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 academic ideas, Wende Hutton of Canaan Partners is thinking about the other end of the pipeline: digital technology that helps drug or device companies improve the chances that their products will be prescribed by doctors and reimbursed by insurance companies.

Canaan is not primarily a digital health investor. It only has four companies in its current portfolio, but when I spoke to Hutton toward the end of the first full day of J.P. Morgan last week, she said digital health was “the theme du jour….in four-for-four meetings” that day. She had just met with the president of the American Medical Association and three pharma companies that all have digital health initiatives.

In an interview last fall marking the close of Canaan’s new fund, Hutton and tech partner Dan Ciporin outlined the firm’s desire to dive deeper into digital health.

Hutton filled in some color last week with themes that are top of mind in the industry.

One is the opportunity to help physicians sort signal from noise when treating a patient. Hutton wants to see a system that gives physicians an integrated look at a patient’s medical record, lab results, genes of interest, potential drug-drug interaction red flags, and more, “in a fashion that drives clinical practice in a way that’s not more alerts and burden and emails to open. I don’t see any system that has sorted that out. This convergence needs to be less work for the physician.”

Another opportunity for investment is in what she calls “Switzerland” data companies that help rival device or drug makers pool data. Sharing is ultimately in those companies’ best interests, she said, because their own smaller sets of drug and patient data won’t adequately prove their products’ worth. That’s crucial because health plans and their middlemen like Express Scripts are on the hunt for ways to spend less on drugs. Express Scripts has launched a price war in hepatitis C treatments, and whose CEO said last week that certain cancer immunotherapy treatments and a new class of cholesterol reducers would be next.

To avoid their drugs being discounted—or excluded entirely from big swaths of patients—companies will have to use bigger data sets and “be part of a bigger ecosystem,” said Hutton.

One of Canaan’s investments is a company developing a smoking-cessation device that delivers nicotine through the skin when algorithms predict cravings are about to hit. It also connects wirelessly to “coaches,” a touchstone of many digital health apps that use personal connections to guide behavior.

I asked Hutton if apps that deliver drugs—or through behavior modification aim to prevent the need for drugs—need to submit to clinical testing to show they actually work. “It’s going to happen first in areas where the background clinical literature is already in existence, where you’re providing the toolsets to put the patient at the center for better compliance, then provide the physician with data, downloads, and reports when the patient walks in,” she said. “We’re not talking about running clinical trials.”

A therapeutic intervention that doesn’t require the cost of clinical trials? That’s the risk-avoidance jackpot.

Canaan invests in drugs, too—anything from new platform technologies to drugs sitting idle at pharma companies that could use a new home. But many of what it calls early stage investments are relatively more conservative. These include new companies spun out from more established platforms, as Canaan has done in North Carolina with nanoparticle design firm Liquidia Technologies and two of its satellite companies; or products that have been around the block a few times—such as the wound healing product Dermagraft or the Pfizer programs Canaan helped pull off the shelf to create Durata Therapeutics (antibiotics) and Labrys Biologics (a migraine drug). Durata (NASDAQ: DRTX) went public in 2012; Labrys was acquired in 2014 by Teva Pharmaceutical Industries (NYSE: TEVA).

“We do look for opportunities where we can take forward clinical assets with a lot of data or intellectual property in back of [them],” Hutton told me last fall. “When a lot of risk is reduced, it’s a core part of what appeals to us.”

No biotech VC has a portfolio full of nothing but bigfoots, of course. But in these boom times, the sound of those bigfoots can drown out everything else. It’s good to remember other, less risky roads traveled.