds downright radical after an unprecedented two-year run that doesn’t seem ready to abate.

But that’s all Avalon needs, because GSK is pitching in a lot of cash and resources—like the massive “screens” to help find potential drugs to hit the biological targets in the research Avalon has scouted.

GSK is collaborating with Avalon on as many as 10 of these projects. Avalon is putting in about $3 million per program, and GSK the rest.

“It takes $15 million to do a drug discovery program to clinical candidate,” said Lichter. “If I did all that in venture dollars I’d need [to sell the program for] $45 million upfront to get a 3x return. A clinical candidate is not worth $45 million ever, I don’t think.”

Is it working? Beyond Lichter’s assurances, there is no hard evidence. GSK has not exercised any options to acquire yet, but it’s early. Only three of the collaborative projects have been unveiled: Silarus Therapeutics, Thyritope Biosciences, and Sitari Pharmaceuticals.

Another good sign would be a new fund, Avalon’s eleventh, which Lichter said is under way. (The tenth closed in 2012 with $200 million in commitments, and it’s being invested roughly half in tech, half in biotech.) If the new one closes this year, as Lichter expects, it should mean that LPs aren’t revolting against the biotech strategy.

Part of the pitch for the new fund is that Avalon wants to do the risk-sharing arrangement again, either with GSK or another pharma. “Even if GSK doesn’t want to do it again I would imagine we’d find someone else just as happy to step into those shoes and get 10 new shots on goal,” he said.

Avalon is doing more conventional biotech investments, too—if a company exploring applications made possible by expanding the basic information used in DNA code can be considered conventional.

But the relative modesty of the “build to buy” philosophy of Avalon’s GSK collaboration generally applies to the rest of its biotech plan, too.

When asked about the early stage investors who often throw $30 million or more into a Series A round, Lichter replied, “We’re rarely competing for deals with them, and if they want something I’m looking at, I step away. They can have it. I don’t need it. There are plenty of good deals out there.”

While Lichter pays heed to the science journals for the latest … Next Page »

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